As an investor and trader you need to understand how the float of stock can influence how it trades, and its volatility. Low float stocks are some of the best stocks to trade because they tend to be extremely volatile, making rapid movements either up or down sometimes in a matter of days. Let’s look at what the float actually is, and how it affects stocks. We will also analyze how to find low float stocks, and the pros and cons of investing and trading them.
What is float in stocks?
The float in stocks measures the number of shares that are available to trade by retail investors, and it is a percentage of the outstanding shares. The lower the number of shares in the float, the higher the probability that a stock may be more volatile. The reason is that since there are fewer shares to be traded, the stock tends to be less liquid, which means that a small order can be a greater percentage of the daily traded volume, and have a bigger impact on the price.
The float is calculated by taking the number of outstanding shares and subtracting the number of shares owned by insiders, or other long-term investors with large stakes that are not actively trading the stock. While it can be represented in a number, it can also be divided by the number of outstanding shares, and be shown as a percentage.
What are low float stocks?
Low float stocks are stocks whose float is a small percentage of the outstanding shares, at least 30%. This means that of all the shares of the company, only 30% can be openly traded at any given time. Low float stocks, tend to be more volatile as we explained because the number of available shares to trade is so low.
Low float stocks also tend to have a low daily traded volume, due to the fact that there are fewer shares available to trade.
Why low float stocks are ideal for trading and short squeezes
Trading and earning a profit depends on volatility, the higher the volatility, the higher the possible losses or gains. Since low float stocks tend to move a lot quicker and faster, they are usually traded a lot more, because traders and day traders favor them over other stocks.
While stocks with a low float can generate a lot of gains in a single day, it can also lead to big losses.
Short squeezes are also increasingly more common in low float stocks because the lack of available shares to trade makes the stock even more volatile. There are plenty of examples in the past of short squeezes that were exacerbated by the low float of the stock. This is especially evident in stocks where there is a large percentage of the float sold short.
How to find low float stocks
The simplest way to find low float stocks is by using a stock screener and filtering the float size. While some screeners allow you to filter the float by the number of shares others allow you to set a specific percentage of the shares outstanding that make up the float.
If you are looking for low float stocks to trade, you should analyze the volume traded both daily, weekly and monthly, because that can also directly influence how a low float stock trades.
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Pros and cons of low float stocks
Can generate higher gains: One of the main advantages of low float stocks is that they can generate higher returns. Because low float stocks are less traded, any large orders can have a big impact on the price.
Ideal for trading: Due to their higher volatility, low float stocks are one of the best options to trade.
React better to news: If a piece of positive news comes out about the company, usually low float stocks react extremely well, and tend to have a great performance.
Not the best stocks to invest in: Low float stocks are not the best for long-term investors that are looking for a relatively stable stock that does not make their portfolio more volatile.
You need to stomach the higher volatility: Investors and traders who short-sell or buy low float stocks, should be aware of the higher volatility, and they need to know how to deal with it.
May have a low volume (illiquid): Usually due to the fact that there are fewer shares available to trade low float stocks tend to be more illiquid, and this could certainly influence how the stock should be traded.
Riskier: Due to their higher volatility, and in some cases illiquidity, low float stocks are riskier, and so for that reason, institutional investors often avoid having an open position on them.
Low float stocks can be a double-edged sword. While they are certainly some of the best types of stocks to trade, they can also go against you, and for that reason, it is important to understand the implications of trading these types of stocks.