My Go-to Volatility Indicator for Penny Stocks
Dear Penny Stock Millionaire,
I’ve brushed on the importance of looking at the float of stocks before when doing your analysis, but now it’s time to dive in-depth about the benefits of low float stocks and trading them.
In terms of float, low is the way to go when it comes to trading penny stocks.
In case you’re scratching your head, let me clarify: I’m not talking about the huge slow-moving floats like you see in the Macy’s Thanksgiving Day Parade. In the stock market, “float” refers to the number of shares of a stock that are available to the public for trading.
Low float stocks tend to offer lots of volatility, which means that they can spike in big ways that can potentially net you profits.
However, trading low float stocks can also present a high level of risk, so you have to know what you’re doing. I’ll tackle that in this post.
Here, I’ll offer an introduction to low float stocks — what they are, how you can benefit from trading them, and some of the best indicators and tips for how to get started with them.
Not to be roundabout, but before you can understand low float stocks, you need to understand a little something called shares outstanding.
What Are Shares Outstanding?
The shares outstanding refers to all of the shares of a company’s stock. This includes shares held by all shareholders, including what are called “restricted shares,” which are held by company insiders/officers and big blocks of shares held by institutional investors.
If you’re looking at a company’s balance sheet, you can find the number of shares outstanding listed by the heading “Capital Stock.”
The shares outstanding are an important piece of the puzzle when calculating a company’s market capitalization.
So there are the shares outstanding, which include the restricted shares that wouldn’t readily be available to traders like you and me.
Then, there’s what’s called the “float”.
What Are Float Shares?
The float refers to the number of shares that are freely available for trading.
Even if a company has a massive amount of shares outstanding, if many of them are held by insiders, they aren’t necessarily tradable for people like you and me.
If the number of shares available for other traders is fairly low, the stock is said to have a low float.
There isn’t a specific number that denotes a low float. Traders might have their own standards for what constitutes a low float. For instance, some might consider a stock with 10–20 million shares that are freely available for trading a low float stock.
Benefits of Trading Low Float Stocks
Here’s the thing about low float stocks: they don’t have a ton of supply.
This means that any catalyst that causes demand (or lack thereof) will have a larger effect on the shares that are available. In plain English, this means the stock is more volatile.
Wait, so is this good news or bad news for traders? A little bit of both, because this simultaneously raises the risk, but also the potential rewards. Let’s talk about the risks first.
Risks of Low Float Stocks
The volatility that is inherent to a low float stock means that it can have rapid moves in either direction.
Since there aren’t many available shares, the supply and demand can be impacted quickly and drastically based on news (good or bad).
Because of this, these stocks are ripe for fraudulent campaigns like the “short and distort,” so it’s always important to perform both fundamental AND technical analysis on the stocks and to dig deep to determine the validity of press releases and news.
Adding to the risk factor, low float stocks are more common for micro- or small-cap companies. These companies aren’t as established as large-cap companies and tend to have more volatility and risk inherently. So, the low float simply compounds this risk.
Rewards of Low Float Stocks
The good news is that just about everything that makes low float stocks risky also makes them potentially rewarding as well.
Because these stocks can have big moves, as a trader you can grab potential opportunities if you can predict or get ahead of the trend.
While news is generally a catalyst for movement in a low float stock, if you’re intelligent about keeping watchlists, conducting both fundamental and technical analysis, and identifying hot sectors, you can potentially benefit.
As I explain in my PennyStocking 101 guide, “since there’s not a lot of supply out there and if the company announces good news, ‘low float stocks’ can spike 50%, 100% or even 200% in a day whereas stocks with many publicly available shares can’t spike that much since there are sellers at every level on the way up willing to take profits.”
Now that you’ve evaluated the pros and cons of trading low float stocks, maybe you’re intrigued.
That leads to the next question: how to find low float stocks? There are two key indicators that you need to look at before you start trading low float stocks.
1. High Volume
When it comes to the stock market, volume equals movement.
Volume is the number of shares of a stock traded during a finite period of time. This is based on every transaction — because for every buyer, there is a seller. So every buy and every sell aren’t added to the volume separately, but rather as a single transaction unit.
Volume is an important indicator to use as part of your technical analysis because it can help you determine the strength of the price movement of a given stock within a given time period.
When a price moves, the bigger the volume, the bigger and more meaningful the overall move. This is particularly true for low float stocks. So when looking at low float stocks, be sure that they have sufficient volume before getting into a trade.
2. News Catalyst
The very fact that a stock is low float indicates that there is a relatively small supply of stock shares available for trading. This means that the supply and demand can shift on a dime.
So when a juicy news catalyst hits, it can strongly impact the price of a stock in question, causing it to rapidly rise (or fall, depending on the news) in price.
As a trader, it’s possible to profit both as the price goes up, or as the price goes down — it’s just a matter of figuring out which way the stock is moving.
How can you use the news to your advantage?
Be sure to research the catalyst to see if the news “has legs.” Cut through the bullshit of self-serving PR statements and try to find the real scoop yourself.
Be sure to back it up with research from the earnings reports and by checking out the stock’s charts to see if you can find any strong patterns.
If you’ve identified a strong news catalyst and can back it up with research, it’s a key indicator that a low float stock could be moving in ways that could offer trading opportunities.
Of course, I should add a caveat about rumors. Rumors can move a stock price, but you shouldn’t necessarily trust them!
The Bottom Line
Low float stocks can be a great way to profit off of the stock market if you are willing to do your research and make sure you have your analysis nailed down.
The fact that they are low float means that the volatility in the trade is going to be much higher. More volatility = More price action = More potential profit$$.
Tomorrow I’ll tell you how to start trading and profiting from low float stocks in 5 easy steps. Stay tuned.
Editor, Penny Stock Millionaires