What is the meaning of free float?

Edited by Ben Lobel
What is the meaning of free float?

On 22 January 2021, about 140% of GameStop’s public float was shorted – an extraordinary situation that triggered one of the most famous short squeezes in history. Online chatter led to a buying frenzy, which was then met with aggressive short selling. The number of shares shorted ended up exceeding the total available float, drastically impacting the stock’s free float.

This event highlights that free float is more than just a number in the stock markets. So, what is free float and how to calculate it? Read on.

What is free float?

Free float refers to the number of a company’s shares that are readily available for trading in the open market. It excludes shares held by insiders, promoters, governments, or strategic investors unlikely to sell in the near future.

Put simply: free float = tradable shares.

Free float vs total shares outstanding

Total shares outstanding represent all shares ever issued by a company, regardless of who holds them. Free float, on the other hand, focuses specifically on the tradable portion. This distinction is vital because stock market indices, like the US 500  or UK 100, often weigh companies based on their free float rather than total market cap. This ensures that the index accurately reflects the stock market’s tradable universe.

Understanding what free float is matters for stock traders because it directly influences a stock’s supply and demand dynamics. A higher free float generally indicates greater liquidity, making it easier to enter and exit positions without significantly impacting the stock price. Conversely, a low free float can lead to higher volatility, since even small trading volumes can have a disproportionate effect on the share price.

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Why free float matters in the financial markets

Free float primarily affects stock liquidity and volatility. A higher free float generally translates to greater liquidity. When a large number of shares are available for trading, it is easier for traders to find a counterparty, leading to tighter spreads and faster order execution. Conversely, low free float could translate to poor liquidity, with even small buy or sell orders drastically moving the price.

The relationship between free float and stock volatility is often inverse. Stocks with a high free float tend to be less volatile because the large supply of shares absorbs buying or selling pressures. Price moves are generally more gradual and reflective of fundamental news or broader market trends. However, stocks with a low free float are prone to higher volatility, with even minor news or a relatively small trading volume triggering sharp price swings.

Understanding these dynamics and risk management techniques can strengthen your trading strategy.

Calculating free float

Free float is calculated by subtracting all restricted shares from the total shares outstanding. Let’s understand this with a step-by-step guide on how to calculate free float:

  • Step 1: identify total shares outstanding

    This is the total number of shares a company has issued. This information is typically available in the company’s financial reports (annual reports, quarterly filings) or on financial data websites.

  • Step 2: identify restricted shares

    Determine the number of shares held by non-public entities, including:
    Promoter/insider holdings
    Government holdings
    Strategic corporate investors
    Shares under lock-in periods (eg, employee stock options that haven't vested)

  • Step 3: subtract restricted shares from total shares outstanding

    The resultant number is the free float.

    Example: Company A
    Total shares outstanding = 500 million
    Shares held by promoters = 250 million
    Shares held by strategic investors = 20 million
    Shares held by the government = 50 million
    Free float = 500m – (250m + 20m + 50m) = 180 million shares

    This illustrates how free float is calculated in practice.

Free float vs. restricted shares

It is important to distinguish the meaning of free float from restricted shares. Free float refers to freely tradable shares that can be bought and sold by the general public. They are part of the active supply and demand dynamics of the market.

Restricted shares, on the other hand, are shares that are not available for public trading. These are typically held by:

Free float provides a more accurate representation of the market’s supply and demand dynamics, true liquidity and investable universe. 

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How free float affects stock prices and trading strategies

A stock’s free float impacts its price behaviour and, consequently, the trading strategies you employ.

Stocks with a low free float often see sharp, exaggerated price moves, since even a moderate increase in buying or selling pressure can move the price. This makes such stocks attractive for short-term strategies.

On the other hand, the price of stocks with a high free float tends to be more stable and predictable since the large supply of shares can absorb significant buying or selling pressure. These stocks are generally preferred by long-term investors and institutional funds.

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Traders and investors use free float to:

Exploring trading accounts and demo accounts

Understanding what free float is has practical implications for investment decisions. It can help you better assess liquidity and potential volatility, which in turn can help you choose stocks that align with your risk tolerance and trading objectives.

Once you’ve chosen your preferred stocks, use a demo account to practice trading strategies without risking real capital.

When you’re ready to dive into the live markets, create an account to begin your trading journey.

FAQs

What is free float in the stock market?

Free float refers to the number of shares of a company that are available for trading in the open market. It excludes shares held by promoters, governments, strategic investors, and other entities with long-term or restricted holdings.

How is free float calculated?

Free float is calculated by subtracting all restricted shares from the total number of shares outstanding.

How does free float impact stock liquidity?

A higher free float generally leads to greater liquidity and lower volatility, while a low free float can result in lower liquidity and higher volatility.

Why do investors consider free float before trading?

Free float is used to assess a stock’s liquidity, potential volatility, and its true representation in market indices. It helps investors understand the supply-demand dynamics and make informed decisions.