What is the floating action?
Free float is the number of shares available for trading in a particular stock. Weak float stocks are those that have a low number of shares. Free float stocks are calculated by subtracting closely held stocks and limited stock of the total outstanding shares of a company.
Closely held shares are those held by insiders, major shareholders and employees. Restricted shares refer to insider shares that cannot be traded due to a temporary restriction, such as the lock-up period after a initial public offering (IPO).
A stock with a small free float will generally be more volatile than a stock with a large free float. Indeed, with fewer shares available, it may be more difficult to find a buyer or a seller. This results in a greater spreads and often a lower volume.
Key points to remember
- Free float refers to the number of shares a company has available to trade on the open market.
- To calculate a company’s free float, subtract its restricted stock and restricted stock from its total number of shares outstanding.
- Floating shares will change over time as new shares may be issued, shares may be redeemed, or insiders or significant shareholders may buy or sell the shares.
- Weak floating stocks tend to have higher spreads and higher volatility than a comparable larger floating stock.
- Investors may find it difficult to enter or exit positions in stocks with low free float.
Understanding Floating Stocks
A company may have a large number of outstanding shares, but limited floating stock. For example, suppose a company has 50 million shares outstanding. Of those 50 million shares, large institutions hold 35 million shares, management and insiders hold 5 million, and employee share ownership plan (ESOP) owns 2 million shares. The free float is therefore only 8 million shares (50 million shares less 42 million shares), or 16% of the shares in circulation.
The amount of a company’s free float may increase or decrease over time. This can happen for various reasons. For example, a company may sell additional shares to raise more capital, which then increases the floating stock. If restricted or restricted stock becomes available, the floating stock will also increase.
On the other hand, if a company decides to set up a share buyback, the number of outstanding shares will decrease. In this case, the floating shares as a percentage of outstanding shares will also decrease.
Why floating stocks are important
A company’s free float is an important number for investors because it indicates how many shares are actually available to be bought and sold by the general investing public. Low float is usually an obstacle to active trading. This lack of trading activity can make it difficult for investors to enter or exit positions in stocks with limited float.
Institutional investors often avoid trading companies with smaller free floats because there are fewer shares to trade, leading to limitation liquidity and wider bid-ask spreads. Instead, institutional investors (such as mutual funds, pension funds, and insurance companies) who buy large blocks of shares will seek to invest in companies with larger free float. If they invest in companies with large free float, their large purchases will not have as much impact on the share price.
A company is not responsible for how stocks within the float are traded by the public – it is a function of the secondary market. Therefore, stocks bought, sold or even sold short by investors do not affect the free float because these stocks do not represent a change in the number of stocks available for trading. They simply represent a redistribution of shares. Likewise, the creation and options trading on a stock do not affect the free float.
Example of floating stocks
As of June 2020, General Electric (GE) had 8.75 billion shares outstanding. Of this number, 0.13% was held by insiders. 63.61% were held by large establishments.Therefore, a total of 63.7% or 5.57 billion shares were likely not available for public trading. The free float is therefore 3.18 billion shares (8.75 – 5.57).
It is important to note that institutions do not hold stock forever. The Institutional ownership number will change regularly, but not always by a significant percentage. The fall in institutional ownership coupled with a decline in share price could signal that institutions are dumping stocks. The increase in institutional ownership shows that institutions are accumulating shares.
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