Traders can consider low-float stocks for their high volatility and potential in times of significant price swings. Their limited supply can cause rapid price fluctuations. In this blog, we will discuss everything about low-float stocks and how to trade them.
Defining low-float stocks
Low-float stocks refer to shares with a relatively small number of available units for trading, typically fewer than 10 million. This limited supply makes them more susceptible to significant price swings, as even small changes in demand can have a big impact.
These stocks are often attractive to day traders who aim to capitalize on rapid price fluctuations. However, the scarcity of shares can lead to wider bid-ask spreads. This can make transactions less fluid and potentially more costly.
Advantages and disadvantages of trading low-float stocks
Advantages
- Higher volatility: Low-float stocks can demonstrate larger price movements, meaning even small changes in price may result in noticeable fluctuations in position value.
- Potential for large price swings: Given the limited number of available shares for trading, any change in demand can result in a large price change.
- Lower competition in niche stocks: There are often fewer shares available in niche sectors, meaning that traders can focus on these less crowded stocks.
Disadvantages
- Increased risk of manipulation: A small number of shares means that the stock price can be easily influenced by single entities or small groups of individuals, creating potential distortions in market value
- Higher spreads and slippage: Little liquidity usually means that bid-ask spreads and slippage are larger, resulting in higher transactional costs and possibly dampening returns
- Greater susceptibility to news events: Low float stocks are considerably more reactive to news and will usually experience significant price movement in short time spans of an earnings announcement or similar event
How to identify low-float stocks?
1. Check the float data
The simplest way to get low-float stocks is to check the float, which is the total number of publicly available float shares. Float data is available on financial websites, stock research services, or through a company's filings with the Securities and Exchange Commission (SEC).
Understanding float size is essential because it determines how easily a stock can be traded without significantly impacting the stock’s price.
2. Review the company's market capitalization
Low-float stocks are usually related to small-cap or micro-cap companies. Such companies tend to have small market capitalization. This means they have a lower overall stock value. A stock's market cap gives investors the context they need to understand if it might share a low float.
Additionally, smaller companies tend to have more restricted shares available for trading. This increases volatility and the potential for large price movements. Comparing the market cap with the float size can help investors assess the potential for price volatility based on floating shares characteristics.
3. Monitor trading volume
One key characteristic of low-float stocks is their comparatively low volume. This implies that fewer shares trade each day, and the stock may not be as liquid as others. Low trading volumes can lead to higher volatility, as smaller trades can cause more significant price changes.
Investors should monitor trading volumes to identify potential low-float stocks, particularly when unusual spikes in volume occur. Such increases in volume could signal growing interest in the stock or indicate the onset of price swings, which might present trading opportunities.
4. Use stock screening tools
Many financial platforms offer stock screening tools that allow investors to filter stocks based on various criteria, including float size. These screeners allow investors to quickly identify stocks with a low float.
These tools can also provide other useful metrics, such as price, market cap, and volume, making it easier for traders to find stocks that meet their investment strategy. Most platforms allow for customization, so investors can set specific thresholds for float size and scan large volumes of stocks for potential opportunities.
5. Examine insider and institutional ownership
One more method to find low-float stocks is to look at insider and institutional ownership levels. High ownership by insiders or institutions means there are fewer hands available to trade in the public market. Company executives and other insiders may own a large portion of the company stock, which would leave a limited number of shares available to the general public.
Institutional investors, such as mutual funds or hedge funds, who hold large blocks of shares also tend to limit the float. One can keep track of how many shares are locked up by insiders or institutions by reviewing ownership filings (US companies have 13D and/or 13G filings).
6. Track float-related news and filings
Corporate actions such as stock splits, secondary offerings, or share buybacks can drive alterations to a company's float. Investors should monitor news about these moves, as they can impact the number of shares available to trade by the general public.
For example, if a company announces a secondary offering, it can expand the float by issuing additional shares. Moreover, stock splits can affect the float, though the company's overall market capitalization remains unchanged. Focusing on these events could lead investors to low-float stocks.
Trading strategies for low-float stocks
Short squeeze plays
Low-float stocks are more vulnerable to short squeezes, where the stock price rapidly rises due to short sellers purchasing back shares to cover their positions. Traders can take advantage of short squeeze opportunities by monitoring the short interest and identifying when a stock is heavily shorted.
These stocks tend to exhibit sudden, explosive price movements as short sellers are forced to cover their positions, which c an lead to heightened volatility during such events for traders who anticipate the squeeze.
Breakout trading
Breakouts occur when a stock moves outside a defined resistance or support level, often signaling the start of a strong trend. For low-float stocks, a breakout can be accompanied by significant changes in market price.
Traders can identify potential breakout opportunities using technical chart patterns like triangles, channels, and flags. Once the stock breaks through a key level with strong volume, traders can enter the position and ride the trend until it shows signs of exhaustion.
The risks and rewards of trading low-float stocks
Trading low-float stocks offers more volatility and gain potential but comes with significant risks. With fewer share counts available for trading, these stocks are more susceptible to price manipulation, such as pump-and-dump schemes. Traders should use risk management techniques to navigate the market's unpredictable nature and prevent substantial losses.
Disclaimer: All material published on our website is intended for informational purposes only and should not be considered personal advice or recommendation. As margin FX/CFDs are highly leveraged products, your gains and losses are magnified, and you could lose substantially more than your initial deposit. Investing in margin FX/CFDs does not give you any entitlements or rights to the underlying assets (e.g. the right to receive dividend payments). CFDs carry a high risk of investment loss.