I’ve heard that it’s not a good idea to short stocks with small floats, but don’t really understand how this works. What exactly is the “float” of a stock and what should we be looking for in terms of shorting a stock relative to its float?

A stock’s float refers to a company’s shares that are freely bought and sold without restrictions in the public, i.e., the number of shares held by the public and available for trading. As the largest proportion of stocks trading on the exchanges, the float consists of regular shares that many of us will hear or read about in the news. [Authorized shares refer to the largest number of shares that a company can issue, whether as public shares or for use within the company only, and the number of these shares is determined when the company is created. Outstanding shares are shares that have actually been issued and includes restricted shares that are usually reserved for employees as part of salary packages or benefits.]

With those definitions established, it also helps to know just what a short squeeze is. As a stock starts to rise quickly, short sellers may try to liquidate (cover) their positions by buying the stock. If enough short sellers are involved, the price gets pushed higher and higher the short squeeze. Consider then the situation with a stock that has a small float, or, a smaller number of unrestricted shares available for public use. With even fewer shares available, it would be harder to get out of the position without the chance of losing more than you would have gained had the stock fallen as hoped.

Before shorting, evaluate how the float and short term influences such as news surrounding a company could affect a position. Since short squeezes tend to occur more often with the stocks of small cap companies with small floats, they would be riskier positions to take for kind of play. The smaller number of available shares exacerbates the situation as short sellers race to close positions as the stock moves higher.