Low Float Stocks: Exploring Scarcity and Volatility

Low-float stocks are those that have a small number of shares available for public trading. This can lead to higher market volatility due to the limited supply of shares (the scarcity effect), which can result in larger price swings. So while low-float stocks might offer potential returns, they also come with high risk.

Let's explore how low float, scarcity, and volatility are connected, and take a closer look at the risks that follow.

What Are Low Float Stocks?

The float, often expressed as a percentage of overall shares, typically constitutes 10% to 25% of the share supply for low-float stocks. In contrast, high-float stocks have a larger percentage of total shares available for public trading.

In terms of quantity, a low float generally ranges between 10 million and 20 million shares.

The limited availability of shares can make low-float stocks challenging to buy or sell, potentially leading to significant price fluctuations over a short period.

Bid-Ask Spread on Low Float Stocks

The bid-ask spread is an important concept in the context of low-float stocks because it directly impacts the trading of these stocks. It's the difference between the purchase and sale price a brokerage would offer, and it tends to be wider for low-float stocks compared to regular shares. This is due to the associated risks.

For example, PrimeEnergy Resources, an independent oil and gas exploration firm, had a $3 spread on shares valued at around $65. In contrast, the spreads on regular and high-float stocks are often no more than a few cents.

The Scarcity Effect and Volatility

Since many traders are trying to get their hands on some of the limited shares, trading volumes are increasing significantly. Traders, therefore, find themselves trading in a market where the share price can and does change rapidly.

The exaggerated price movement and volatility make decisions more challenging than with high-float shares. In such an environment, risk exposure skyrockets.

Low-Float Stocks Volatility Example

Low-float stocks of Data Storage Solutions are a good example of price volatility.

The following day, trading opened at $12.60 and closed at $9.68, with more than 48 million shares traded. This means that the total float of 4.2 million shares was traded around 12 times in a single day.

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Risk Considerations

A limited number of shares and high trading volumes cause fast shifts in the stock market. Even the smallest trades can lead to major changes in the stock price, so forecasting price movements becomes very difficult.

The rapidly shifting market dynamics are among the greatest risks in trading low-float stocks.

All of the above ultimately leads to higher transaction costs for investors as brokerages look to mitigate risks.

Market Manipulation and Risk Management

Besides inherent risks, low-float stocks are often targets for market manipulation, such as pump-and-dump schemes.

To manage these risks and exposure to market manipulation when trading in low-float stocks, investors usually maintain a diverse portfolio. Diversification spreads the risk across several stocks.

In addition to diversifying, any investor should define sensible stop-loss orders to manage losses.

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Low Float Phenomena

Low-float shares are a highly volatile investment vehicle. The low number of shares provokes the scarcity effect, so the supply and demand oscillate wildly, and potentially lead to volatile price action.

Low-float stocks can be a compelling short-term addition to a broad and diverse investment strategy. In these scenarios, stop-loss orders on the investments could help.

You should do due diligence before committing to this high-risk, potentially rewarding investment strategy. If you choose to invest in low-float stocks, it's best to proceed with caution and lots of research. All the information in this blog is purely educational and should NOT be considered advice.