What Are Meme Stocks?
Where were you in January of 2021 when the meme stock phenomenon first started with AMC and GameStop stocks? While these are...
8 min read
Al Hill : Jun 21, 2021
Last Updated: May 18, 2022
Alton Hill is a Cofounder at TradingSim. He has a passion to help people and found that one of his ways of doing so, is through the world of Day Trading. Alton’s skillset is in Product Development and Design Thinking which he uses to write and improve the overall experience for TradingSim.
Stock float is one of the most important metrics that can influence the price of a security. While it can be a confusing term to understand as a beginning trader, it is worth the effort to know. After all, it can mean the difference between big gains and big losses.
The more metrics you have to evaluate a security before trading it, the better. As a rule of thumb, anyway.
Perhaps you won’t be too concerned with a dividend if you’re only looking to day trade a specific stock. You won’t own the stock long enough for the dividend to matter.
But one metric that can dramatically affect a stock’s price movement and volatility, is the float.
Therein lies the importance of this numerical data.
Of the number of shares that are tradable for any given security, those shares are either freely tradeable on the market or insider-owned shares that are locked up. That is, unless the insiders decide to sell more shares, which is another subject in itself.
For the most part, inside shares are owned by the employees of the company they work for. The insider owned shares are not easily tradeable as they come with restrictions. For that reason, the market at large doesn’t bother much about the insider owned shares.
On the other hand, free floating shares are owned and traded by general investors. Investors like you, perhaps.
In many cases, institutions also own a majority of these publicly available shares. These institution-owned stocks are typically held for a long time. Examples of institutions include pension funds or hedge funds.
Because most institutional firms are not actively trading their portfolio every day, this leaves only a remaining portion of the overall shares of a company that are readily tradable.
The float of a security measures the total amount of shares that can freely change hands. In many ways, it depicts the liquidity of the market for certain companies.
The more number of shares there are to change hands, the greater the liquidity.
To better understand “floating stock,” let’s illustrate this with an example.
A company ABC Inc. has 100,000 shares outstanding.
Of the shares outstanding, 5000 are held by its employees, 40,000 shares are held by institutions. The remaining shares are held by regular investors.
From this, the stock float is 55,000. This is the sum of the total outstanding shares minus the shares held by insiders and institutions.
As you can see, while the outstanding shares may be as high as 95,000 for this particular hypothetical company, the actual shares available at any given time, may be much lower.
The impact this has on stock prices and volatility can be dramatic. After all, it is supply and demand that dictate the prices of stocks.
To that end, if more and more institutions gobble up the oustanding shares of a company, it takes less and less demand for the price to rocket higher.
Scarcity of shares, as it were.
This is exactly what happens during the early period of a company’s publicly traded life.
A low float stock as the name suggests indicates that the number of shares outstanding are low. For such stocks, the daily and average volume tends to be low. The low volumes of such stocks lead to volatility and as a result, wide bid and ask prices.
Before the company dilutes its value by throwing more shares into the market, the lower float in the beginning can cause its price to skyrocket as long as demand is there.
For such low float stocks, a fundamental driven rally creates demand. In other words, investors are stumbling over themselves to buy shares when they are scarce, driving the price higher in dramatic fashion.
There is a myth that low float stocks are mostly stocks on the pink sheet or OTCBB market listings.
However, this is not the case. In some cases you can find some micro-cap stocks with listings on the main exchanges such as the NASDAQ or the NYSE. A stock can also be low float if for some reason the float reduces relative to its usual average.
While the definition is a bit flexible, a stock is considered a low float stock which has fewer than 50-100 million in tradable shares.
Stocks with a high float tend to be more predictable and less volatile. For all intents and purposes, you can expect a stock to be a “high float stock” with anything above 100 million available shares.
Due to the large number of shares in the float, the liquidity can absorb any big moves. Therefore, while it is common to see 30% or 40% or even 100% moves during a short amount of time in a low float stock, this is not often seen with high float stocks.
The lack of scarcity means the value is often at “equilibrium” with the amount of shares being traded. Thus it takes more effort to move the price.
Larger companies such as AAPL or FB are examples of stocks with high float.
To imagine the difference, lets take a stock with a float of 18 million and 23.5 million outstanding shares, and compare it with AAPL at 16.68 billion float and 16.75 billion shares outstanding.
EYES ran 1293% in just 4 trading days:
AAPL moves 18% in 38 trading days.
Clearly, there is a difference. For most investors or traders, it is usually a safe bet to trade stocks that have a higher float.
Trading low float stocks can be lucrative in the short run, but they typically come with the headaches of volatility and a lack of secure fundamentals.
Market capitalization, or market cap for short, is closely linked to the free float of the stock.
When researching stocks, companies are usually categorized based on their market capitalization. Pull up any ticker on finance.yahoo.com or any other site, and you’ll see Market Cap at the top of the list, usually:
The important question for traders, is whether you should pay attention to this.
Market cap is a measure of a company’s size: the total value of a company’s outstanding shares of stocks. These outstanding shares include publicly traded shares as well as restricted shares that are held by insiders.
To calculate market capitalization you simply take the number of a company’s shares that are outstanding. Multiply the shares outstanding by the current stock price in order to get the market cap of the stock.
Let’s illustrate this with a simple example.
Say a company ABC Inc. has a total of 5 million shares outstanding. If this company is trading at a stock price of $10, you can get the market cap by multiplying the shares outstanding with the stock price.
In this example, we get $50 million as the market capitalization of the company.
Within market capitalization, there are certain classifications. The different categories can vary depending on who you ask. However, market capitalization is broadly classified into the following:
Now that we understand what market capitalization is, we can see the difference.
Market cap is based on the total value of the company’s shares.
Float is the number of outstanding shares that are available for general trading by the public.
There is also another measure called the free float market cap method of calculation. In the free float calculation method, the market cap excludes shares that are locked in. The shares that are locked in are inside shares that are not available for the general public.
Generally, the free float method of calculating the market cap is widely used. Major indexes such as the Dow Jones Industrial Average and the S&P500 make use of the free float method.
Free float and market cap are important metrics for investors. When combined together, these two values show the total available shares for the public to trade.
One common question among traders is whether one can manipulate the price of a stock based on the float.
As mentioned above, a reduction in the float can almost immediately raise the price of a security. This might seem contrary to the notion of “higher the float, bigger the price.”
This is not the case however. For example, when risk averse investors are on the short side of the stock, reducing the float can squeeze these investors out of the market.
This research paper of Float manipulation and stock prices gives insight into how firms can expand or shrink the float. The researchers observe Japanese stock listings and the price impact of firms who reduce their float between 0.1% up to 100% for periods of one to three months.
The study concludes that the price of a stock tends to rise when the float is reduced and conversely, the price of the stock falls when the float is increased.
The returns of the stock are also said to be cross-sectionally related to the reduction in the float.
There is strong evidence that firms tend to issue equity or redeem their convertible debts when the float is low. After all, they want the highest price they can get for their shares.
For this reason, firms have strong incentives for manipulating the stock price via its float.
The answer to this is yes. Companies can raise or decrease their float in a handful of ways.
As you might expect by now, there are pros and cons when it comes to trading stocks with a low float. For a more in depth look, be sure to check out our post on Float Rotation.
Let’s talk about the upside first!
Because low float stocks are volatile, there is a tremendous upside to the stock. Traders who can take a calculated risk on low float stocks could end up with big returns.
Despite the inherent risks, traders can find an occasional good trade with tremendous upside potential in low float stocks. One of the important things to look for is liquidity.
In many ways, trading low float stocks can be similar to trading penny stocks or micro-cap stocks.
Low float stocks can be very risky to hold because they can have violent moves in either direction. With so few shares available to trade, the impact on supply and demand can be significant.
Low float stocks can be easy to manipulate with large unexpected orders. This is something that investors need to bear in mind.
Stocks with low floats also tend to be volatile around fundamental news releases. These include any type of news that is related to the industry or the sector in particular. Liquidity also increases around such events which can give good opportunity for investors to exit the stock after making a good trade.
Be sure to check for any filings with the SEC as these companies tend to offer shares during price spikes.
There are a number of services that offer float data. Yahoo Finance and Finviz are just a few of the popular ones. Popular charting platforms may offer this as well, usually with a subscription to fundamental data.
Here is a snapshot of some of the fundamental data that finviz.com provides free of charge:
Regardless of the service you use, you may find some discrepancies from one to the next.
Hopefully this helps fill in some gaps when it comes to stock float and the impact it may have on your trading.
As with any piece of information in the markets, it is always wise to study the context and historical examples. Here at TradingSim.com, we can help with this as we have the ability to filter your search for simulated trades based on float size.
Hopefully you’ll take the time to develop your playbook and decide whether you like the price action and risk of low floats or high float stocks.
Best of luck!
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