A Conversation About Low Float Stocks and Why Traders Should Understand Them

As a recent example, John McAfee’s new company has caught everyone’s attention. Most of that interest comes from the fact its stock price has been spiking since McAfee took $MGT over through a reverse merger. At one point, it had climbed more than 1,000% in just 2 weeks. But why was it spiking like this? One reason could be its low float. The following message was shared while $MGT was just starting to trade higher:

Screen Shot 2016-05-19 at 5.13.53 PM

What does this message mean? Why should we understand it? The following Q&A details our conversation with Dave Kelly (the trader who shared the above message and one who has a fairly extensive background in trading). We hope this talk can help new traders and investors better understand the market.

1. In your opinion what defines a low float stock?

For me any stock with a float fewer than 15 million tradable shares is low float. Keep in mind that the float is different than the shares outstanding. The shares outstanding include restricted shares that are given to insiders and require permission from the SEC to be traded. So the shares outstanding is usually a higher number than the float. The float is the number of shares that the public can trade.

2. Do you think there are risks AND rewards to low float stocks? What are they?

RISKS: Low float stocks can be very risky to hold because they can have violent moves in either direction. With so few shares available to trade, the impact on supply and demand can be significant. This is especially true if the company behind the stock is involved in a newsworthy event. Because news can drive the price, they are susceptible to organized “short and distort” campaigns. In addition to this, low float stocks are usually micro caps or very small caps; this adds additional risk for anyone considering holding them long term. In my experience, many of them are not even investable but they can become very tradeable under the right circumstances.

REWARDS: Because the moves to the upside can also be dramatic, there can be great reward in trading them. A few examples that come to mind that I’ve traded are MGT (the last week), DGLY (in late 2014), and APT (also in late 2014). I can’t think of one from 2015, which illustrates that the really good opportunities don’t come around that often.

If you are trading a low float stock, it’s important to look for liquidity; you don’t want to get stuck holding shares that you cannot sell (prior to a news event, these stocks do not generally have much liquidity – which is trading volume). However, since news is what usually drives these stocks to be tradeable, there tends to be a ton of liquidity in the ones that are good trading opportunities. In the three I mentioned above, you have John McAfee announced as Chairman of the Board and CEO (MGT), civil unrest due to police shootings and a call for body warn cameras (DGLY), and the Ebola crisis (APT) – these are pretty big news events and they usually cause me to look at the float size of any stock that may benefit. I don’t short low float stocks. I’m not a fan of infinite risk.

3. One common thing we see about low float stocks is this “hard to borrow” or “shares unavailable to short” message sent by brokers. Help new traders and investors understand this.

In order to short a stock, you must borrow the shares from a broker. Since the available shares in low float stocks is so small, there is often nothing available to borrow. It’s similar to a stock with a high short interest; at some point the shares that a broker can loan out become scarce. I do suspect that there is “naked short selling” in some of these low-float stocks but that’s another story – and another risk, come to think of it.

4. Do you think activity in low float stocks is the sign of a cycle beginning or ending – a market top or bottom?

I believe the Dow Theory says something about a rally in low quality stocks that is not confirmed by a rally in high quality stocks is a bearish signal. I think I read that in Technical Analysis of Stock Trends (which is a great book by the way). Ok, I digress, I see rallies in low float stocks as news driven, so I don’t make any correlation to the overall market.

Any final words of advice for anyone who finds themselves watching,
trading, or analyzing these stocks? Be very cautious! I always shorten my timeframes and try to never hold them overnight. And as always, practice a good risk management strategy. You can read about my risk management style right here.

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