Most biotech investors spend so much time focusing on a stock’s market action that they overlook the stock’s float. That’s a mistake because the number of floating shares can be a strong indicator of a biotech stock’s potential volatility.
- What Are Floating Shares?
- Why Floating Shares Matter
- The Bottom Line
What Are Floating Shares?
With a publicly-traded company, the 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.
Businesses rarely release all the shares they issue at once. Instead they usually keep a number of restricted stocks for their directors, officers and employee benefits packages and retirement plans. Some organizations also keep back some stocks to use for capital later. For example, a business might use their restricted stocks as capital to buy another organization. The number of shares released to the public are the floating shares.
Why Floating Shares Matter
A low number of floating shares indicates a stock could be subject to extreme moves during a catalyst event. In the biotech trading industry, I consider a stock to be “low float” if the number of floating shares is 50 million or less. I typically trade biotech 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 enough liquidity.
By comparison, if only 500,000 shares of a biotech stock are available to trade, that stock is inherently less liquid and bid-ask spreads can get wide. The value of extremely low float biotech stocks can rise or fall significantly if a market participant takes the ask or hits the bid respectively.
Consider the example of Cara Therapeutics, Inc. (CARA), a biotech business that develops therapies to treat pain and inflammation. In mid-2017, it had a float of 26.85 million shares. I would consider this a low float. Since it had a low float, CARA was vulnerable to extreme moves during a catalyst.
That catalyst occurred during the summer of 2017, when Cara Therapeutics announced top-line results from its Phase 2b trial of oral CR845 in chronic pain patients suffering the effects of osteoarthritis of the hips and knees. The drugs saw hip patients reduce their pain by 39% and knee patients reduce their pain by 35%. While these results aren’t bad, they were not convincing enough for the market. The price of the CARA stocks plummeted almost 40%, causing many investors to lose money. However, those who had observed the float and knew the catalyst event was approaching were not surprised.
Combine a catalyst with a low float and you observe the law of supply and demand in action. In this case, traders wanted to sell their CARA stock, but there was low demand for it. When this happens, stock prices typically fall fast.
The Bottom Line
When you’re trading a biotech stock, don’t forget to assess the float, because it may impact the volatility of your position. If you don’t want to be susceptible to significant value drops, look for biotech stocks with a high number of floating shares. However, if you enjoy playing a riskier game with more volatile stocks that could potentially generate a high degree of profits, consider low float biotech stocks. For more trading tips, listen to our informative podcasts.