Note I’m not a financial advisor or qualified in any way to give a professional finance opinion, but I am an engineer, and here’s how I break the market down.
This post builds off my previous thesis on what’s going on in the market: https://abhishekpratapa.medium.com/an-engineers-unfiltered-take-on-the-stock-market-34b668d3d381
TLDR of the Previous Article
Fed buying up assets creating liquidity, not enough people are borrowing, excess liquidity sloshing around. Bonds aren’t great because the yields are low (demand high because of the Fed buying, supply low). So all that excess cash goes into stocks. Pump baby pump.
Let’s look at how to potentially use that to our advantage.
If you have very little time, and just want the deets go to the section titled: OKAY SO LOW MARKET CAP… LOW FLOAT…
So how do I make some money, eh??
In physics, momentum is defined as the mass in motion. The formula for it is given below:
If something has a large momentum (large mass or velocity), it’ll be very hard to change its direction. Catching a ball traveling at 10 miles an hour is relatively easy, but try stopping a car moving at even 10 miles an hour, it’s gonna be catastrophic (please take this as a theoretical exercise, not a practical one).
In stock trading, momentum is defined to be the speed at which the price of a stock is changing. And this somewhat makes sense. A large company’s stock price tends to change directions very slowly, whereas it isn't unheard of to hear about a small company's stock price rise 1000% every other week. (Tesla is the exception and quite the outlier here, Elon shrug).
So in this strategy, if the price of a stock is going up, you go up with it, easy. The smaller the stock the faster the velocity and I’m going to the moon, right?
Not so fast just as fast as these stocks go up they come down just as quickly if not quicker.
There are extraneous factors to consider when looking at what drives stock prices. For instance, what caused the stock price to go up? Good news? Is the stock getting popular with Reddit users? Is it just a random blip?
The size of the company, the number of shares (or float) a company publically has, its financials, and many other indicators investors look at, affect the share price, how much it goes up or down in a given period of time. You could spend a lifetime looking at it and still not wrap your head around what’s going on. Fortunately, you don’t have to, it’s a numbers game.
TLDR — If you push an elephant it probably won’t move very much, but if you push a deer it’s probably gonna be pissed at you. That’s kind of where the metaphor falls apart though.
RISKS (Well just the biggest one IMO)
For small stocks, there are lots of risks. Again don’t invest money you don’t expect to lose. It’s like Las Vegas but buttoned up in a suit and tie. Gambling at its finest, and like card counting we just have to learn the tricks of the trade.
I can’t reiterate this further. The issue IS that just like gambling at a casino. It’s important to understand the risks.
The biggest risk in my opinion is that small companies love offerings.
Offerings are often terrible for a stock price in the short term, but knowing what kind of offering is important.
There are offerings that dilute a companies shares and offerings that don’t. The offerings that dilute a companies shares often drop the share price, very rapidly.
Dilution is adding more shares to the total number of shares offered by the company. For example, if Company Awesome had 3,000 shares priced at 6 dollars, the market cap (or value) of that company would be: 18,000 dollars. If Company Awesome then decided to say hey here are 3,000 more shares (so 3,000 original shares plus 3,000 additional shares) the stock price would drop because the company is probably still worth around 18,000 dollars and at 6 dollars a share the market cap of the company effectively doubled. So the stock price might go down to 3 dollars. (Oversimplified many nuances but explains the point).
What’s worse is that we’ve effectively made the mass in our momentum equation bigger (more shares at 6,000). Meaning that this stock is more resistant to price changes. Our momentum strategy won’t work as well.
These are things you should know. So the low float stocks over the high float stocks, check.
TLDR — I can’t stress enough it’s important to keep these risks in mind to be aware of things that could go very wrong. Have an exit strategy, and set a stop loss to minimize losses.
LOW MARKET CAP
Another criterion when assessing a stock is that it has a relatively low market cap. Take Berkshire Hathway Class A shares. It has a relatively low float at 650k shares so initially, it might look like a good buy but be wary. If you look at the share price you’ll discover that each share trades at ~340k dollars!! That’s for ONE SHARE. The total market cap of Berkshire Hathway is around half a trillion dollars, you heard that right. So that means for you to double your money, Berkshire Hathway would have to reach a trillion dollars! Seemingly insane.
Okay, I’ll admit the example was a bit extreme but it gets an important point across. The affordability of the stock price is extremely important. And there are certain things to look for. A stock with a lower market cap has more room to grow upwards, but it’s also riskier.
A common saying goes that stock under 5 dollars isn’t very appealing to institutional investors (like JP Morgan Chase, Merill Lynch). And a stock over 5 dollars is more appealing to institutional investors. Now there are no hard legal restrictions and this may just be a myth among retail investors (probably you reading).
Albet, the psychology seems to almost be self-fulfilling for this one. There are certain requirements, though, to get listed on a stock exchange and if a stock falls below that minimum requirement for a certain amount of time, then it can be delisted. Being delisted isn’t bad but often it comes with a sharp drop in the stock price be aware of it.
A stock listed in an exchange like the NYSE, NASDAQ has certain benefits like ensuring liquidity (your stock will be bought and sold). OTC stocks have no such requirements, trade at your own risk.
Back to the 5 dollars. If the stock is worth around a cup of coffee then it’ll be more appealing to the average investor than if it’s say priced at Berkshire Hathway Class A share price at 340k. All things equal lower share price creates more liquidity and enables more people to participate in the ownership of the stock.
The classic example is Tesla, and Apple both rose after a stock split, being that the stocks split to create an effectively lower share price. In a 1 to 4 split, if you own 1 share at 400 dollars, after the split you get 4 shares each at 100 dollars. The total amount of stock you own is 400 dollars but now instead of 1 share, you have 4. In both cases, you saw the market cap of Apple and Tesla rise after the stock splits.
TLDR — A lower share price can mean more people buy the stock increasing the company’s total value. It’s not the only thing that matters though. Compliance with exchanges, and the 5 dollar share price myth play into the psychology of the trader.
OKAY SO LOW MARKET CAP… LOW FLOAT…
If I had the time I’d make an excel spreadsheet or app to track these low float, low market cap upward momentum stocks. Right now I don’t but here are some tools to point you in the right direction.
I know this is where the article is really weak. I gave you all these insights and a manual way of finding them. Something like an app or an excel spreadsheet would have been nice. But I’ll put all my tools out there:
- Here’s a website with a list of low float stocks: https://www.lowfloat.com/all
- Cross-reference the tickers with the market cap you get on yahoo finance: https://finance.yahoo.com/ (Market cap is based on industry, a sector so use your best judgment. See how much the company was valued in the past compared to what it is valued now, etc.)
- At the opening bell, see if the stocks you have listed show up on the https://finance.yahoo.com/gainers/ list or above 10% – 15%. If so put some money into them and wait for momentum to kick in.
- Note that if the stock ran the previous day or a week before or something like that all bets are off.
- Remember the stock will do up just as quickly as it might come down so sell often and quickly when you're in the green. Observe the price and watch it. Only you know your risk tolerance.
WHY DOES THIS WORK?
Well read up on liquidity and my previous thesis here: https://abhishekpratapa.medium.com/an-engineers-unfiltered-take-on-the-stock-market-34b668d3d381
It won’t work for much longer probably only a couple of days, things like this get exploited but hey, use it while you can. When there’s so much cash in the market and hedge funds are a little weary to short than they used to (GME fiasco), stuff like this happens.
If the market tanks, or volatility increases or bond yields shoot up, or the Fed comes in with more monetary policy, all bets are off. Until then good luck wolves.
(I admit the quality of this post isn’t up to par but it’s time-sensitive so I decided to write it. I’ll come back and edit it hopefully before the loop gets closed).