Ok so you have a basic grasp of how buying and selling stocks and a very general understanding of what type of stocks exist (penny stocks, blue chip, dividend paying stocks). Now it’s time to get into price movement. Why do certain stocks shoot way up in value and drop like a rock at a moment’s notice? Why do some stocks sit in the same spot forever?
The percentage that a stock loses or gains value in a short period of time is called volatility. A very volatile stock may gain 70% in value in a single day and then lose 80% the next day. Many penny stocks are known for being very volatile. A very stable stock will normally stay in the digit percentage gains and losses and in many cases don’t even go far above a 1% change. Blue chip stocks normally have this characteristic or so the “experts” will have you believe.
In actuality whether a stock is a blue chip or a penny stock doesn’t have a lot of bearing on how much volatility it has. The real sign is the float. If you look at the number of shares a company has and remove the shares that cannot be traded on the open market that’s the float. So let’s say company XYZ has a total of 100 shares. 65 of those shares are held by high ranking officials of the company and they cannot be freely traded in the public market. I’ll get into the reason behind that in another post, but stick with me. So that leaves 35 shares as the float.
Stocks with a very low percentage of shares that can trade in the open are known as “low float stocks.” These stocks are generally far more volatile than high float stocks. The reason behind this is something called liquidity.
Liquidity is a measure of how easily shares of a stock can be bought and sold. For example let’s say John Investor wants to sell 100 shares of stock XYZ, but only 50 shares on average are traded for that company every day in the stock market. Will it be easy for him to get rid of those shares? Probably not. Now let’s say that 50,000,000 shares are traded every day for that stock. Chances are he’ll find a buyer pretty fast if not instantly.
Ok so how do they fully relate to each other? It’s pretty simple really. If you have a stock with very few shares to trade then the liquidity will be lower than other stocks because there are fewer people to sell shares. Because there are fewer people selling you may have to up your offer on a share to buy it.
Let’s look at a couple real world examples that further illustrate the point that high volatility comes more from float than from actual share prices. I think one of the best examples is Netflix (NFLX). The stock is currently at $448 a share but it can swing $40-50 in a single day because the percentage of shares in the open market is so low (11% currently).
On the other end of the spectrum is a high float stock like Ford Motor Company (F). The current stock price is $15.62 but it’s EXTREMELY rare to see the price move more than $0.15-$0.20 in a single day. Ford has 45% of all shares for trade in the open market. This means you need a massive wave of buying or selling to really move the price at all.
So remember, it’s not about the price of the share when you’re trying to figure out how safe a stock is. It’s far more likely that the float will decide.