There’s no denying that in the world of trading and investment, many words and phrases have double meanings. Learning what they mean in terms of trading can make it easier to understand what analysts and forecasters are trying to tell you in their regular reports.
This article will focus on one term in particular: floating stocks. Thrown around on the trading floor frequently, let’s see together what a floating stock is and why it’s important for investors.
What is a float in stocks:
In simple terms, a floating stock can mean a couple of different things depending on the context.
- The main and most common definition is that they are the number of shares available for trading of a particular stock.
- Another definition for it is that they mean the process of listing a company on an exchange where the general public can purchase shares. So floating a stock means to bring it public, as in an initial public offering.
Most of the time, the total number of shares available for buying and selling is expressed in their dollar value amount. Other times, they are expressed as the percentage of the company’s total outstanding shares.
So for example, ABC company has 1 million dollars worth of shares but only $600,000 of that is actually available for trading. So the float is $600,000 or 60 percent of the total outstanding shares.
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How do float stocks work?
The example above is a good indication of the nature of floating stocks overall. A company might have a large number of outstanding stocks but only a small percentage of that is available for public trading or floating. This can be due to a lot of different reasons.
For example, ABC company has $100 million worth of outstanding shares in total. Of the $100 million shares, 60% ($60 million) are owned by large institutions, such as hedge funds, 5% ($5 million) is owned by insiders, and another 5% is owned by employees of the company under an employee stock ownership plan (ESOP).
This means that 70% or $70 million of the company’s outstanding shares are tied up and unavailable for traders. Through this, a trader can infer that 30% or $30 million is floating or available for public trading.
Fluctuations on float stocks
Given the ever-changing nature of the stock market, the total number of float stocks can change over time. This can happen, for example, if a company decides to share additional shares to raise capital, this will then increase the number of float stocks in turn.
Private institutions might also decide to unload and sell the stocks they own, increasing the number of float stocks as well.
Alternatively, a company might initiate a buyback of its own stocks. As a consequence, the number of outstanding shares will decrease and the floating shares as a percentage of outstanding stock will also go down.
Why are float stocks important for investors?
With the definitions of float stocks in mind, it’s self-evident why it’s important for investors. When the number of float stocks is low, this generally means an investor will have a harder time penetrating the market for that particular stock.
It might also mean that an investor will have a harder time exiting since fewer investors will be buying.
Institutional investors (such as mutual funds, pension funds, and insurance companies) will often avoid trading in companies with smaller floats because there are fewer shares to trade, thus leading to limited liquidity and wider bid-ask spreads. Instead, institutional investors that buy large blocks of stock will look to invest in companies with a larger float.
As always in the stock market though, there are expectations to this rule.
High vs. Low
Despite many investors staying away from stocks with smaller floats, it is actually quite rare for a company to float all its outstanding shares. Most companies prefer to keep their float stocks at around 10% of their outstanding shares. There are many reasons for this but the most common ones are:
It is believed that the market will not be able to absorb all the outstanding shares. This will lead the company to underwrite and sell only a small percentage of its shares at a time.
Insiders, or the internal owners of the stocks, cannot or do not wish to sell their shares. This might stem from their own desires to maintain majority control or because the shares are too profitable to let go, such as in the case of dividend yields.
There are cases where a smaller float is more beneficial for a company. For instance, a smaller float may help boost the stock more than a larger float, since it may be able to attract a smaller set of investors who are more excited about the investment.
Conversely, it should be noted that a higher float stock is generally seen to be more favorable. High float stock promotes more activity among investors looking for a quick entrance and exit in an investment.
When looking at and trading with float stocks, it’s important to keep the following in mind:
A higher price at an initial public offering can set a psychological range for a stock price, helping support the price over a longer period of time.
A company has no control over how floating stocks are traded in the public market. This might be one of the reasons they take care not to allow too much of their stocks to be floating.
In connection with the former point, shares that are purchased, sold, or even shorted by investors do not have an effect on the overall float. This is because these actions do not represent a change in the number of shares available for trade. They simply represent a redistribution of shares.
Similarly, the creation and trading of options on a stock do not affect the float.
Are there any advantages of purchase low float stock?
Yes, many day traders who are looking to make a quick profit enjoy picking up low float stocks, as due to the volatile nature of them their share prices can drastically change in a single day.
For example, experienced day traders are often able to purchase low float stock cheaply before they skyrocket in value before the end of the trading day.
In order to make competitive profits of 10% to 50%. So, there are some upsides to purchasing low float stock.
Are there any disadvantages of purchasing them?
Yes, there are a few disadvantages of choosing to purchase stock which has a low percentage of floating stock.
Firstly, the smaller the number of shares which a company has available for purchase on the open market, the harder it may be to purchase stock at a price point that you're comfortable with.
Furthermore, you may also find it challenging to sell your stock at your desired price point.
The risk of volatility:
Stocks which have a low float, are also known for being more volatile than stocks which have a high float. This is since they often feature higher spreads and lower volumes which often leads to unpredictability and volatility.
Historically, low float stocks have also been volatile as if a company offers more restricted shares and closely held shares then float. If you purchase low float shares and the owners of restricted shares or closely held shares decide to sell off most shares, the value of your shares may plummet in a single day.
So make sure to complete your due diligence if you choose to purchase them.
Is it still worth investing in low float stocks?
While there are risks associated with investing in low float stocks, it's still well worth incorporating them into a diversified investment portfolio.
Especially if you are the type of investor who prefers holding on to stocks in order to benefit from long term gains or are interested in becoming a day trader.
The primary advantages of purchasing high float stocks:
As mentioned previously one of the main advantages of purchasing high float stocks is that you should have no trouble purchasing or selling stocks at a set price.
As the volume of stocks which are available at any given point in time will be relatively high. So if you're looking to decrease your investment portfolio's risk it's a wise idea to purchase high float stocks to add to your portfolio.
If you plan on purchasing low float stocks, just be mindful of the fact that it may be harder to sell your stocks. If you purchase them be prepared to hang on to your stocks for the foreseeable future.
Also be sure to have both low and high float stocks in your stock portfolio.
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