Many of the most successful traders and investors I know all seem to have one thing in common —they find their own particular niche in the market.
There is a staggering variety of investment instruments out there and trying to learn and trade them all is a fool’s errand. Instead, many successful traders find their own corner of the investing world, learn its intricacies and profit off their very specific knowledge.
Specializing in this way allows you to make much more informed trades, identify and disregard stock scams, and limit your overall risk.
For some, trading low float stocks is that niche.
Trading low float stocks is not for everyone. They are notoriously volatile, so you have to have a high risk tolerance, but that volatility also provides a lot of profit opportunities for disciplined traders.
What is low float stock?
Float refers to how many shares a company has available for trading. A stock that is categorized as “low float” is any publicly traded stock that has relatively few shares available for trade on public markets.
Different traders use different standards to determine exactly how many shares constitute low float, but most would consider any stock that has around 10 million available shares or less to be low float.
To put that in perspective, Apple Inc., one of the largest publicly-traded companies in the world, has a float of over 9.5 billion shares.
How to determine a company’s float
Most websites listing stock prices also list companies’ floats, typically under a category such as “Statistics” or “Share Statistics,” but it’s also pretty easy to determine a company’s float on your own.
A stock’s float is determined by calculating the company’s outstanding shares minus restricted shares, which are the shares that are not publicly available because they are owned by institutional investors, company insiders, or are a part of an employee compensation plan.
Here’s a quick example of the calculation:
XYZ Widgets Inc. could have 100 million shares outstanding, but company management owns 40 million shares, an institutional investor owns another 40 million, and 10 million shares are set aside as a part of the employee compensation plan. That means the company’s floating stock available for public trading is only 10 million shares.
Some traders express float in terms of float percentage, which is the percentage of stocks available. In our example, XYZ Widgets has 10 million of 100 million shares available, which means it has a float percentage of 10%.
Every trader has their own opinions, but most traders believe that a good float percentage for a low float stock is less than 25%, but any lower than 10% is a sign of illiquidity.
What types of companies have low float?
Companies can have a small amount of floating stock for a number of reasons, and it is important to understand why a company has limited float before investing.
Closely held stocks
Some low float stocks are simply “closely held.” Such stocks may belong to large companies but have a large amount of restricted stocks because of institutional ownership, company insiders or a company compensation plan. These closely held shares rarely reach the open market and are not available for public trading.
Reverse stock splits
Other companies fall into the low float category because they’ve chosen to execute reverse stock splits. A company will often do this when the price of their stock is so low that they might get delisted from their exchange.
For example, if a company listed on the NASDAQ is trading below a dollar, they risk being cast off into the OTC markets, so they might decide that every 10 shares now equals one share.
That’s a 10:1 stock split and the price of their stock would go from say $0.50 to $5.00, but they would suddenly have a far fewer number of shares available.
Of course, another reason why a company would have a low number of shares available is that they are just getting started and simply haven’t issued that many shares.
Young companies may also have more restricted shares than more established companies since they tend to be more closely held at the onset due to a lock-up period that usually follows an IPO.
Investing in companies without a significant financial record carries its own risk, of course, but these companies are also some of the fastest moving.
Advantages of trading low float stock
Traders love low float stocks for one principle reason—volatility. Since, by definition, low float stocks have a lower supply of shares available, any increase or decrease in demand can have a profound effect on the stock’s price.
It’s Economics 101—simple supply and demand. When there’s a scarcity in any commodity that is suddenly subject to heavy demand, the price of that commodity quickly goes up. The opposite is true if everyone wants to sell that product.
This means that low float stocks are much more responsive to any news, financial updates, or rumors, and they can see massive price fluctuations within a single day’s trading.
That’s great if you can identify the stock’s momentum and trade accordingly. Traders who successfully trade low float stocks are adept at shorting when they see a stock falling and buying long as the stock rebounds.
For investors who have deeper pockets, low float stocks can also represent a relatively cheaper path to controlling a high percentage of a company’s outstanding shares. This is especially true of low float penny stocks. A cheap stock price combined with a low float could allow you to control the entire float of a stock.
Disadvantages of trading low float stock
High volatility can mean huge gains if you’re on the right side of the trade, but a sudden movement in a direction you didn’t expect can cost you a lot of money.
A one-day, 200% increase in stock price sounds pretty good unless, for whatever reason, you had decided to short that particular stock. That’s when you’d wish you were investing in a company that had a few more shares outstanding making for less dramatic price swings.
When you trade low float stocks, you also have to be especially careful to watch out for illiquidity. Stocks with an extremely low float, like a million shares or less, can be so lightly traded that you might be unable to quickly sell off a position should the market turn against you.
Watching your losses mount as you are unable to unwind a position is the low float stock trader’s version of watching a real-life horror movie. You see the carnage coming, but are unable to put a stop to it.
For this reason, most traders who specialize in low float stocks pay close attention to a stock’s trading volume before taking a position. Volume refers to how many shares trade in a given day, and if it’s not very many, you may have a lot of difficulty unwinding a position, which could lead to substantial losses.
A larger float eliminates that problem, but then you won’t see quite as much volatility.
Traders also look at “relative volume” which shows how many shares per day are trading now in comparison to average trading volume in the past.
Relative volume is expressed as a ratio, so if a stock is trading three times as many shares now as it did in the past, that’s a relative volume of three. Anything over two or so indicates that comparatively more shares are being traded, the stock probably has sufficient liquidity for the time being, and something is driving increased interest in the stock.
Low float stocks are also more susceptible to false news campaigns or pump and dump stock scams as unscrupulous traders try to take advantage of the volatility of low float stocks.
These scammers know that a rumor, even if it’s unfounded, can have a profound effect on the price of a low float stock, so they invent a news item on a stock in which they are major shareholders, spread it as widely as they can and sell their positions before the news is proven false.
Make sure you only trade off news items that come from reputable sources.
How to find low float stocks
Most brokerages and many stock market information sites offer stock screening software that allows you to find stocks based on a million different parameters including float percentage, past performance, recent trading activity, or just about anything else.
You can set the parameters to find any stocks with a float lower than 10 million shares and voila, you’ve found low float stocks. You can then filter the results down further to find low float penny stocks, low float stocks that are moving in a given direction, belong to a certain industry group, have high volume, etc.
If you only want to trade low float stocks for insurance companies that trade for less than $5 a share, have less than 10 million outstanding shares, and has spiked more than 20% in the last week, a screener will scan as many financial markets as you want to find the five or six stocks that meet your criteria.
In the coming weeks, I’ll review some of my favorite stock screeners, but there are several websites with free stock screeners that you can experiment with.
Trading low float stocks
I will address all the various strategies for trading low float stocks in another article, but hopefully I can give you a general sense of what most low float stock traders do.
Since low float stocks typically have higher volatility, most traders who specialize in them are day traders, meaning that they rarely hold positions for longer than one trading session.
Day traders specializing in low float stocks trade off news catalysts, or news items that will push a stock in one direction or another. They ride the upward wave by buying long and when other investors start to sell in order to lock in profits, they try to profit off the downward push by selling short.
In this way, experienced day traders will often buy and sell shares of the same stock on the same day to take advantage of the increased volatility inherent in companies that have fewer shares available.
The problem with waiting to come across a news catalyst is that it’s almost impossible to monitor enough news outlets. And when you do come across something, by the time you’ve read it, a million other day traders probably have too and you’ll be too late.
Many day traders solve this problem by monitoring stock prices through screeners, looking for stocks with dramatic movements backed up by a significant enough number of shares changing hands to indicate that something is going on.
From there, they’ll look at the stock’s chart and analyze technical indicators to try to determine if the price is still trending up, plateauing or heading back down and then trade accordingly.
This is a very generic summary of typical low float stock trading, but I hope it demonstrates the technical skills and risk tolerance necessary to make it as a trader of low float stocks.
Selecting a brokerage to trade low float stocks
Since you can find low float stocks that trade on pretty much any stock market in the world, it isn’t necessary to find a specialty broker. Even if you plan on trading low float penny stocks or low float stocks trading over the counter, almost every brokerage can handle your transactions.
That’s not to say that all brokerages are the same, however.
In short order I’ll write up reviews of the online brokerages I have tried over the years, but in general, you can select a good brokerage by keeping the following things in mind:
- Do they trade the class of low float stocks you want?
Ninety percent of brokerages will handle any low float trades you want to make, but there are a few that limit the penny stocks you can trade or don’t have access to OTC markets.
Make sure your securities brokerage handles exactly the products you will be incorporating into your strategy.
- Will they allow you to exercise your strategy?
Most traders who target low float stocks like to engage in short selling when they anticipate and want to profit from a downward price swing. Check your brokerage’s rules regarding short sales if you want to incorporate them into your trading strategy.
If you’re getting into low float stocks, you will probably be day trading which means commissions are a critical question.
Day trading involves a lot of transactions and if you’re getting hit with a high commission every time you make a move, it will seriously eat into your ability to make money trading stocks.
Many brokerages are offering free trades these days but that doesn’t always apply to all transactions, especially if you’re purchasing stocks over the counter.
Think carefully about what kind of trades you anticipate making and make sure you know exactly how much you’ll pay per trade.
- Trading platforms
Look carefully at a brokerage’s trading platform before committing. Is the layout intuitive? Will you be able to make transactions quickly and monitor your positions easily?
You also may find yourself staring at their platform for long periods over the course of a trading day, so make sure you’re comfortable with the layout and how busy your screen is.
Most brokerages allow you to test run their trading software and I strongly urge you to do so before you open an account.
Stock screening tools make it so much easier to find low float stocks. They’re indispensable, especially if you are looking for stocks that fall into a very specific niche. Not all stock screening tools are the same, however. Some have so many options they’re overwhelming, while others don’t offer enough criteria with which to screen.
If you find a free online screener that you really like, it’s not so important that your brokerage offers one too, but it is much easier to do your screening and your trading all in the same place.
- Customer support
You really don’t want to find yourself in a situation where you desperately need to make a transaction and a glitch in your trading software won’t allow you to do it, but it does happen. The question then is how quickly does your brokerage respond and help you overcome the problem?
Read online reviews of potential brokerages and see how customers rate their customer support teams.
- Continuing education
Some brokerages provide excellent educational resources that can really help you develop as a trader.
Even if you are dedicated to trading low float stocks and low float stocks alone, there is always much to learn about various trading strategies and styles of analysis. The market is always changing. If you don’t keep up, your days as a trader will be numbered.
- Investment research
Some larger brokerages give you access to their massive Wall Street research departments.
This might not provide a huge advantage if you are day trading and paying more attention to price swings than companies, but staying on top of economic indicators and larger, macro market trends can help you in your overall financial decision-making.
This shouldn’t ever be an issue if you are going with one of the big name brokerages, but if you found an obscure online brokerage or investment adviser, you should probably double check that they are in good standing with the Financial Industry Regulatory Authority.