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The Headache
Discussion of Issues that Make Your Head Hurt
Market Capitalization is the single most important value when investing
Published 03/26/21 by arakouzo [0 Comments]

The second question most people ask when considering investing in a particular stock, cryptocurrency, or anything else (the first being “Is this thing going to go up in value”) is normally “How high can this thing’s value go”.

In considering that second question, a lot of people mistakenly look at the current price of something and try to guess how much “room to grow” it might have. For example, a crypto coin that costs 10 cents looks a lot more attractive than a coin that costs 20 dollars, because if that 10-cent coin goes up to $100, you just made 1000 times your initial investment, while if that 20-dollar coin goes up to $100 dollars, you only made 5 times your investment.

So people may invest some money into that 10-cent coin, then get frustrated when six weeks later, it’s gone up to 12 cents, one tiny fraction of a cent at a time, while that 20-dollar coin has doubled.

What these people failed to look at was market cap. Market cap is essentially just a measurement of how much value exists in the market for a particular thing. You take the total number of coins, shares, or whatever you're buying that are in circulation and multiply it by the price per thing, and that’s your market cap. So when the price goes up, market cap goes up, when price goes down, market cap goes down, if new coins or shares are created, market cap goes up, if coins or shares are destroyed, market cap goes down.

When you invest, what you’re actually investing in is a small piece of the market. That piece is represented by the coins or shares you buy and their current value, but what actually affects how much you gain or lose is the percent change in the market cap.

When something has a high market cap, it takes a lot more buying or selling to change that market cap by a significant percentage. That’s why you and me buying a few thousand dollars worth of bitcoin with its 1 trillion dollar market cap doesn’t change anything, but a bunch of kids getting together on Reddit can affect the much smaller 6 billion dollar market cap of dogecoin.

The price for an individual crypto coin or stock share doesn’t really matter that much. That’s just the total market cap divided by the number of coins or shares in existence. It doesn’t matter if your $1000 investment buys 100 ten-dollar crypto coins or 10,000 ten-cent coins. What matters is the percent change in value that occurs while you’re holding those coins. If bitcoin triples while your $1000 only buys 0.02 bitcoin, you still tripled your money. While if a cheaper coin like Stellar Lumens (XLM) goes up from 40 to 42 cents, it doesn’t matter if your $1000 buys 2500 of them. Your value still only increased by 5% to $1050.

So if a ten-cent coin has a 500 billion dollar market cap, you will stare all day watching it go up and down fractions of a cent wondering why it’s not mooning. Meanwhile, some random 5-dollar coin with a small 200 million dollar market cap may triple in value in a day while you thought it didn’t have room to grow.

Low market cap investments are volatile. They may moon out of nowhere, and they may crash to nothing just as easily. It doesn’t matter what the price per coin or share is; that is just a number you get when you divide the total market cap by the total number in existence. A $100 stock or crypto may moon if it’s a low market cap investment. Or crash suddenly.

Conversely, high market cap investments are more stable, which makes them less prone to rapid changes in value in either direction. It takes a LOT of buying and selling to change their price. It doesn’t matter if the price is only 10 cents. That’s just the number you get when you divide the market cap by the total number of coins or shares. Unless there’s a huge amount of purchasing or selling going on, that high market cap ten-cent crypto coin or stock share is going to spend most of its days being measured in fractions of a cent out to four decimal places.

So when people find themselves wondering why their Cardano (ADA) crypto has been stagnant for awhile or why XLM never moons, the answer is high market cap. And when people wonder why some obscure stock or shitcoin crypto they’ve never heard of just shot up from $20 to $44 in under a week, and then crashed back down to $18 in an hour as soon as they bought it, that was probably a low market cap investment.

Tip arakouzo for their post.
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