If you’re an amateur investor, you may feel overwhelmed by some of the technical terms.
Knowing just a bit more than the basics can pay off, though. One of the terms you should get a handle on is “low float” stock.
When a stock has low float, it can be more volatile than you expect.
Read on to learn what float is, how to calculate it, and why it can lead to higher volatility.
You’ll be a market master in no time!
What is Float?
A stock’s float is how many shares are available to trade. It is specific to that stock, not the industry or any other group the stock belongs to.
Float is not the same as the number of total outstanding shares.
A company’s total outstanding shares include shares across the entire market, whether they are held or available.
A firm might have restricted or closely held shares that detract from a stock’s float.
These are shares that are held by insiders, company employees, and major shareholders.
They are unlikely or unable to trade these shares. Shares can also be restricted temporarily, like after an initial public offering.
Now that you know exactly what float is, let’s explore what low float is.
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What is a Low Float Stock?
A low float stock is a stock with few available shares.
While a stock’s float changes over time, low float indicates that investors are not trading the stock frequently.
While there is no exact number to indicate low float, a general rule of thumb is that you can consider float below 10-20 million shares as low.
For some perspective, major companies may have float in the billions.
Low float stock is appealing to day traders because they are highly volatile.
This means that the price of the stock changes by large margins in a relatively short period.
You could see prices change by as much as 200% in one day.
Remember that this goes both up and down, though. Float should be just one factor in your decision to trade a stock.
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How to Calculate a Stock’s Float
Step one when you want to calculate a stock’s float is to look for the number of shares outstanding.
You can find this on a balance sheet or by searching a stock information website.
Shares outstanding is a company’s entire collection of shares.
Next is to find how many of these shares have restrictions.
These shares are not able to be sold at all or for a specified time.
Subtract the number of restricted shares from the shares outstanding. This will give you the float.
Why Low Floats Can Lead to Increased Volatility
Why exactly does low float lead to increased volatility?
The short answer is supply and demand. Low float essentially means there is low supply of the stock.
When a news event or other catalyst causes an increase in demand, the supply can’t keep up.
When this happens, the price of the stock increases rapidly. However, the same thing can happen in the opposite direction.
Shares that were once selling like hotcakes are suddenly sitting on the market with no one to buy.
Because there are few shares, the price drops very quickly.
How to Pick the Right Low Float Stock
So how can you choose the right low float stock to invest in?
You’ll want to pick a stock that has big price changes without getting burned by a crash.
This can happen if the float has no liquidity.
Take a look at one key indicator you can use to make the right choice: relative volume.
Liquidity is important when you trade low float stocks.
You want to ensure you are able to sell or buy shares the moment you make a decision.
This will prevent you from being stuck with a stock that is crashing fast.
Volume is the indicator you’ll want to look for. Specifically, you want to look for relative volume.
This is a ratio that shows how the current volume compares to a previous time frame.
For example, this month versus last month.
Consider a stock that was trading an average of 1 million shares per day for the past month and is now trading 3 million shares.
You can tell the stock currently has good liquidity.
This stock has a relative volume of three because it is trading three times the average amount.
Any relative volume greater than two indicates the stock is meeting volume requirements and would be a good choice.
Trading Advice for Low Float Stocks
You’ve identified a low float stock with good relative volume, so now what?
There are a few tips and tricks for trading these volatile stocks. Take a look at our top tips up ahead.
Don’t Leave These Stocks Unattended
These are not the stocks to purchase at opening and leave alone until the afternoon.
You’ll want to observe any open trades that occur and be prepared to buy or sell at a moment’s notice.
This is true for any active trader, but especially for low float stocks.
These stocks can see price changes between 50% to 200% in just one day. You don’t want to miss those peaks or valleys.
Make a Dry Run before Investing
Low float stocks are notoriously volatile as you now know.
Before throwing money into the pot, make a few dry runs.
Start the day by making a list of top contenders, then track them over the course of the day.
Make a note of the gains or losses, when you would have traded during the day, and what your results would have been
. When you’ve built up confidence in your strategies, dive into the real deal.
Final Thoughts: Low Float Stock
You may have been overwhelmed at first, but low float stock can be a great investment.
Take your time to develop a strategy and you’ll be riding the volatility waves like a pro.
If there’s another topic you’ve been overwhelmed by, sound off in the comments below.