With to-the-moon emojis at all-time highs, there are many trading examples showcasing the power and opportunities small float stocks offer.

A stock’s float represents the number of shares that are available for public trading.

While small float stocks are popular vehicles for traders seeking asymmetric returns— trading these stocks can also bring about sizable losses just as quickly.

That’s why it’s so important that traders know some of the ways they can improve their odds of success when speculating in these stocks.

Today I’m going to share with you the mechanics in-play, how they work, and extract information to make better trading decisions.

How is a stock’s float calculated?

A stock’s float is the number of shares of stock available for public trading. The figure does not include shares held by controlling investors or company owners.

Instead, the number is derived by taking the total number of shares of a company and subtracting any restricted shares.

Restricted shares represent stock granted to company executives and directors as a form of compensation.

These shares are non-transferable and must be traded in compliance with special Securities and Exchange Commission (SEC) regulations.

The amount of floating stock a company has can also change over time, as companies might sell more stock to raise money, or company stakeholders might sell their holdings.

Any shares that are purchased, sold, or even shorted by investors in the open market do not affect the float because these actions do not represent a change in the number of shares available for trade.

They simply represent a redistribution of shares. In addition, the float is not affected by the creation and trading of options on a stock.

How to approach trading in low float stocks

A float of 10-20 million shares is generally considered to be a low float.

In contrast, a company like Apple (AAPL) has a float of around 16 billion available shares for the general public to trade.

Stocks with low floats are popular with day traders because they can be used to earn relatively large profits throughout a single trading session.

When searching for low float trading ideas, there are certain key questions that a trader should ask his or herself before committing to a trade. They are:

1.    Is there any kind of catalyst that is expected in the near future?

2.    Is there ample liquidity in the stock?

When it comes to the first item on this list, other than pre scheduled earnings announcements it is impossible to accurately predict when company news is set to be released.

Therefore, it is important to understand that before some sort of news-related catalyst potentially sparks an upward surge in a low float stock there is often a dearth of liquidity in these stocks.

Under such conditions, traders often use scans to identify situations where volume has increased significantly during overnight and pre-market hours, to find situations where “the market” senses some sort of catalyst may be close at hand.

The type of relative increase in volume that should be sought by a trader using this method is a minimum of 1.5 X greater than the monthly average.  

For example, if stock ABC shows average trading volume of 250,000 shares over the past 30 days and pre-market activity is shown to be 750,000 shares, the relative volume would register at 3 times the average amount.

This type of trading is favored by day traders that look to scalp fast intra-day moves for quick profits.

Scalping is a popular form of trading that requires a trader to have the discipline to either take small profits when a stock moves quickly in their favor, or to stop out when the stock moves against them.

Some traders, however, may prefer to employ a strategy like swing trading to profit in these stocks.

In contrast to the very short-term holding periods and almost split second decision making process required by scalpers, swing traders will look to enter a trade in anticipation of the stock rotating in their favor and keeping them in the trade for anywhere from 2 days to a few weeks.

A key part of being successful when using this strategy with low liquidity stocks, though, is to be able to gauge whether the stock is being accumulated, usually as prices are falling or moving within a range for an extended period of time.  

Traders are equipped to find stocks that are secretly being accumulated

One thing you might not realize about these small companies is that many actually have institutional ownership from some of the most well-known mutual fund families.

For these large institutions to be able to take positions in these stocks, it can often take several weeks-to-months of buying small amounts at a time to prevent the stock from rising too much during the accumulation process, which can cause unwanted attention from retail traders.

A real-world example of this could include an institutional analyst that recognizes the potential for a certain drug to have favorable trial results, causing him to make a recommendation to his Portfolio Manager to build a position before the trial results are due.

Now, while they certainly aren’t foolproof, there are a few ways retail traders sniff out when a stock’s shares are being accumulated.

One popular way is to use volume.

Whether it be via dark pools or specialized volume indicators, volume is an ideal tool for uncovering what’s going on beneath the surface.

Specifically, most charting services offer the Accumulation Distribution Line as part of their charting packages.

This indicator is somewhat complex in its construction, so it behooves you as a trader to become more familiar with it on your own time. Details regarding its construction and practical application can be found here.

In the meantime, we can look at an example of how it can be used to detect the stealthy accumulation of a company’s shares simply with the understanding that it is a volume-based indicator designed to measure the cumulative flow of money into and out of a security.

Based on the theory that volume precedes price, a trader who is in search of stealthy share accumulation can look for positive divergence by this indicator against a stock’s price.

An example of this is shown below, where, just last month, shares of Ocuphire Pharma (OCUP), a biotech company with a small float of just 10M shares, were testing the all-time lows set back in November ‘20, but the Accumulation Distribution Line was showing signs of accumulation as it made a series of higher lows against lower prices.

Figure 1

Like all indicators, the Accumulation Distribution Line doesn’t always work.

That’s why it is important to use it in conjunction with other indicators to identify situations with a higher probability of success.

In this case, the positively diverding Accumulation Distribution Line, when combined with the test of November support and positively diverging RSI momentum was the kind of favorable indicator confluence that traders should look for when seeking these high probability setups.