Free float: Explained
BY TIO Staff
|July 12, 2024The term 'free float', also known as 'public float', refers to the portion of shares of a corporation that are in the hands of public investors as opposed to locked-in stock held by promoters, company officers, controlling-interest investors, or government. This number of shares is significant for investors as it indicates the company's size and liquidity.
In the world of trading, understanding the concept of free float is crucial. It can provide insights into the volatility of a particular stock, its liquidity, and the company's market capitalization. This article will delve into the intricacies of free float, its calculation, its implications, and its role in trading.
Understanding Free Float
Free float represents the number of shares available for trading to the general investing public. It excludes shares held by insiders, controlling shareholders, and government entities. The importance of free float lies in its influence on market dynamics. A smaller free float can mean higher stock volatility due to lower liquidity.
Moreover, free float is a critical factor in calculating a company's market capitalization. Market capitalization, or market cap, is the total value of all a company's shares of stock. It is calculated by multiplying the company's share price by its total number of outstanding shares. However, many financial indices use the free-float market capitalization method where only the free-floating shares are considered.
Calculation of Free Float
Calculating the free float of a company involves subtracting the locked-in shares from the total outstanding shares. Locked-in shares are those held by promoters, company officers, controlling-interest investors, or government. These shares are not readily available for trading in the open market.
For example, if a company has 1 million total outstanding shares, and 300,000 are held by insiders or the government, the free float would be 700,000 shares. This calculation is important for investors and traders as it provides an indication of the company's market liquidity and volatility.
Implications of Free Float
The size of a company's free float can have various implications for traders and investors. A larger free float typically means better market liquidity, which allows traders to buy and sell shares without significantly impacting the share price. Conversely, a smaller free float can lead to higher stock price volatility, as a single trade can have a more significant impact on the share price.
Furthermore, companies with a smaller free float can be more susceptible to stock price manipulation. With fewer shares available for trading, it can be easier for a trader or group of traders to influence the stock price by buying or selling in large volumes.
Free Float and Market Indices
Free float is a critical factor in the construction of market indices. Many major indices, such as the FTSE and the S&P 500, use a free-float adjusted market capitalization methodology. This means that only the free-floating shares of a company are considered when calculating the company's market capitalization and its weight in the index.
This method is preferred as it provides a more accurate reflection of the market. It considers only those shares that are available for trading, thereby reflecting the actual liquidity and marketability of the stocks.
Free Float Adjustment Factor
The free float adjustment factor is a figure between 0.0 and 1.0 that represents the proportion of a company's share capital that is freely tradable. It is used by index compilers to adjust the market capitalization of a company for the purposes of index construction.
For example, if a company has a free float adjustment factor of 0.75, this means that 75% of its shares are considered in the calculation of the index. The adjustment factor is reviewed periodically to ensure it remains accurate.
Implications for Traders
The use of free float in index construction has implications for traders. Companies with a larger free float will have a greater weight in the index, which can influence the index's movement. Traders who use index trading strategies should therefore pay attention to the free float of the companies within the index.
Furthermore, changes in a company's free float can lead to its inclusion or exclusion from an index, which can significantly impact the stock's price. Traders should therefore keep an eye on announcements about changes in free float.
Free Float and Stock Volatility
Free float has a direct impact on stock volatility. Stocks with a smaller free float tend to be more volatile than those with a larger free float. This is because with fewer shares available for trading, a single trade can have a more significant impact on the stock's price.
For traders, this volatility can present both opportunities and risks. On one hand, it can provide opportunities for profit if the trader can accurately predict the stock's price movements. On the other hand, it can lead to significant losses if the stock's price moves against the trader's position.
Managing Volatility
Traders can manage the risks associated with stock volatility through various strategies. These include diversification, using stop loss orders, and implementing a sound risk management strategy. Understanding the free float of a stock can also help traders anticipate and manage volatility.
For example, if a trader knows that a stock has a small free float and is therefore likely to be more volatile, they may choose to trade smaller position sizes or use wider stop loss levels to manage their risk.
Opportunities from Volatility
While volatility can present risks, it can also provide opportunities for traders. Volatile stocks can offer the potential for significant price movements, which can lead to substantial profits if the trader can accurately predict these movements.
Traders can use various tools and strategies to predict stock price movements, such as technical analysis, fundamental analysis, and news trading. Understanding the free float of a stock can be a valuable part of this analysis, as it can provide insights into the stock's potential volatility.
Conclusion
In conclusion, the concept of free float is a critical aspect of trading. It provides insights into a stock's liquidity, volatility, and its weight in market indices. Traders who understand and pay attention to the free float of a stock can use this information to inform their trading strategies and manage their risk.
Whether you are a seasoned trader or just starting out, understanding the intricacies of free float can enhance your trading knowledge and potentially lead to more informed and successful trading decisions.
Start Trading with TIOmarkets
Now that you're equipped with the knowledge of free float and its importance in the trading world, it's time to put that understanding into action. Join over 170,000 traders in more than 170 countries who have already chosen TIOmarkets as their trusted forex broker. With access to over 300 instruments across 5 markets, including Forex, indices, stocks, commodities, and futures, you can trade with low fees and robust support. Enhance your trading skills further with our comprehensive educational resources and step-by-step guides. Ready to dive into the world of trading? Create a Trading Account with TIOmarkets today and start your journey towards successful trading.
Risk disclaimer: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Never deposit more than you are prepared to lose. Professional client’s losses can exceed their deposit. Please see our risk warning policy and seek independent professional advice if you do not fully understand. This information is not directed or intended for distribution to or use by residents of certain countries/jurisdictions including, but not limited to, USA & OFAC. The Company holds the right to alter the aforementioned list of countries at its own discretion.
Join us on social media
Behind every blog post lies the combined experience of the people working at TIOmarkets. We are a team of dedicated industry professionals and financial markets enthusiasts committed to providing you with trading education and financial markets commentary. Our goal is to help empower you with the knowledge you need to trade in the markets effectively.
Trade responsibly: CFDs are complex instruments and come with a high risk of losing all your invested capital due to leverage.
These products are not suitable for all investors and you should ensure that you understand the risks involved.