Introduction to The Different Types of Stocks

Stocks are foundational to building wealth in the financial markets, representing ownership in a company and a share in its profits. For investors, they offer the potential for significant returns, but with this opportunity comes a need for informed decision-making. Understanding the different types of stocks is essential for building a strong, diversified portfolio.

Each type of stock comes with its own benefits and risks. Growth stocks might offer high returns but are more volatile, while blue-chip stocks provide stability but may grow more slowly. Your choice of stocks should align with your financial goals and risk tolerance. If you can handle market swings and seek high returns, growth stocks might suit you. If you prioritize steady income and capital preservation, income or defensive stocks could be better. By knowing the characteristics of different stock types, you can make informed decisions that support your long-term financial success.

Plus, if you choose the wrong type of stocks to trade you could expose yourself to significant risks that you might not be aware of.

11 Types of Stocks and Related Instruments

1. Common Stock (Ordinary Share) represents ownership in a company and entitles shareholders to vote on corporate matters and receive dividends. Common stockholders are typically last in line for claims on assets in the event of liquidation but benefit from potential capital appreciation as the company grows.
2. Class A Stock typically offers more voting power per share compared to other classes, such as Class B stock. This means shareholders holding Class A shares have a stronger influence on company decisions, such as electing the board of directors. These shares may also come with different dividend rights.
3. Class B Stock usually has less voting power than Class A stock, making it less influential in corporate decisions. Companies issue Class B shares to offer a broader ownership base while keeping decision-making control with a smaller group of shareholders.
4. Voting and Non-Voting Shares refer to the rights attached to the shares regarding company decisions. Voting shares allow shareholders to vote on important matters like mergers or board appointments, while non-voting shares typically do not grant these rights, though they may still offer dividends.
5. Partly Paid Shares are shares that have not been fully paid for at the time of issuance. Investors pay for these shares in instalments over time. The main risk with partly paid shares is that if the company makes a call for the remaining balance and the shareholder cannot pay, they may forfeit their shares. These can be highly risky and I personally never buy partly paid shares.
6. Convertible Preference Shares are a type of preferred stock that can be converted into a specified number of common shares after a certain date. This provides investors with the opportunity to benefit from potential upside in the company’s stock price while enjoying the fixed dividends of preferred shares.
7. Redeemable Preference Shares can be bought back by the issuing company at a predetermined price and time. This feature provides shareholders with some predictability, as they know when and how much they will receive in return for their shares, unlike regular preference shares that might be held indefinitely.
8. Warrants are financial instruments that give the holder the right, but not the obligation, to purchase a company’s stock at a specific price before a certain date. They are similar to options but are typically issued by the company itself as a means of raising capital, and they often have longer expiration periods.
9. Acquisition Corporations (SPACs), or Special Purpose Acquisition Companies, are companies with no commercial operations that are formed strictly to raise capital through an IPO for the purpose of acquiring an existing company. SPACs are often referred to as “blank check companies” and present both risks and rewards due to the uncertainty surrounding the eventual acquisition target.
10. ETFs (Exchange-Traded Funds) are investment funds that are traded on stock exchanges, much like individual stocks. They hold assets such as stocks, commodities, or bonds, and generally operate with an arbitrage mechanism designed to keep trading close to its net asset value. ETFs provide diversification and are a popular choice for investors looking to track the performance of a specific index or sector.
11. ETNs (Exchange-Traded Notes) are unsecured debt securities that track an underlying index of securities and trade on a major exchange like a stock. Unlike ETFs, ETNs do not hold the underlying assets but rather are backed by the creditworthiness of the issuer, typically a bank. This makes them subject to credit risk, but they can offer unique opportunities for investors, especially in accessing hard-to-trade markets. These should be considered higher risk than ETFs.

Systematic traders generally focus on trading common stocks (ordinary shares) and ETFs because these instruments offer the greatest liquidity, extensive price history, and are widely understood within the market. Let’s deep dive into some of the more interesting types of stock in more detail

Common and Preferred Stock

Understanding the distinction between common and preferred stock is essential for making informed investment decisions.

Common Stock

Common stock represents ownership in a company, granting shareholders voting rights and a share of profits through dividends, though these dividends are not guaranteed. The main appeal of common stock is the potential for capital appreciation—if the company performs well, the value of its shares can increase, offering potentially significant returns. Common shareholders are last in line for claims on assets in the event of liquidation, making this a higher-risk, higher-reward investment.

Preferred Stock

Preferred stock, on the other hand, offers more stability. It provides fixed dividends, often higher than those of common stock, and takes precedence over common stock in claims on assets during liquidation. Preferred shares do not usually come with voting rights but are often more secure due to their fixed income stream. Some preferred stocks are cumulative, ensuring that missed dividends must be paid out before common stock dividends are issued, while non-cumulative preferred stocks do not carry this feature. Convertible preferred shares can be exchanged for common stock, offering the potential for capital gains, while redeemable preference shares can be bought back by the issuing company, providing a degree of predictability.

In summary, common stock offers growth potential and voting rights, while preferred stock provides a more stable income with priority in financial claims. Your choice between the two should align with your investment goals and risk tolerance.

Growth Stocks vs. Value Stocks

When constructing a diversified portfolio, it’s important to understand the differences between growth stocks and value stocks. Each offers distinct opportunities and risks, making them suitable for different types of traders.

Growth Stocks

Growth stocks are shares in companies expected to grow at an above-average rate compared to others in the market. These companies typically reinvest their earnings into expansion, research, and development, rather than paying dividends. The focus is on achieving substantial revenue and profit growth, which can lead to significant increases in the stock’s price over time. Traders are often drawn to growth stocks for their high potential returns, but this comes with higher volatility and risk. These stocks are more susceptible to market swings, especially during economic downturns, as their valuations are often based on future expectations rather than current earnings.

Value Stocks

Value stocks, in contrast, represent shares in companies that are considered undervalued by the market. These companies often have stable earnings, pay dividends, and are typically in more mature industries. Value stocks are attractive because they trade at a lower price relative to their fundamentals, such as earnings, dividends, or sales, indicating that they may be overlooked or undervalued by the market. The potential for appreciation comes from the market eventually recognizing the stock’s true value, leading to price increases. Value stocks are generally considered less risky than growth stocks, as they are often more established companies with a history of steady performance.

Growth vs. Value in Systematic Trading

For systematic traders who rely on end-of-day price and volume data, the traditional distinctions between growth and value stocks are often less prominent in the strategy development process. Since systematic trading involves backtesting strategies using historical data, the focus tends to be on price action, volume patterns, and technical indicators rather than on fundamental metrics like earnings growth or price-to-earnings ratios.

However, systematic traders can incorporate elements of value-oriented trading into their systems by using available data, such as historical dividend yields, as a proxy for evaluating stock characteristics. For example, a systematic trader might use a filter that screens for stocks with a history of higher dividend yields, which could be indicative of value stocks. This approach allows traders to capture some of the benefits of value investing—such as potential price stability and income generation—while still adhering to a rules-based trading framework.

The key advantage of systematic trading is the ability to backtest strategies rigorously before deploying them in live markets. This means that even if a trader doesn’t explicitly focus on growth or value stocks, their system is designed to capitalize on specific market behaviours that have proven effective in the past. Whether trading growth or value stocks, the emphasis remains on following a disciplined, data-driven approach that removes emotion from the decision-making process.

In conclusion, while the traditional distinctions between growth and value stocks will not be the primary focus for systematic traders, understanding these concepts can still inform the development of filters and rules that align with a trader’s overall strategy. By leveraging historical price, volume, and available dividend data, systematic traders can create robust systems that perform well across different market conditions.

Income Stocks

Income stocks are shares of companies that consistently pay high dividends. These stocks typically come from well-established firms with a stable earnings history, making them attractive to traders seeking regular income rather than capital gains. Examples include utility companies, telecommunications firms, and real estate investment trusts (REITs). In a portfolio, income stocks provide stability and reduce overall volatility through their consistent payouts, which can help offset potential losses in more volatile holdings.

For systematic traders, income stocks may not be the main focus unless the strategy specifically targets dividend yields. However, dividend yields can serve as a useful filter in identifying stable, lower-risk stocks.

While high paying dividend stocks may be alluring from an ‘income’ perspective, they may be less exciting from a total return perspective. In my comprehensive article on dividend stocks I showed that frequently a simple trend following system will out perform the same system with a filter to require high or growing dividend yields like the so called Dividend Aristocrats.

The key message here is not to just buy a stock for ‘income’, but to think in terms of ‘total return’ and backtest your assumptions correctly to determine if they are actually correct.

Blue-Chip Stocks

Blue-chip stocks are shares of large, financially sound companies with a history of reliable performance. Known for their stability and long-term growth potential, these stocks are less volatile than those of smaller companies and often play a key role in conservative investment portfolios. Companies like Apple, Microsoft, and Johnson & Johnson are classic examples.

For systematic traders, blue-chip stocks are relevant because of their high liquidity and tight bid-ask spreads, making them ideal for strategies requiring quick, efficient trade execution. Systematic traders wishing to trade only large capitalization blue chip stocks should consider developing trading systems that trade only stocks in the main stock market indices such as the S&P500 Index, Nasdaq 100, TSX 60 or the ASX200.

Users of Norgate Data can develop trading systems using historically accurate index constituents in these and many other indices.

Traders who do not have access to historically accurate index constituents cannot develop and backtest systems on blue-chip stocks because their backtests will be misleading due to survivorship bias.

Cyclical and Non-Cyclical Stocks

Cyclical stocks are tied closely to the economic cycle, performing well during periods of growth and struggling during downturns. Industries like automotive, travel, and luxury goods often produce cyclical stocks. Conversely, non-cyclical or defensive stocks belong to companies offering essential goods and services, making them more stable during economic downturns. Examples include food, healthcare, and utility companies.

For systematic traders, cyclical stocks offer opportunities for those who can time market cycles, seasonality trading strategies or momentum strategies, while non-cyclical stocks are valuable in systems aimed at reducing volatility.

The reality for systematic traders, however, is that the only way to distinguish between cyclical and non-cyclical stocks in testing is by the sector the stocks are in. Luckily when we backtest with Amibroker and Norgate Data, we can access the industry sector the stock is in. There are some quite useful investigations you can do testing different types of trading system on different industry sectors.

Defensive Stocks

Defensive stocks, similar to non-cyclical stocks, perform well or maintain value during economic downturns. These stocks are from industries that provide essential services, such as healthcare and consumer staples, making them less volatile and a safe haven during market corrections. In a conservative portfolio, defensive stocks balance risk by offering stability. For systematic traders, these stocks may be useful as part of a trading strategy designed to withstand market volatility by focusing only on defensive sectors.

IPO Stock

An IPO, or Initial Public Offering, is when a private company offers its shares to the public for the first time. IPOs can present significant opportunities for traders by offering access to a company’s growth potential from the outset. However, they come with substantial risks due to the limited information and potential for high volatility as the market assesses the company’s value. Evaluating IPO stocks requires careful analysis of the company’s fundamentals and market conditions.

For systematic traders, IPO stocks are often less suitable due to the lack of historical data necessary for backtesting, although momentum traders may find opportunities once a trading history is established. However it is possible to develop a trading system for stocks that have recently been listed. As soon as the stock is in your historical data set you can trade it systematically.

One example of a trading strategy that has potential is to buy stocks that have been listed for less than a certain number of days and are breaking out to new highs. Buying these stocks and holding while the trend remains in place can be profitable as shown by the backtest below.

Penny Stocks

In the US Stock Market, which prefers higher priced stocks, penny stocks are low-priced shares, often trading for less than $5, associated with small, less-established companies. These stocks tend to be more volatile, with lower liquidity and more limited public information, making them a high-risk, high-reward option. While penny stocks can offer significant returns, they are also prone to manipulation and significant losses.

Effective trading strategies for penny stocks require strict risk management, such as small position sizes, wide stop losses that are held out of the market so they are not triggered by intraday volatility and broad diversification.

For systematic traders, one of the best trading strategies for penny stocks is long term trend following because small companies that reach a growth phase can undergo very significant trends. Liquidity is a significant concern and we must ensure our trading systems have a sufficiently high liquidity filter to allow us to get in and out of our penny stock trades with acceptable slippage.

There is an important distinction between the US Stock Market and the Australian and Canadian stock market here. In the US most well established stocks have a high stock price. However in Australia it is quite common for a large company listed in the ASX200 index to have a stock price of less than $5 per share. This does not mean they are ‘penny stocks’. On the Australian Stock Exchange I would consider stocks to be ‘Penny Stocks’ when they have a share price of less than about $0.50 per share, although even these can be quite liquid, so I generally do not reject a stock from a system based on a low share price unless there is low liquidity.

One notable exception is for mean reversion trading systems where the average profit per trade is low. Very low priced shares have a high tick size relative to the stock price, resulting in larger slippage than in higher priced stocks. This slippage can ruin a mean reversion system because of the low average profit per trade even though a trend following system could be perfectly capable of handling the same level of slippage.

Market Capitalization

Market capitalization, or “market cap,” is a measure of a company’s size, calculated by multiplying its current stock price by its total number of outstanding shares. Market cap is frequently used in stock classification and can influence a stock’s risk profile, growth potential, and how it fits into an investment strategy. The problem for systematic traders is that we frequently cannot access the market cap of a stock directly since end of day data providers only give the stock price and traded volume and do not list the number of shares outstanding. Thus systematic traders need to use different indices to gauge the capitalization of a stock as explained below. Stocks are generally categorized into three main groups based on their market capitalization: large-cap, mid-cap, and small-cap.

Large-Cap Stocks

Large-cap stocks refer to companies with a market capitalization typically exceeding $10 billion. These companies are often industry leaders with established business models, extensive market reach, and a strong track record of profitability. Large-cap stocks are generally known for their stability, lower volatility, and consistent dividend payments, making them attractive to conservative traders who prioritize capital preservation.

For systematic traders, large cap stocks are typically a great area for rotational momentum trading strategies such as the one below that holds the strongest stocks in the Nasdaq 100 and rebalances every few weeks to ensure it continues to hold the strongest stocks. This trading system is available to members of The Trader Success System.

Major indices tracking large-cap stocks include the S&P 500 and the Dow Jones Industrial Average (DJIA) in the U.S., and the S&P/ASX 50 and S&P/ASX 200 in Australia.

Mid-Cap Stocks

Mid-cap stocks are companies with a market capitalization typically ranging from $2 billion to $10 billion. These companies represent a middle ground between the stability of large-cap stocks and the growth potential of small-cap stocks. Mid-cap stocks often belong to companies that are still growing and expanding their market share but are more established than small-cap companies.

Major indices tracking mid-cap stocks include the S&P MidCap 400 or the Russell 1000 in the U.S. and the S&P/ASX MidCap 50 in Australia.

Small-Cap Stocks

Small-cap stocks refer to companies with a market capitalization typically between $300 million and $2 billion. These companies are often in the early stages of development or operate in niche markets. Small-cap stocks are known for their higher risk due to their smaller size, less established business models, and greater sensitivity to market volatility. However, they also offer the potential for significant returns, especially if the company experiences rapid growth.

For systematic traders, small-cap stocks are a typically a great area for trend following trading strategies.

Major indices tracking small-cap stocks include the Russell 2000 in the U.S. and the S&P/ASX Small Ordinaries in Australia.

Using Market Capitalization in Systematic Trading

In systematic trading, market capitalization can be an useful factor in defining the universe of stocks that a system trades. While direct market cap data may not be accessible through most end-of-day price and volume data feeds, traders can use proxies such as average daily turnover or the inclusion of stocks in specific indices to approximate market cap categories.

For instance, a large-cap trading system might focus on stocks within the S&P 500, Nasdaq 100 or S&P/ASX 200 indices, where high liquidity and lower volatility are prioritized. Conversely, a small-cap trading system could target stocks within the Russell 2000 or S&P/ASX Small Ordinaries, seeking higher returns at the cost of increased risk and volatility.

By filtering stocks based on their average daily turnover or their presence in certain indices, systematic traders can effectively tailor their strategies to different market cap categories. This approach allows for the design of systems that are aligned with the trader’s risk tolerance and performance objectives, whether they are seeking the stability of large-cap stocks or the growth potential of small-cap stocks.

Foreign Stocks: A World of Opportunity

Foreign stocks are simply shares of companies that are listed on exchanges outside a trader’s home country. For example, if you’re based in Australia, stocks listed on the New York Stock Exchange (NYSE) or the Hong Kong Stock Exchange (HKEX) would be considered foreign stocks. Despite the vast opportunities they offer, most traders tend to stick to their local markets, missing out on the benefits of global diversification.

One of the primary reasons traders avoid foreign stocks is the fear of the unknown—different market regulations, currency fluctuations, and unfamiliar trading environments can be intimidating. However, with the right tools and knowledge, these barriers can be easily overcome. International brokers like Interactive Brokers provide access to a wide range of global markets, allowing you to trade stocks all over the world in multiple currencies from a single account. This opens up enormous opportunities for diversification, enabling you to reduce risk by spreading your investments across different economies and industries.

Ignoring foreign stocks is a massive mistake. Some of my best gains have come from trading stocks listed outside my home country. The ability to include U.S., Australian, Canadian (TSX), and Hong Kong stocks in your portfolio is a game-changer. It allows you to create a truly diversified portfolio that can weather different market conditions. Remember, at the end of the day, a stock is a stock, no matter where it is listed. What matters is how it fits into your trading strategy and risk profile.

One of the great advantages of systematic trading is the ease with which you can diversify internationally. With the right data provider, you can easily integrate foreign stocks into your trading systems. For those interested in trading U.S., Australian, and Canadian stocks, I recommend using Norgate Data. For access to other global markets, Metastock Data is a reliable option Metastock Data. These platforms provide the necessary end-of-day data history to help you backtest and implement your strategies across multiple markets, ensuring that your portfolio is truly diversified and optimized for success.

Members of The Trader Success System get access to complete, fully backtested trading systems for many different markets including the US Stock Market, Australian Stocks, Canadian Stocks, Hong Kong Stocks and London Stocks.

Dividend Stocks vs. Non-Dividend Stocks

Dividend stocks are typically characterized by their regular dividend payments, often from well-established companies with steady earnings. Traders can use dividend yield, dividend growth, or the timing of dividend payments as factors in their backtested trading systems. This can be particularly useful in strategies aimed at income generation or enhancing total returns. However, as we have shown in my Ultimate Guide to Dividend Stocks, this strategy may not be as appealing as you might expect!

On the other hand, non-dividend stocks are often found in companies that prefer to reinvest earnings into growth rather than distribute them to shareholders. While these stocks might not provide regular income, they can offer significant capital appreciation, especially in growth-oriented sectors. For systematic traders, these stocks can be attractive in trend trading strategies that focus on capital gains rather than income, using price momentum and other technical indicators to capitalize on their growth potential.

For systematic traders, the distinction between dividend and non-dividend stocks can be incorporated into trading systems using tools like Norgate Data, which provides detailed information on dividends, their timing and historical payments. It is critical to fully backtest your ideas before incorporating them. I have found through testing that many commonly held ideas about investing in dividend paying stocks are just plain wrong.

Conclusion on Types of Stocks for Systematic Traders

Systematic traders generally focus on trading common stocks (ordinary shares) and ETFs because these instruments offer the greatest liquidity, extensive price history, and are widely understood within the market. The high liquidity of common stocks and ETFs ensures that trades can be executed efficiently, even with larger positions, and their long price histories provide the necessary data for rigorous backtesting of trading systems. Most systematic trading strategies, including my own, specify that only common stocks or ETFs are eligible for inclusion, as these assets align best with the criteria for reliable, rule-based trading. This focus helps ensure consistency and reliability in executing trading strategies across different market conditions.

To get access to the trading systems discussed in this article and learn how to backtest and evaluate trading strategies for different types of stock, join The Trader Success System – it is the last stock trading course you will ever need!