Floating Along in a World of Penny Stocks
Dear Penny Stock Millionaire,
One of the most important concepts for you to learn as you start your trading career is what makes stock prices rise and fall.
- What drives volatility?
- What makes a stock jump 336% in a single day?
- What makes a ridiculous selloff occur first thing in the morning?
The simple answer? Supply vs. demand.
Today I’m zeroing in on one factor affecting supply vs. demand of penny stocks.
Back in college, I wanted to be an economics major. Then I took a class and it was sooo boring. I hated it! I switched majors to philosophy. Know what? I’m glad I switched but I’m also grateful I took the economics class because I learned the basics about how markets work.
Supply vs. demand is the age-old law of trade. But how does this apply to trading the stock market?
The answer to that is stock float.
One of the most important things I look for as a trader is stock float. When I’m creating my stock watchlist, I know I can trade around certain patterns that low float stocks undergo.
What’s stock float? I’m glad you asked. That’s what I’m teaching you today, so put on your learning cap and let’s get started.
What is a Stock Float?
Stock float is the number of freely traded shares of a particular stock. But it’s not quite that simple…
When a company goes public, the board authorizes the creation of a certain number of shares. Based on the corporate charter, this is the maximum number of shares a company can legally offer. An increase in the number of shares must be voted on by the shareholders.
Typically, a company issues less than the authorized amount. This is so they can raise more funds down the road without having to get approval from the shareholders.
For example, say Company X decides to raise capital through an IPO (initial public offering). Their board of directors authorizes the creation of one million shares. Those shares are called authorized shares.
The company offers 500,000 shares to trade on the open market. These shares are referred to as float shares. They’re the shares you and I can trade.
The company also issues 200,000 shares for company insiders or key employees as part of a stock option plan. These restricted shares can’t be transferred until certain conditions are met. This can include holding the shares for a specific period or meeting corporate milestones.
In this example, the total outstanding shares add up to 700,000. The company holds another 300,000 shares they can issue in the future. The stock float is 500,000 shares.
Keep in mind that sometimes a large percentage of stock is owned by institutional investors like mutual funds. Usually, institutional investors buy and hold for long periods. While they don’t reduce the float, effectively, they reduce the number of shares trading on the open market.
The kinds of stocks I trade, penny stocks, are rarely held by mutual funds or institutional investors. This means the number of outstanding shares is a lot closer to the number of float shares. I’ll show you how to find that information later in this post.
Benefits of Understanding Stock Float for Traders
Back to supply vs demand…
When the float is low (I’ll define low float in the next section) there are fewer shares available to trade on the open market. This can have a huge impact on the price movement of a stock.
It’s the basic economics principle I learned back in college: If demand is high and supply is low, prices go up. If demand is low and supply is high, prices go down.
It works exactly the same way when trading penny stocks.
Types of Stock Float
In general, I think of high float and low float stocks. Whether a stock is high or low float depends on the number of shares available to trade.
There’s not a set number of shares that make a stock high float. But the consensus agreement seems to be somewhere in the 15 to 20 million range. Anything lower than 15 million shares in the float and most traders consider a stock to be low float.
High float stocks tend to be less volatile because there are so many shares available. It takes a lot more buying power to move the stock price higher. While price movement might follow a market or sector trend, they don’t often have big swings because supply meets demand.
Which is why I focus most of my energy on low float stocks …
What is considered a low float stock? You might have looked at the numbers above and thought to yourself, “Wow, that’s a difference of 5 million shares between low and high float. How does that work?”
Good question. Like so much in the stock market, this isn’t an exact science.
According to Tim Bohen, Co-editor of the Penny Stock Letter, anything lower than 10 million is considered low float. So which is it? 10 million shares? 15 million? Or some other arbitrary number?
Since I’m focused on penny stocks, let’s go with Bohen’s number and say 10 million floating shares is ideal for a low float stock.
Using Stock Float
Now that you have an understanding of stock float, how do you use the information to increase your possibility of trading success?
First, you should understand how to find the float of a stock.
There are a few ways that you can accomplish this, one is through a stock screener. Some brokers have stock screeners built in, or you can use websites that will perform that function for you.
For example, you can get a sorted database of low float stocks (under 10 million floating shares) at lowfloat.com.
A word of caution, if you’re using something like lowfloat.com to identify low float stocks, I definitely recommend you do further research. The site will steer you in the right direction but you also need to check their findings against other data.
The Bottom Line
Alright I’ve gone on long enough for today, to wrap up today, stock float is one of the most important indicators that you can look at before you invest.
Tomorrow, I’ll go over exactly how you can (and should) use float in your trading strategy. So stay tuned!
Editor, Penny Stock Millionaires