Most investors are so busy looking at a stock’s market action that they don’t take a serious look at the stock’s float. That’s a mistake because the number of floating shares can give you a hint of a biotech stock’s potential volatility.
Floating shares defined
With a publicly-traded company, floating shares — “float” in trader-speak — refers to the number of shares issued that can be traded by market participants. The float equals its total number of shares minus any restricted stock.
Why floating shares matter
A low amount of floating shares indicates that a stock could be subject to extreme moves in the event of a catalyst. In biotechs, I consider a stock to be “low float” if the number of floating shares is 50 million or less, and I typically trade stocks with a float ranging from 10 million to 100 million. When a stock has floating shares in this range — even if it is on the low end — it typically has sufficient liquidity.
By comparison, If only 500,000 shares are available to trade, the stock is inherently less liquid, and bid-ask spreads can get wide; the stock could rise or fall significantly if a market participant takes the ask or hits the bid, respectively.
Let’s take a look at an example.
Cara Therapeutics Inc. (CARA) had a float of 26.85 million shares, which I would consider a low float. Here’s a look at some statistics provided by Morningstar.
Since the stock has a “low float,” CARA could potentially see extreme moves.
Thus, when the company had a negative catalyst this summer when it announced top-line results from its Phase IIb trial of oral CR845 in chronic pain patients with osteoarthritis of the hip or knee, the stock price plummeted.
Combine a catalyst with a low float and you get to see the law of supply and demand in action; in this case, traders were looking to sell, but there was low demand for the stock. When this happens, stock prices tend to fall fast.
As you can see from this chart, CARA shares plummeted nearly 40% after the announcement.
The bottom line
When you’re trading a stock, examine the float because it may impact the volatility of your position. If you don’t want to susceptible to significant drops, look for biotech stocks with a high number of floating shares. However, if you want some volatility, and want to potentially generate a high degree of profits, factor lower floats into your decision-making process.
Kyle Dennis runs Kyle Dennis’ Biotech Breakouts (biotechbreakouts.com). He is an event-based trader, who prefers low-priced and small-cap biotech stocks.
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