Whether you are an experienced or newbie trader/investor, understanding 'overhang' on a stock can mean the difference between getting stuck in a stock that isn't moving versus making much quicker returns.  Here's why, and a tool you can use to monitor it.

Youv'e probably been there, you've researched a stock and you are interested in buying it.  The story is good and so is the sentiment around it, you are hoping that, from the current share-price, you'll make a quick buck or hold it longer-term for bigger gains.  

The problem is you buy the stock and it seems stuck (range-bound), just doesn't seem to get past a certain price, despite good volume. 

So why is that?

Well there is a fairly good chance the stock has overhang.  Here are some examples of stock overhang causes:

1. Large Pending Issuances: Future issuance of new shares, such as from secondary offerings or convertible securities such as CLN's (Convertible Loan Notes)
2. Unexercised Options or Warrants: Outstanding stock options, warrants, or convertible bonds that could be converted into common stock.
3. Locked-Up Shares: Shares held by insiders or early investors that are subject to lock-up periods after an IPO but will become available for trading later.
4. Insider Ownership: A concentration of shares held by insiders or institutions that could be sold in large quantities if conditions change.
5. Share Placings: A favourite on the AIM market, a large issuance of shares, probably issued at a discount to the closing share price.

The Impact 

Stock overhang represents potential downward pressure on the share price, as increased supply in the market, without a corresponding rise in demand, can drive prices lower.

1. Downward Price Pressure

• If investors know that a large amount of stock is likely to enter the market, they may anticipate a drop in the stock price and adjust their positions accordingly.
• For example, when insiders’ lock-up periods expire, the selling of previously unavailable shares can dilute the value of existing shares and push the price down.

2. Investor Sentiment

• Perceived overhang can affect investor confidence. Even if no immediate selling occurs, the knowledge of potential dilution or large pending sales might make the stock less attractive.

3. Valuation

• Companies with significant overhang might face challenges with valuations. For example, large option pools or convertible debt that could lead to new share issuance create uncertainty about future ownership dilution and thus impact the valuation.

Examples

Essentially, Stock overhang matters because it reflects latent supply that can influence the stock price, valuation, and investor sentiment.

With Smaller Cap, lower liquidity stocks, the impact can be more dramatic. 

For example, take a company capped at £10M that executes a placing for £2M.  Thats 20% dilution (new shares to hit the market on the settlement date).  If that stock is not particlularly liquid (volume as been low), i.e. it's a 'keep the lights on placing' and sentiment around the stock is poor, that £2M could take 6 months to wash through at the average daily volume.  The result of this is that, the share price will likely stay pretty much where it is until that £2M has been churned. 

Another example, when companies issue placings is that often the market makers themselves take stock. But why though they are not investors?  Well because market makers are supposedly there to make a market i.e. offer to buy the stock and sell it with a spread.  The spread is the difference bewteen the price they will buy at and sell at (their profit for making the market). 

So imagine if a company issues £500,000 of a placing to a market maker (either directly or in-directly) at a 10% discount to the share price say at 1.5p per share, the market maker will immediately be able to offer those shares for purchases at 1.65p and make a 10% spread (profit).  They are not interested if the share is fundamentally going to 5p, they will just take their turn and move on.  This however becomes overhang!

Other Sellers

You may have noticed RNS (News Releases) on stocks labelled as 'TR1 Notification of Holdings'.  These releases are typically to update the market on when holders holding over 3% of the stock are buying or selling.  In market conditions like we have seen over the past couple of years, many institutional TR1 holders have been selling small and nano-cap stocks either due to their market positioning or forced redemptions.  

Known sellers are therefore another exaample of overhang.  If a seller is decreasing their position and hold say 5% of a company (say 5m shares), it's quite possible that the stock will get stuck at their average exit price until that stock has been sold.  

Even worse, if a debt provder (an entity that has lent the money company) has been issued with a Convertible Loan Note (a loan that can be converted into equity) with a price of conversion at a discount to the VWAP price, the CLN will likely weigh on the share price until fully converted, again another example of overhang.

What Can You Do?

In the situations above there is no doubt that it is going to be difficult to make a return on your trade or investment until the overhang has cleared.  That said, some placings can be washed through in just a couple of days, if there is positive sentiment and high liquidity.  As I write, a company Quantum BlockChain this week issued a £2M share placing following some potentially game-changing news and as a result the placing churned 80% of the new issued shares in just one day.  It's likely the QBT placing volume will be fully churned by day two.  

Assuming the majority of the volume represents the placing shares this could mean that the share price could be about to make a move up, providing sentiment remains.

So the key is, for any stock you are interested in that has overhang, you will need to keep track of the daily and cumulative volume and when you believe it is close to, or has cleared, that could be the entry point whereby you shouldn't be a victim of overhang.

SmallCapPix Vol Tracker

SmallCapPix have ceated a tool just for this.  The tool allows to you to simply select a stock and enter a target volume (the overhang if you like).  Each day, the stock cumulative volume will be updated, showing you a precent complete figure.  When the cumulative volume reaches or exceeds the target volume, it is 100% complete.  

Example SmallCapPix Vol Tracker monitoring recent QBT and HEX Placings

You do however have to use the tool as a guide as there is no guarantee that the cumulative volume represents exacly the overhang scenario (e.g. the Placing or TR1 Seller).

So, in summary, overhang matters and it matters a lot in smaller cap low-liquidity stocks.  However, by keeping a track of overhang and estimating when it's cleared, can mean the difference between sitting and waiting for you chosen stock to make its move or realise the move much quicker and make your gains!

You can set-up a Vol Tracker here