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What is Free Float Market Capitalisation?

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Synopsis:

In this article, we will discuss free float market capitalisation and how it is calculated. We will talk about how it impacts the stock market and the benefits of using it. We will also touch upon the limitations and risks associated.

Although every share of a publicly listed company is part of its capital not all of the shares are publicly traded in the market. Some of them are held by the government, or insiders to the company such as the promoters and employees. This gives a better picture of the stock’s market value as it considers only the shares that actually traded in the stock market. This is a popular method in valuation for many indices in the Indian market.

Understanding the Free Float Market Capitalisation in Technical Analysis

Free float market capitalisation plays an important role in technical analysis. Let’s see how it contributes in many ways.

1) It presents an accurate picture of the market value of a stock in the truest sense, based on their availability for public trading. 

2) This comes in handy during the calculation of weightage, for major indices helping them represent the market sentiment more closely.

3) Based on the level of free float, one can assess the liquidity of the company. When the free float is higher, the company is more liquid and hence buying or selling of shares becomes easier.

4) Price sensitivity of a stock is also indicated by the free float level. A stock with low free float indicates limited shares in the market, and hence the price of the stock is bound to be more volatile. 

5) Market movements can be predicted by using free float data, which analysts often do to assess market trends.

Overview of Free Float Market Capitalisation

While total market capitalisation is a metric that considers all the shares of a publicly listed company. This includes the shares held by the government or insiders such as promoters and employees as well. Free float market capitalisation on the other hand, excludes the shares held by government, and the insiders, basically anyone or any entity that is not the general public. This makes it easier to judge the true market value of a company and presents a better view of the company and its financial metrics. 

Free Float Market Capitalisation Formula

There is a simple formula for doing this calculation. You have to multiply the price of the company’s shares against the number of the company’s shares available for trading in the market (free float shares in other words):

Free Float Market Capitalisation = Share Price × Free Float Shares

Example of Free Float Market Capitalisation

Consider this example. A company’s share is trading at INR 100. The company has 10 million shares trading publicly - free float shares. Now apply the formula. 

Free Float Market Capitalisation = INR 100 (Share Price) × 10 million shares (Free Float Shares) 

Free Float Market Capitalisation = INR 1,000 million

Key Characteristics of Free Float Market Capitalisation

1) For the calculation of free float shares, restricted shares are excluded. Restricted shares are those that are not publicly available for trading.

2) Free float is a metric used in index calculations and helps in weighting stocks in indices. 

3) The value of a company’s free float can vary across stock exchanges as each one might use a different method for the calculation. 

Additional Read: What is Candlestick Pattern?

How Does the Free Float Market Capitalisation Work in Stock Market?

1) Share exclusion: Shares held by insiders are excluded while only the publicly traded shares are counted. 

2) Index weightage: Stock market indices such as the Nifty 50, or the Sensex make use of free float shares data to assign weightage to the companies. 

3) Impact of buying and selling: The free float level of a company is an indication of its liquidity in the market, and a highly liquid stock moves more freely, resulting in increased buying and selling. 

4) Price sensitivity: The free float level of a company also indicates the price volatility of the stock. A company with low free float is more vulnerable to volatility in its share price. 

5) Market perception: The free float level also has an impact on investor sentiments. A company with higher free float is often considered more preferable due to a perceived transparency.

Significance of the Free Float Market Capitalisation in Trading

1. Investor Insight: Free float market capitalization provides a clear indication of the proportion of a company's shares that are accessible for public trade, excluding locked-in equities held by promoters and governments. This statistic helps investors determine a stock's genuine market liquidity.

2. Index Representation: Stocks in major indexes are weighted according to their free float market capitalization. This means that a company's influence on index movements is defined by the value of its freely traded shares, resulting in a more accurate reflection of market trends.

3. Volatility and Pricing: Because there are fewer shares available for trading, equities with a smaller free float may experience greater volatility as a result of larger price swings in reaction to buy and sell orders.

4. Corporate Control Insights: Understanding a company's free float can provide insight into the likelihood of corporate control issues or takeovers, as a smaller free float indicates that greater control is kept by significant stakeholders, potentially leading to equilibrium or resistance to corporate changes.

Advantages of Free Float Market Capitalisation

One of the key benefits of free float market capitalization is that it provides a more accurate estimate of a company's liquid market worth. This enables investors to make more informed selections based on the actual shares they can purchase or sell. Furthermore, free float estimates avoid overestimation of firm size, which can occur when all shares, even those not traded publicly, are considered. This strategy also helps index funds, which use it to build a healthy  portfolio of liquid equities.

Impact of Free Float Market Capitalisation

Free float market capitalisation has a direct impact on the weighting of companies in different stock market indices. Companies having a higher level of free float have a greater impact on the entire index, making them more important for tracking market changes. It also affects the stock's liquidity; businesses with a big free float typically have more trading activity, resulting in tighter spreads and lower price volatility. Companies with a low level of free float, on the other hand, are more likely to experience significant price changes due to the scarcity of shares.

Additional Read: What Are Ascending and Descending Triangle Patterns

Limitations and Risks of Free Float Market Capitalisation

Limitations

Risks

Ignores shares held by insiders, institutions, or governments and only takes into account shares that are available for public trading.

Stocks with low free float are more susceptible to manipulation, which can result in inflated price swings.

A low free float indicates that there are fewer shares available for trading, which makes the stock more volatile.

A company's true size and value may not be fully shown by market capitalization based on free float.

Unsuitable for assessing businesses with significant insider ownership or government ownership.

Reduced liquidity in low free float stocks might make it more difficult to acquire or sell without materially changing the price.

Insider transactions or shifts in institutional holdings can have a significant effect on the free float.

Public investor behavior, which might be irrational or short-term oriented, is a major reliance of the strategy.

Conclusion

Free float market capitalization provides a more accurate depiction of a company's market worth by focusing on shares that are accessible for public trade. It is critical for index computations, liquidity assessments, and market analysis, particularly in economies such as the Indian stock market. Traders have to be mindful of its limits, however, notably those related to liquidity and volatility.

Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.

This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

For All Disclaimers Click Here: https://bit.ly/3Tcsfuc

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Frequently Asked Questions

What is free float market capitalisation meaning in the stock market?

Answer Field

Free float market capitalization refers to the total value of a company's publicly traded shares, excluding shares held by insiders, giving a clearer picture of its market value.

How does free float market capitalisation indicate a potential market reversal?

Answer Field

In stocks with low free float market capitalization, sudden spikes in buying or selling pressure can lead to significant price swings, potentially signaling a market reversal due to limited liquidity.

What are the key characteristics of free float market capitalisation?

Answer Field

Key characteristics include excluding non-public shares, reflecting true market liquidity, being used in index calculations, and acting as a measure of market transparency.

How can traders use the free float market capitalisation to make profitable trades?

Answer Field

Traders can use free float market capitalisation to gauge liquidity and volatility. Stocks with higher free float are more liquid and stable, making them less risky, while lower free float stocks offer more volatility for short-term gains via a trading account.

What is the relationship between the free float market capitalisation and market volatility?

Answer Field

Lower free float market capitalization generally leads to higher market volatility, as fewer shares are available for trading, making the stock more sensitive to large trades.

What are the common mistakes traders make when trading with a free float market capitalisation?

Answer Field

Common mistakes include underestimating the volatility of low free float market capitalization stocks, failing to account for liquidity issues, and ignoring the effect of large insider holdings on the overall stock price.

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