Three Fibonacci Trading Strategies + Infographic & Video Explanation

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At times it feels like traders give the Fibonacci trading sequence an almost mystical power. Yet, despite its mysterious accuracy in trading and in nature, Fibonacci is nothing more than simple retracement levels. These levels are the only representative of where a security could have a price reaction, but nothing is etched in stone.

What is the Fibonacci trading strategy?

In the stock market, the Fibonacci trading strategy traces trends in stocks.  When a stock is trending in one direction, some believe that there will be a pullback, or decline in prices.  Fibonacci traders contend a pullback will most likely happen at the Fibonacci retracement levels of 23.6%, 38.2%, 61.8%, or 76.4%. As we’ll discuss below, a pullback is also possible at 50%.

For instance, if GE (NYSE:GE) is selling at $20 and rises to 21, the pullback will be 23, 38, 50, 61, or 76 cents. Fibonacci traders will expect support at these levels.

On the contrary, some day trading experts see these Fibonacci numbers as a short-sell strategy. For instance, if GE stock is at $21 and falls to $20.62, some Fibonacci traders may see the 38 cent drop as a good sign to short the stock.

For all intents and purposes, the Fibonacci retracement is a valid trading strategy to trade stocks. However, Fibonacci numbers aren’t always the best indicators of a trend.

What do trading experts say about Fibonacci trading?

Chris Svorcik is a forex trader who often uses Fibonacci trading. He says that traders can use the Fib method, but says that they need more experience to master Fibonacci trading. 

“I am a huge fan of EW[Elliott Wave, another trading strategy] and Fibs, but it does require some experience to handle it. Using moving averages does in my view shorten the learning curve. Also using price swings or EW as a support tool rather than a main trading tool, I think, makes it less complicated, ” said Svorcik.

Daniel Leboe, an analyst with Zach’s, also likes using the Fibonacci retracement. However, he also advises caution to traders when using the trading strategy. 

“Fibonacci retracement is a good tool to use when deciding if now is a good time to buy, but do not look at it as the holy grail. In this volatile market, we are prone to blow through levels. Make sure you have a shopping list of stocks you like ready so that you can pull the trigger when the time comes,” said Leboe.

“Fibonacci queen” says traders should have a plan with trading strategy

Experienced trader Carolun Boroden trades so often with the Fibonacci strategy that she’s been dubbed the “Fibonacci Queen.” She says that even if traders follow the Fibonacci strategy, they should still have a specific trading plan.

“You [need] a specific plan that describes what your trade setups are; how you’re going to get into the trades; what you are going to risk; how you’re going to manage the trade and take profits; how you’re going to have certain targets, or you’re going to trail a stop.”

Carolun Boroden

Does the Fibonacci trading strategy predict stock market trends?

While some financial experts are skeptical of the Fibonacci strategy, it has predicted other downturns before. In February before the COVID-19 crisis, the Dow Jones retraced about 50% before the economic crash. Andrew Adams is a technical analyst at Saut Strategy. He wrote in a research note that the pullback at that ratio meant an end to the previous bull market.

“Rallies of all sizes do regularly eventually pull back at least to the 38.2%-50% Fibonacci levels,” wrote Adams.

Not long after that retracement, the bear market devastated the stock market.

While the strategy has predicted a bearish market, it can also predict a bullish market as well.  According to CNBC’s Jim Cramer, Boroden’s Fibonacci strategy predicted a stock market recovery in May.  

“The charts, as interpreted by Carolyn Boroden, suggest that the major averages are still in rally mode, but it’s a precarious rally where you need to proceed with caution if we fail to break out from these levels and slip back to where we were not that long ago,” said Cramer.

“She thinks the S&P is a buy right here. There’s too much going right in her charts for her to say anything else. However, she says you should be ready to sell if we fail to break out over the 200-day moving average, eventually,” added Cramer.

While the Fibonacci trading strategy isn’t exact, if used correctly, it can predict major stock market trends. The different Fibonacci trending strategies will be explored in this article.

Fibonacci Trading Personas

Before we go into the gritty details about Fibonacci trading strategies, it is worth our time to discuss the different types of fibonacci trading personas you might encounter. While mostly fictitious, these three personas do an awesome job of summarizing common trading practices.

Fibonacci Persona Infographic

Which Persona Best Describes You

You must first ask yourself the question of how you plan on leveraging Fibonacci in your trading regimen. If you haven’t done so already, think about writing a trading plan to review before, during, and after the market closes.

Depending on what the market is offering, you might fluctuate between the low and high volatility Fibonacci trader. Or, you may find yourself only using Fibonacci as an ancillary tool to support your trade plan thesis.

Fibonacci assists in seeing hidden levels of support and resistance to help you determine you entry and exit targets. To what degree you emphasize these levels depends upon your own conviction with the tool.

Chapter 1: Origin of the Fibonacci Sequence

Does this numbering scheme mean anything to you – 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377? Not really, right?

Well, don’t be surprised, not many recognize the pattern. These numbers are the root of one of the most important techniques for identifying psychological levels in life and in trading.

Behold the mighty Fibonacci ratios!

Hundreds of years ago, an Italian mathematician named Fibonacci described a very important correlation between numbers and nature. He introduced a number sequence starting with two numbers: 0 and 1.

Building a Fibonacci Sequence [1].

Again, we start with 0 and 1.

0, 1

The sequence requires you to add the last two numbers to get the next number in the sequence. Following this logic, we get the following equation:

0 + 1 = 1

Now we have our third number in the sequence – 1. See below for the updated sequence.

0, 1, 1

Now we add the last number in the sequence to the previous number once again:

1 + 1 = 2

We again update our sequence with the number 2.

0, 1, 1, 2

and then…

1 + 2 = 3

and then…

0, 1, 1, 2, 3

and then….

0, 1, 1, 2, 3, 5

and then….

0, 1, 1, 2, 3, 5, 8

and then….

0, 1, 1, 2, 3, 5, 8, 13

This process goes on to infinity.

Chapter 2: Key Fibonacci Ratios

Fibonacci discovered every number in the sequence is approximately 61.8% of the next number in the sequence.

55 / 89 = 0.6179775280898876 = 61.8%

233 / 377 = 0.6180371352785146 = 61.8%

144 / 233 = 0.6180257510729614 = 61.8%

This is not the only correlation. Fibonacci also uncovered that every number in the sequence is approximately 38.2% of the Fibonacci number two steps ahead.

(13, 21, 34)

13 / 34 = 0.3823529411764706 = 38.2%

(21, 34, 55)

21 / 55 = 0.3818181818181818 = 38.2%

(55, 89, 144)

55 / 144 = 0.3819444444444444 = 38.2%

(144, 233, 377)

144 / 377 = 0.3819628647214854 = 38.2%

Also, we have another ratio! Every number in the Fibonacci sequence is 23.6% of the number after the next two numbers in the sequence:

(55, 89, 144, 233)

55 / 233 = 0.2360515021459227 = 23.6%

Pretty cool, huh?

Chapter 3: Fibonacci Ratios Everywhere

Fibonacci Sea Shell

Fibonacci Sea Shell

Here is an example of the Fibonacci in nature with this sea shell. The volume of each part of the shell matches exactly the Fibonacci numbers sequence. Thus, each part of this shell is 61.8% of the next.

It works the same way with this aloe flower:

Aloe Flower Fibonacci sequence
Aloe Flower Fibonacci

If we separate the aloe flower into even particles, following the natural curve of the flower, we will get the same 61.8% result.

This ratio is not only found in animals and flowers. This ratio is literally everywhere around us. It is in the whirlpool in the sink, in the tornados when looked at through satellite in space or in a water spiral.

The Fibonacci ratio is constantly right in front of us and we are subliminally used to it. Thus, the human eye considers objects based on the Fibonacci ratio as beautiful and attractive.

On that token, big corporations like Apple and Toyota have built their logos based on the Fibonacci ratio. After all, these are two of the most attractive and engaging logos in the world.

Still not a believer, check out this study from Harvard’s math department where they cite a study from Dr. Rowland from Merrimack College on how to tie knots using Fibonacci [2].

Chapter 4: Fibonacci Ratios in Trading

Coming back to the markets, trading with Fibonacci isn’t all that complicated.

A logical method for entering a trade is when the stock is going through a pullback.

Well, where would you think to place your entry?

Without knowing anything about Fibonacci trading, you would likely say 50%.

That my friend makes you a Fibonacci trader.

That’s what Fibonacci trading is about, understanding stocks do not move in a linear fashion. Fibonacci helps new traders understand that stocks move in waves and the smaller the retracement, the stronger the trend.

Now, it’s time to take you to the level of an intermediate Fibonacci trader. To do this, you need to know the other two critical levels – 38.2% and 61.8% retracement.

Price action must be analyzed at these levels to understand if the countertrend move will stop and the trend will resume.

Fibonacci retracement levels are used by many retail and floor traders [3], therefore whether you trade using them or not, you should at least be aware of their existence.

Some advanced traders will take it a step further and add Fibonacci arcs and Fibonacci fans to their trading arsenal in search of an edge. We will touch on these later.

Chapter 5: How to Interpret Fibonacci Levels

Defining the Primary Trend

Strong Uptrend

Defining the primary trend with Fibonacci requires you to measure each pullback of the security. If you see a series of new highs with retracements of 50% or less, you are in a strong uptrend.

strong-uptrend
Strong Uptrend

The above chart is of Alphabet Inc., on a 5-minute chart. Notice how Google doesn’t have any retracement greater than 50%. These successive new highs with minor pullbacks are the sign you are in a strong uptrend.

Choppy Market Fib Levels

Here is another example of a trend with Chipotle (CMG).

Choppy Market
Choppy Market

Do you see how each pullback is greater than 78.6% from the initial range? This level of retracement repeatedly produces a choppy pattern. Therefore, you would not want to have lofty profit targets on a trade while the stock is in a tight trading range.

78.6% is not a hard-fast rule. If you see retracements of 61.8% or 100%, the stock is likely in a basing phase before the next move.

That’s it, you now understand how to use Fibonacci to define the strength in the market.

Remember, the market is either trending or flat.

A general rule of thumb for the overall market is it trends 20% of the time and is range bound the other 80%.

Chapter 6: Three Simple Fibonacci Trading Strategies

#1 – Pullback Trades

First, you want to identify a security in a strong trend.

A strong trend can be defined as a stock with successive highs with pullbacks of less than 50%.

If you are day trading, you will want to identify this setup on a 5-minute chart 20 to 30 minutes after the market opens.

After identifying a strong uptrend, observe how the stock behaves around the 38.2% and 50% retracement levels from the morning highs by looking at the time and sales and Level 2.

Once you see the trading activity slowing down or turning, enter the trade.

You can use the most recent high or a Fibonacci extension level as a target point to exit the trade.

38.2% retracement example
38.2% retracement fibonnaci trading example

In the above chart, notice how LGVN stays above the 38.2% retracement level before making a higher high.

Where Can Things Go Wrong?

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The chart above looks so clean and safe. The reality is that you will likely have a 40%-70% hit rate depending on your ability to honor your rules and manage your emotions.

Therefore, you need to prepare for when things go wrong. In a pullback trade, the likely issue will be the stock will not stop where you expect it to. It may pullback to a full 100% retracement, or it could even go negative on the date.

I have had situations trading the Nikkei where a stock will have a 15% or greater swing from the morning highs.

You can protect yourself from this scenario by doing the following:

Trade Low Volatility Stocks

Penny stocks look great when a trader is discussing their 30% gain in one hour. However, it’s brutal if you are on the other side of the trade. Trade stocks with high volume and some volatility because we need to make a living, but don’t feel like you must trade with the other gunslingers.

Max Time Loss

Look back over your winning trades and determine how long it takes you to turn a profit with 85% confidence.

If that is 5 minutes or one hour, this now becomes your time stop. If there is only a 15% chance you will walk away a winner, just exit the trade with a predetermined allowable loss percentage or right at market.

Max Stop Loss

There is no way around it, you will have blowup trades. I do not care how good you are, at some point the market will bite you. To this point, have a max stop loss figure in mind.

As a general rule, we prefer 10%. But since we only use a small portion of the account size for each position, this keeps a total portfolio loss of under 2%. With lower volatility stocks, this may trigger a stop only once or twice a year.

The point is you, need to be prepared for the inevitable.

#2 – Breakout Trades

Breakout trades have one of the highest failure rates in trading. To help these odds, we’ll give you a few things you can do to up the chances of things working out.

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Clearing a Fibonacci Extension Level

Fibonacci extensions are just that, once price clears the 100% retracement and presses on.

You want to find a stock clearing this extension level with volume.

Clearing Fibonacci Extension Levels
Clearing Fibonacci Extension Levels

It’s not enough to just buy the breakout.

Therefore, you want to make sure as the stock is approaching the breakout level, it has not retraced more than 38.2% of the prior swing. This will increase the odds the stock is set to go higher.

Where Can Things Go Wrong?

In terms of where things can go wrong, it’s the same as we mentioned for pullback trades. The one difference is that you are exposed to more risk because the stock could have a deeper retracement since you are buying at the peak or selling at the low.

So, to mitigate this risk, you will need to use the same mitigation tactics as mentioned for pullback trades.

#3 Trading with Indicators

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You can use Fibonacci as a complementary method with your indicator of choice. Just be careful you do not end up with a spaghetti chart.

Fibonacci Retracement + MACD

This Fibonacci trading strategy includes the assistance of the well-known MACD. Here we will try to match the moments when the price interacts with important Fibonacci levels in conjunction with MACD crosses to identify an entry point.

We hold the stock until we receive a crossover from the MACD in the opposite direction.

Fibonacci Retracement w/ MACD
Fibonacci MACD

This is the 60-minute chart of Yahoo.

The two green circles on the chart highlight the moments when the price bounces from the 23.6% and 38.2% Fibonacci levels.

At the same time, the green circles on the MACD show a cross up of the indicator.

Thus, we go long every time we match a price bounce with a bullish MACD crossover.

The red circles show the close signals we receive from the MACD.

We open two long positions with Yahoo and we generate a profit of $5.12 per share.

Fibonacci Retracement + Stochastic Oscillator + Bill Williams Alligator

In this Fibonacci trading system, we will try to match bounces of the price with overbought/oversold signals of the stochastic. When we get these two signals, we will open positions.

If the price starts trending in our favor, we stay in the market if the alligator is “eating” and its lines are far from each other. When the alligator lines overlap, the alligator falls asleep and we exit our position.

Fibonacci Alligator Stochastics combination
Fibonacci Alligator

This is the 30-minute chart of TD Bank.

The price drops to the 61.8% Fibonacci level and starts hesitating in the green circle. Meanwhile, the stochastic gives an oversold signal as shown in the other green circle.

This is exactly what we need when the price hits 61.8% and we go long! A few hours later, the price starts moving in our favor. At the same time, the alligator begins eating!

We hold our position until the alligator stops eating. This happens in the red circle on the chart and we exit our long position. This trade brought us a total profit of $2.22 per share.

Fibonacci and Volume

We saved this one for last because it’s our favorite go-to with Fibonacci. Volume is honestly the one technical indicator even fundamentalist are aware of.

Fibonacci and Volume
Fibonacci and Volume

We mention this a little later in the article when it comes to trading during lunch, but this method works really during any time of the day.

As a trader, when you see the price coming into a Fibonacci support area, the biggest clue you can look to is the volume to see if that support will hold. Notice how in the above chart the stock had a number of spikes higher in volume on the move up, but the pullback to support at the 61.8% retracement saw volume plummet.

This doesn’t mean people are not interested in the stock, it means that there are fewer sellers pushing the price lower.

This is where longs come in and accumulate shares in anticipation for the rally higher.

Chapter 7: Advanced Fibonacci Trading Topics

Fibonacci Speed Resistance Arcs

Fibonacci Arcs are used to analyze the speed and strength of reversals or corrective movements. To install arcs on your chart you measure the bottom and the top of the trend with the arcs tool.

The arcs appear as half circles under your trend, which are the levels of the arc’s distance from the top of the trend with 23.6%, 38.2%, 50.0%, and 61.8% respectively.

Each of the Fibonacci arcs is a psychological level where the price might find support or resistance.

Fibonacci Arc

This is the 30-minute chart of Apple.

I have placed Fibonacci arcs on a bullish trend of Apple. The arc we are interested in is portrayed 38.2% distance from the highest point of the trend.

When the price starts a reversal, it goes all the way to the 38.2% arc, where it finds support. This is the moment where we should go long.

Lastly, we recommend placing a stop right below the bottom created on the arc.

Fibonacci Time Zones

Fibonacci time zones are based on the length of time a move should take to complete, before a change in trend. You need to pick a recent swing low or high as your starting point and the indicator will plot out the additional points based on the Fibonacci series.

Fibonacci Time Zones

Notice, in this case, Apple’s price undertakes a move based on Fibonacci numbers 0, 1, 2, 3, 5, and 8.

Do you remember when we said that Fibonacci ratios also refer to human psychology? This also applies to time as well.

Negatives of Trading with Fibonacci

Increased Expectations

Unfortunately, with Fibonacci trading, you begin to expect certain things to happen. For example, if you see an extension as the price target, you can become so locked on that figure you are unable to close the trade waiting for bigger profits.

If you are trading pullbacks, you may expect things to bounce only for the stock to head much lower without looking back.

Therefore, if you are trading with Fibonacci at the core of your system, expect things not to work out about 40% of the time.

Take that in for a second. That is quite a bit of times where you’ll be wrong. This means it is absolutely critical you use proper money management techniques to ensure you protect your capital when things go wrong.

Closing Too Soon

The other scenario is where you set your profit target at the next Fibonacci level up, only to see the stock explode right through this resistance. Thus, resulting in you leaving profits on the table.

Leaving it on the Table
Leaving it on the Table

What Are We to Do?

Fibonacci will not solve your trading woes. Again, you can hope to be right 60% to 70% of the time. This is not only when you enter bad trades, but also exiting too soon.

So, what are we to do?

The answer is to keep placing trades and collecting your data for each trade. You will have to accept the fact you will not win on every single trade.

Trading During Lunch

Talk to any day trader and they will tell you trading during lunch is the most difficult time of day to master.

The reason lunchtime trading is so challenging is that stocks tend to float about with no rhyme or reason. Volume and range trail off considerably.

So, how can you profit during the time when others like to get lunch? Simple answer – Fibonacci levels.

Often times, during the lunch hour, a stock will make a pullback to a key Fibonacci support level. For bigger corrections, that might be 78.6%.

Ken Chow of Pacific Trading Academy, also mentions the benefit of a lower-risk entry at the 78.6% level.[4]

However, everyone isn’t as pessimistic as Ken, so you can go with 50% or 61.8%. It all depends on what the stock is actually doing.

Midday Pullback Example

Fibonacci Lunch Time Trading
Fibonacci Lunch Time Trading

The above chart is of the stock GEVO. Notice how the stock gapped up in the morning and then formed a nice base at the 50% retracement level.  Now at this point of the day, you want to see two things happen: (1) volume drop to almost anemic levels and (2) price stabilize at the Fibonacci level.

The combination of these two things almost guarantees volatility also will hit lower levels. You want to see the volatility drop, so in the event you are wrong, the stock will not go against you too much.

Managing the Trade

So, naturally, the question is how do you manage the trade.

First, you want to see the stock base for at least one hour. Then you want to see higher lows in the tight range. In the GEVO example, you want to place your buy order above the range with a stop underneath.

Curious to see what happened?

400 Percent in One Day
400 Percent in One Day

Of course, this doesn’t happen all the time. So, please do not say we are pushing lunch breakouts that can run 400%.

This is just a real-life example that shows the power of Fibonacci levels providing support during the middle of the day.

Now, remember, you have to exercise extreme caution with the middle of the day trading.

Not so much from the perspective of the market going against you, as you can see you have tight stops.

It’s more around the fact these setups fail a lot.

So, again, keep tight stops and always have realistic expectations.

Conclusion

  • The Fibonacci sequence starts from 0; 1, and every number thereafter is built by the sum of the previous two.
  • Every number in the Fibonacci sequence is 61.8% of the next number.
  • Numbers in the Fibonacci sequence are 38.2% of the number after the next in the sequence.
  • Every number in the Fibonacci sequence is 23.6% of the number after the next two numbers in the sequence.
  • The deeper the retracement on a pullback, the less likely the stock will break out to new highs
  • Fibonacci levels are critical in equity trading because they represent a trader’s behavior and psychological reaction to price changes.
  • The most common Fibonacci trading instrument is the Fibonacci retracement, which is a crucial part of the equity’s technical analysis.
  • Other Fibonacci trading tools are the Fibonacci speed resistance arcs and Fibonacci time zones
  • Whether you trade pullbacks, breakouts or indicators; you must have a trading plan to manage your position.

Like anything else in life, to get good at something you need to practice. So, if you have a second check out Tradingsim.com.

Here you can practice all of the Fibonacci trading techniques detailed in this article on over 11,000 stocks and top 20 futures contracts for the last 2.5 years. Our customers are able to test out strategies by placing trades in our market replay tool and not just relying on some computer-generated profitability report to tell them what would have happened.

As we all know, looking at results of a report and placing trades are two totally different things!

External References

  1. Reich, Dan. The Fibonacci Sequence, Spirals, and the Golden Mean. Department of Mathematics, Temple University
  2. Twisting with Fibonacci [Study]. Harvard College Mathematics Review. p.66
  3. Fibonacci Retracement. Wikipedia
  4. Chow, Ken. Trading with Fibonacci Ratios [Blog Post]. Pacific Trading Academy

Photo Credit

Aloe Flower
Shell 

Stock Float Explained

Stock float is one of the most important metrics that can influence the price of a security. While it can be a confusing term to understand as a beginning trader, it is worth the effort to know. After all, it can mean the difference between big gains and big losses.

Why Stock Float Is Important

The more metrics you have to evaluate a security before trading it, the better. As a rule of thumb, anyway.

Perhaps you won’t be too concerned with a dividend if you’re only looking to day trade a specific stock. You won’t own the stock long enough for the dividend to matter.

But one metric that can dramatically affect a stock’s price movement and volatility, is the float.

Therein lies the importance of this numerical data.

The Role of Insiders

Of the number of shares that are tradable for any given security, those shares are either freely tradeable on the market or insider-owned shares that are locked up. That is, unless the insiders decide to sell more shares, which is another subject in itself.

For the most part, inside shares are owned by the employees of the company they work for. The insider owned shares are not easily tradeable as they come with restrictions. For that reason, the market at large doesn’t bother much about the insider owned shares.

On the other hand, free floating shares are owned and traded by general investors. Investors like you, perhaps.

Institutions

In many cases, institutions also own a majority of these publicly available shares. These institution-owned stocks are typically held for a long time. Examples of institutions include pension funds or hedge funds.

Because most institutional firms are not actively trading their portfolio every day, this leaves only a remaining portion of the overall shares of a company that are readily tradable.

What Is A Stock Float?

The float of a security measures the total amount of shares that can freely change hands. In many ways, it depicts the liquidity of the market for certain companies.

The more number of shares there are to change hands, the greater the liquidity.

Calculating Stock Float

To better understand “floating stock,” let’s illustrate this with an example.

A company ABC Inc. has 100,000 shares outstanding.

Of the shares outstanding, 5000 are held by its employees, 40,000 shares are held by institutions. The remaining shares are held by regular investors.

From this, the stock float is 55,000. This is the sum of the total outstanding shares minus the shares held by insiders and institutions.

Stock float explanation

As you can see, while the outstanding shares may be as high as 95,000 for this particular hypothetical company, the actual shares available at any given time, may be much lower.

Float Impact

The impact this has on stock prices and volatility can be dramatic. After all, it is supply and demand that dictate the prices of stocks.

To that end, if more and more institutions gobble up the oustanding shares of a company, it takes less and less demand for the price to rocket higher.

Scarcity of shares, as it were.

This is exactly what happens during the early period of a company’s publicly traded life.

Low Float Stocks

A low float stock as the name suggests indicates that the number of shares outstanding are low. For such stocks, the daily and average volume tends to be low. The low volumes of such stocks lead to volatility and as a result, wide bid and ask prices.

Before the company dilutes its value by throwing more shares into the market, the lower float in the beginning can cause its price to skyrocket as long as demand is there.

For such low float stocks, a fundamental driven rally creates demand. In other words, investors are stumbling over themselves to buy shares when they are scarce, driving the price higher in dramatic fashion.

Over The Counter Stocks

There is a myth that low float stocks are mostly stocks on the pink sheet or OTCBB market listings.

However, this is not the case. In some cases you can find some micro-cap stocks with listings on the main exchanges such as the NASDAQ or the NYSE. A stock can also be low float if for some reason the float reduces relative to its usual average.

While the definition is a bit flexible, a stock is considered a low float stock which has fewer than 50-100 million in tradable shares.

High Float Stocks

Stocks with a high float tend to be more predictable and less volatile. For all intents and purposes, you can expect a stock to be a “high float stock” with anything above 100 million available shares.

Due to the large number of shares in the float, the liquidity can absorb any big moves. Therefore, while it is common to see 30% or 40% or even 100% moves during a short amount of time in a low float stock, this is not often seen with high float stocks.

The lack of scarcity means the value is often at “equilibrium” with the amount of shares being traded. Thus it takes more effort to move the price.

Larger companies such as AAPL or FB are examples of stocks with high float.

Comparison Between High and Low Floats

To imagine the difference, lets take a stock with a float of 18 million and 23.5 million outstanding shares, and compare it with AAPL at 16.68 billion float and 16.75 billion shares outstanding.

EYES ran 1293% in just 4 trading days:

EYES 1293% small stock float example
EYES small float stock example

AAPL moves 18% in 38 trading days.

Large stock float example
AAPL large float stock example

Clearly, there is a difference. For most investors or traders, it is usually a safe bet to trade stocks that have a higher float.

Trading low float stocks can be lucrative in the short run, but they typically come with the headaches of volatility and a lack of secure fundamentals.

Market Cap vs. Free-Float Market
Cap

Market capitalization, or market cap for short, is closely linked to the free float of the stock.

When researching stocks, companies are usually categorized based on their market capitalization. Pull up any ticker on finance.yahoo.com or any other site, and you’ll see Market Cap at the top of the list, usually:

Yahoo Finance Market Cap for AAPL
Yahoo! Finance Market Cap for AAPL

The important question for traders, is whether you should pay attention to this.

Market cap is a measure of a company’s size: the total value of a company’s outstanding shares of stocks. These outstanding shares include publicly traded shares as well as restricted shares that are held by insiders.

How To Calculate Market Capitalization

To calculate market capitalization you simply take the number of a company’s shares that are outstanding. Multiply the shares outstanding by the current stock price in order to get the market cap of the stock.

Let’s illustrate this with a simple example.

Say a company ABC Inc. has a total of 5 million shares outstanding. If this company is trading at a stock price of $10, you can get the market cap by multiplying the shares outstanding with the stock price.

In this example, we get $50 million as the market capitalization of the company.

Within market capitalization, there are certain classifications. The different categories can vary depending on who you ask. However, market capitalization is broadly classified into the following:

Now that we understand what market capitalization is, we can see the difference.

Market cap is based on the total value of the company’s shares.

Float is the number of outstanding shares that are available for general trading by the public.

The Free Float Market Cap Calculation Method

There is also another measure called the free float market cap method of calculation. In the free float calculation method, the market cap excludes shares that are locked in. The shares that are locked in are inside shares that are not available for the general public.

Generally, the free float method of calculating the market cap is widely used. Major indexes such as the Dow Jones Industrial Average and the S&P500 make use of the free float method.

Free float and market cap are important metrics for investors. When combined together, these two values show the total available shares for the public to trade.

Stock Price Manipulation Through Float

One common question among traders is whether one can manipulate the price of a stock based on the float.

As mentioned above, a reduction in the float can almost immediately raise the price of a security. This might seem contrary to the notion of “higher the float, bigger the price.”

This is not the case however. For example, when risk averse investors are on the short side of the stock, reducing the float can squeeze these investors out of the market.

This research paper of Float manipulation and stock prices gives insight into how firms can expand or shrink the float. The researchers observe Japanese stock listings and the price impact of firms who reduce their float between 0.1% up to 100% for periods of one to three months.

The study concludes that the price of a stock tends to rise when the float is reduced and conversely, the price of the stock falls when the float is increased.

The returns of the stock are also said to be cross-sectionally related to the reduction in the float.

There is strong evidence that firms tend to issue equity or redeem their convertible debts when the float is low. After all, they want the highest price they can get for their shares.

For this reason, firms have strong incentives for manipulating the stock price via its float.

Can A Company Increase or Decrease Its Float?

The answer to this is yes. Companies can raise or decrease their float in a handful of ways.

  • A company can raise the float by issuing new shares and it can reduce the float by announcing buy back of its shares.  Other examples include a company announcing a stock split which could impact the float.
  • Insider activity is also one of the factors influencing the float. For example, insiders who usually own options can choose to exercise their option. This can also influence the float. However, for this to occur there needs to be a significant amount of option exercises.
  • A company can also increase its float by deciding to sell some of the inside shares. This is done for legitimate reasons such as raising cash, but there could also be ulterior motives.
  • Typically, you can see the float changing when there are some big changes. The trigger for the changes to the float can be due to the fundamental drivers such as news events or company reports and rumors.

Pros and Cons of Trading Low Float Stocks

As you might expect by now, there are pros and cons when it comes to trading stocks with a low float. For a more in depth look, be sure to check out our post on Float Rotation.

Let’s talk about the upside first!

Pros

Because low float stocks are volatile, there is a tremendous upside to the stock. Traders who can take a calculated risk on low float stocks could end up with big returns.

Despite the inherent risks, traders can find an occasional good trade with tremendous upside potential in low float stocks. One of the important things to look for is liquidity.

Cons

In many ways, trading low float stocks can be similar to trading penny stocks or micro-cap stocks.

Low float stocks can be very risky to hold because they can have violent moves in either direction. With so few shares available to trade, the impact on supply and demand can be significant.

Low float stocks can be easy to manipulate with large unexpected orders. This is something that investors need to bear in mind.

Stocks with low floats also tend to be volatile around fundamental news releases. These include any type of news that is related to the industry or the sector in particular. Liquidity also increases around such events which can give good opportunity for investors to exit the stock after making a good trade.

Be sure to check for any filings with the SEC as these companies tend to offer shares during price spikes.

How To Find Float Data

There are a number of services that offer float data. Yahoo Finance and Finviz are just a few of the popular ones. Popular charting platforms may offer this as well, usually with a subscription to fundamental data.

Here is a snapshot of some of the fundamental data that finviz.com provides free of charge:

finviz.com float data
finviz.com fundamentals data

Regardless of the service you use, you may find some discrepancies from one to the next.

Conclusion

Hopefully this helps fill in some gaps when it comes to stock float and the impact it may have on your trading.

As with any piece of information in the markets, it is always wise to study the context and historical examples. Here at TradingSim.com, we can help with this as we have the ability to filter your search for simulated trades based on float size.

Hopefully you’ll take the time to develop your playbook and decide whether you like the price action and risk of low floats or high float stocks.

Best of luck!