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Beware of Sharp Moves in Tiny Stocks

NEW YORK ( TheStreet) -- Two stocks on the move lately -- Revolutionary Lighting (RVLT - Get Report) and Superconductor Technologies (SCON - Get Report) -- show the risks that low-capitalization stocks face because of their smaller floats.

Revolutionary Lighting is a micro-cap in the light-emitting diode (LED) business. It's a company with a low stock float, a clean balance sheet and capable upper-level management. It recently received a round of financing from Aston Capital. Those funds were used to pay off debt, and structure the firm to move forward with a capital sheet that could dedicate earnings to growth of the business.

Revolutionary Lighting is in a similar position to Superconductor Technologies. A leader in the development and production of high-temperature superconducting materials, Superconductor Tech soared on bullish news that it had received purchase orders from multiple customers. Shares closed at $4.15 Monday, up 15 cents.

To develop the capabilities to deliver the orders, Superconductor Technologies had to raise capital. It chose to do an equity offering rather than borrow money. As a result of the dilution of the existing shares, basic supply and demand here, the price fell by 26%.

Revolutionary Lighting could be ready to do the same.

In recent market action, Revolutionary Lightning has soared from $0.90 to a closing price of $4.01 Monday. There were several factors contributing to the surge:
  • Equity financing was secured in early March;
  • Management issued a very bullish outlook in early April; and
  • It received positive press from TheStreet, Seeking Alpha and other media over this period.

Actions such as these will often times take the price of a micro-cap (market cap $300.2 million) such as Revolutionary Lighting much higher in a short period of time. The chart below shows how Revolutionary Lighting skyrocketed more than 400% in 2013.

RVLT Chart RVLT data by YCharts

The recent developments do not fundamentally alter the fact that the company is losing money (-200% profit margin with a negative return on equity of more than 150%) and may be vulnerable to a selloff. Revolutionary Lighting has only $1 million in revenue, and the stock is trading as if it is valued around $400 million. In other words, the stock is way overvalued!

The relative strength index (RSI), a sign of when a security has been overbought or oversold, is now very high. RSI signals that this stock could be ready to turn and fall, taking out all stops. This often happens with small-cap stocks as speculators and momentum traders will ride the wave to higher share prices and then sell after gains have been booked. So how in the world would the stock tank without anyone selling into it?
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