The Investment FAQ (part 1 of 20)
Christopher Lott
Version: $Id: part01,v 1.62 2005/01/05 12:40:47 lott Exp lott $
Compiler: Christopher Lott
This is the table of contents for the plain-text version of
The Investment FAQ, and is the first part of a 20-part posting.
Please visit The Investment FAQ web site for the latest version:
http://invest-faq.com/
The Investment FAQ is a collection of articles about investments and
personal finance, including stocks, bonds, mutual funds, options,
discount brokers, information sources, life insurance, etc. Although
the FAQ is more of a reference than a tutorial, if you pick your
articles carefully, the FAQ can serve as a comprehensive, unbiased
introduction to investing.
Terms of Use
The following terms and conditions apply to the plain-text version of
The Investment FAQ that is posted regularly to various newsgroups.
Different terms and conditions apply to documents on The Investment
FAQ web site.
The Investment FAQ is copyright 2005 by Christopher Lott, and is
protected by copyright as a collective work and/or compilation,
pursuant to U.S. copyright laws, international conventions, and other
copyright laws. The contents of The Investment FAQ are intended for
personal use, not for sale or other commercial redistribution.
The plain-text version of The Investment FAQ may be copied, stored,
made available on web sites, or distributed on electronic media
provided the following conditions are met:
+ The URL of The Investment FAQ home page is displayed prominently.
+ No fees or compensation are charged for this information,
excluding charges for the media used to distribute it.
+ No advertisements appear on the same web page as this material.
+ Proper attribution is given to the authors of individual articles.
+ This copyright notice is included intact.
Disclaimers
Neither the compiler of nor contributors to The Investment FAQ make
any express or implied warranties (including, without limitation, any
warranty of merchantability or fitness for a particular purpose or
use) regarding the information supplied. The Investment FAQ is
provided to the user "as is". Neither the compiler nor contributors
warrant that The Investment FAQ will be error free. Neither the
compiler nor contributors will be liable to any user or anyone else
for any inaccuracy, error or omission, regardless of cause, in The
Investment FAQ or for any damages (whether direct or indirect,
consequential, punitive or exemplary) resulting therefrom.
Rules, regulations, laws, conditions, rates, and such information
discussed in this FAQ all change quite rapidly. Information given
here was current at the time of writing but is almost guaranteed to be
out of date by the time you read it. Mention of a product does not
constitute an endorsement. Answers to questions sometimes rely on
information given in other answers. Readers outside the USA can reach
US-800 telephone numbers, for a charge, using a service such as MCI's
Call USA. All prices are listed in US dollars unless otherwise
specified.
Availability of the FAQ
Web:
http://invest-faq.com/
Anonymous ftp:
site: rtfm.mit.edu
path: /pub/usenet-by-group/news.answers/investment-faq/general/*
Email:
address: mail-...@rtfm.mit.edu
required msg body:
send usenet-by-group/news.answers/investment-faq/general/*
News:
posted monthly to misc.invest.misc, misc.invest.stocks,
misc.invest.mutual-funds, misc.invest.technical, misc.invest.options,
and the moderated groups misc.answers & news.answers.
Please send comments and new submissions to the compiler.
--------------------Check http://invest-faq.com/ for updates------------------
TABLE OF CONTENTS
Advice - Beginning Investors part 2
Advice - Buying a Car at a Reasonable Price part 2
Advice - Errors in Investing part 2
Advice - Using a Full-Service Broker part 2
Advice - Mutual-Fund Expenses part 2
Advice - One-Line Wisdom part 2
Advice - Paying for Investment Advice part 2
Advice - Researching a Company part 2
Advice - Target Stock Prices part 2
Analysis - Amortization Tables part 2
Analysis - Annual Reports part 2
Analysis - Beta and Alpha part 2
Analysis - Book-to-Bill Ratio part 2
Analysis - Book Value part 2
Analysis - Computing Compound Return part 2
Analysis - Future and Present Value of Money part 2
Analysis - Goodwill part 2
Analysis - Internal Rate of Return (IRR) part 3
Analysis - Paying Debts Early versus Making Investments part 3
Analysis - Price-Earnings (P/E) Ratio part 3
Analysis - Percentage Rates part 3
Analysis - Risks of Investments part 3
Analysis - Return on Equity versus Return on Capital part 3
Analysis - Rule of 72 part 3
Analysis - Same-Store Sales part 3
Bonds - Basics part 3
Bonds - Amortizing Premium part 3
Bonds - Duration Measure part 3
Bonds - Moody Bond Ratings part 3
Bonds - Municipal Bond Terminology part 4
Bonds - Relationship of Price and Interest Rate part 4
Bonds - Tranches part 4
Bonds - Treasury Debt Instruments part 4
Bonds - Treasury Direct part 4
Bonds - U.S. Savings Bonds part 4
Bonds - U.S. Savings Bonds for Education part 4
Bonds - Value of U.S. Treasury Bills part 4
Bonds - Zero-Coupon part 4
CDs - Basics part 4
CDs - Market Index Linked part 4
Derivatives - Basics part 4
Derivatives - Black-Scholes Option Pricing Model part 5
Derivatives - Futures part 5
Derivatives - Futures and Fair Value part 5
Derivatives - Stock Option Basics part 5
Derivatives - Stock Option Covered Calls part 5
Derivatives - Stock Option Covered Puts part 5
Derivatives - Stock Option Ordering part 5
Derivatives - Stock Option Splits part 5
Derivatives - Stock Option Symbols part 5
Derivatives - LEAPs part 5
Education Savings Plans - Section 529 Plans part 5
Education Savings Plans - Coverdell part 5
Exchanges - The American Stock Exchange part 5
Exchanges - The Chicago Board Options Exchange part 5
Exchanges - Circuit Breakers, Curbs, and Other Trading part 6
Exchanges - Contact Information part 6
Exchanges - Instinet part 6
Exchanges - Market Makers and Specialists part 6
Exchanges - The NASDAQ part 6
Exchanges - The New York Stock Exchange part 6
Exchanges - Members and Seats on AMEX part 6
Exchanges - Ticker Tape Terminology part 6
Financial Planning - Basics part 6
Financial Planning - Choosing a Financial Planner part 6
Financial Planning - Compensation and Conflicts of Interest part 6
Financial Planning - Estate Planning Checkup part 6
Information Sources - Books part 7
Information Sources - Conference Calls part 7
Information Sources - Free to All Who Ask part 7
Information Sources - Investment Associations part 7
Information Sources - Value Line part 7
Information Sources - Wall $treet Week part 7
Insurance - Annuities part 8
Insurance - Life part 8
Insurance - Viatical Settlements part 8
Insurance - Variable Universal Life (VUL) part 8
Mutual Funds - Basics part 8
Mutual Funds - Average Annual Return part 8
Mutual Funds - Buying from Brokers versus Fund Companies part 8
Mutual Funds - Distributions and Tax Implications part 9
Mutual Funds - Fees and Expenses part 9
Mutual Funds - Index Funds and Beating the Market part 9
Mutual Funds - Money-Market Funds part 9
Mutual Funds - Reading a Prospectus part 9
Mutual Funds - Redemptions part 9
Mutual Funds - Types of Funds part 9
Mutual Funds - Versus Stocks part 9
Real Estate - 12 Steps to Buying a Home part 9
Real Estate - Investment Trusts (REITs) part 9
Real Estate - Renting versus Buying a Home part 10
Regulation - Accredited Investor part 10
Regulation - Full Disclosure part 10
Regulation - Money-Supply Measures M1, M2, and M3 part 10
Regulation - Federal Reserve and Interest Rates part 10
Regulation - Margin Requirements part 10
Regulation - Securities and Exchange Commission (U.S.) part 10
Regulation - SEC Rule 144 part 10
Regulation - SEC Registered Advisory Service part 10
Regulation - SEC/NASDAQ Settlement part 10
Regulation - Series of Examinations/Registrations part 10
Regulation - SIPC, or How to Survive a Bankrupt Broker part 10
Retirement Plans - 401(k) part 11
Retirement Plans - 401(k) for Self-Employed People part 11
Retirement Plans - 403(b) part 11
Retirement Plans - 457(b) part 11
Retirement Plans - Co-mingling funds in IRA accounts part 11
Retirement Plans - Keogh part 11
Retirement Plans - Roth IRA part 11
Retirement Plans - SEP IRA part 11
Retirement Plans - Traditional IRA part 12
Software - Archive of Free Investment-Related Programs part 12
Software - Portfolio Tracking and Technical Analysis part 12
Stocks - Basics part 12
Stocks - American Depositary Receipts (ADRs) part 12
Stocks - Cyclicals part 12
Stocks - Dividends part 12
Stocks - Dramatic Price Changes part 12
Stocks - Holding Company Depositary Recepits (HOLDRs) part 12
Stocks - Income and Royalty Trusts part 12
Stocks - Types of Indexes part 12
Stocks - The Dow Jones Industrial Average part 13
Stocks - Other Indexes part 13
Stocks - Market Volatility Index (VIX) part 13
Stocks - Investor Rights Movement part 13
Stocks - Initial Public Offerings (IPOs) part 13
Stocks - Mergers part 13
Stocks - Market Capitalization part 13
Stocks - Outstanding Shares and Float part 13
Stocks - Preferred Shares part 13
Stocks - Price Basis part 13
Stocks - Price Tables in Newspapers part 13
Stocks - Price Data part 13
Stocks - Replacing Lost Certificates part 13
Stocks - Repurchasing by Companies part 14
Stocks - Researching the Value of Old Certificates part 14
Stocks - Reverse Mergers part 14
Stocks - Shareholder Rights Plan part 14
Stocks - Splits part 14
Stocks - Tracking Stock part 14
Stocks - Exchange-Traded Funds and Unit Investment Trusts part 14
Stocks - Warrants part 14
Strategy - Dogs of the Dow part 14
Strategy - Dollar Cost and Value Averaging part 14
Strategy - Hedging part 14
Strategy - Buying on Margin part 14
Strategy - Writing Put Options To Acquire Stock part 14
Strategy - Socially Responsible Investing part 14
Strategy - When to Buy/Sell Stocks part 14
Strategy - Survey of Stock Investment Strategies part 15
Strategy - Value and Growth part 15
Tax Code - Backup Withholding part 15
Tax Code - Capital Gains Cost Basis part 15
Tax Code - Capital Gains Computation part 15
Tax Code - Capital Gains Tax Rates part 15
Tax Code - Cashless Option Exercise part 15
Tax Code - Deductions for Investors part 15
Tax Code - Estate and Gift Tax part 15
Tax Code - Gifts of Stock part 15
Tax Code - Non-Resident Aliens and US Holdings part 16
Tax Code - Reporting Option Trades part 16
Tax Code - Short Sales Treatment part 16
Tax Code - Tax Swaps part 16
Tax Code - Uniform Gifts to Minors Act (UGMA) part 16
Tax Code - Wash Sale Rule part 16
Technical Analysis - Basics part 16
Technical Analysis - Bollinger Bands part 16
Technical Analysis - Black-Scholes Model part 16
Technical Analysis - Commodity Channel Index part 16
Technical Analysis - Charting Services part 16
Technical Analysis - Data Sources part 16
Technical Analysis - Elliott Wave Theory part 16
Technical Analysis - Information Sources part 17
Technical Analysis - MACD part 17
Technical Analysis - McClellan Oscillator and Summation Index part 17
Technical Analysis - On Balance Volume part 17
Technical Analysis - Relative Strength Indicator part 17
Technical Analysis - Stochastics part 17
Trading - Basics part 17
Trading - After Hours part 17
Trading - Bid, Offer, and Spread part 17
Trading - Brokerage Account Types part 17
Trading - Discount Brokers part 17
Trading - Direct Investing and DRIPs part 18
Trading - Electronically and via the Internet part 18
Trading - Free Ride Rules part 18
Trading - By Insiders part 18
Trading - Introducing Broker part 18
Trading - Jargon and Terminology part 18
Trading - NASD Public Disclosure Hotline part 18
Trading - Buy and Sell Stock Without a Broker part 18
Trading - Non-Resident Aliens and US Exchanges part 18
Trading - Off Exchange part 18
Trading - Opening Prices part 18
Trading - Order Routing and Payment for Order Flow part 19
Trading - Day, GTC, Limit, and Stop-Loss Orders part 19
Trading - Pink Sheet Stocks part 19
Trading - Price Improvement part 19
Trading - Process Date part 19
Trading - Round Lots of Shares part 19
Trading - Security Identification Systems part 19
Trading - Shorting Stocks part 19
Trading - Shorting Against the Box part 19
Trading - Size of the Market part 19
Trading - Tick, Up Tick, and Down Tick part 19
Trading - Transferring an Account part 19
Trading - Can You Trust The Tape? part 20
Trading - Selling Worthless Shares part 20
Trivia - Bull and Bear Lore part 20
Trivia - Presidential Portraits on U.S. Notes part 20
Trivia - Getting Rich Quickly part 20
Trivia - One-Letter Ticker Symbols on NYSE part 20
Trivia - Stock Prices in Sixteenths part 20
Warning - Wade Cook part 20
Warning - Charles Givens part 20
Warning - Dave Rhodes and Other Chain Letters part 20
Warning - Ken Roberts part 20
Warning - Selling Unregistered Securities part 20
--------------------Check http://invest-faq.com/ for updates------------------
Compiler's Acknowledgements:
My sincere thanks to the many contributors for their efforts.
Compilation Copyright (c) 2005 by Christopher Lott.
Christopher Lott
Version: $Id: part10,v 1.62 2005/01/05 12:40:47 lott Exp lott $
Compiler: Christopher Lott
The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance. This is a plain-text
version of The Investment FAQ, part 10 of 20. The web site
always has the latest version, including in-line links. Please browse
http://invest-faq.com/
Terms of Use
Disclaimers
Please send comments and new submissions to the compiler.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Real Estate - Renting versus Buying a Home
Last-Revised: 21 Nov 1995
Contributed-By: Jeff Mincy (mincy at rcn.com), Chris Lott ( contact me )
This note will explain one way to compare the monetary costs of renting
vs. buying a home. It is extremely prejudiced towards the US system.
A few small C programs for computing future value, present value, and
loan amortization schedules (used to write this article) are available.
See the article "Software - Investment-Related Programs" elsewhere in
this FAQ for information about obtaining them.
1. Abstract
* If you are guaranteed an appreciation rate that is a few points
above inflation, buy.
* If the monthly costs of buying are basically the same as renting,
buy.
* The shorter the term, the more advantageous it is to rent.
* Tax consequences in the US are fairly minor in the long term.
2. Introduction
The three important factors that affect the analysis the most are the
following:
1. Relative cash flows; e.g., rent compared to monthly ownership
expenses
2. Length of term
3. Rate of appreciation
The approach used here is to determine the present value of the money
you will pay over the term for the home. In the case of buying, the
appreciation rate and thereby the future value of the home is estimated.
For home appreciate rates, find something like the tables published by
Case Schiller that show changes in house prices for your region. The
real estate section in your local newspaper may print it periodically.
This analysis neglects utility costs because they can easily be the same
whether you rent or buy. However, adding them to the analysis is
simple; treat them the same as the costs for insurance in both cases.
Opportunity costs of buying are effectively captured by the present
value. For example, pretend that you are able to buy a house without
having to have a mortgage. Now the question is, is it better to buy the
house with your hoard of cash or is it better to invest the cash and
continue to rent? To answer this question you have to have estimates for
rental costs and house costs (see below), and you have a projected
growth rate for the cash investment and projected growth rate for the
house. If you project a 4% growth rate for the house and a 15% growth
rate for the cash then holding the cash would be a much better
investment.
First the analysis for renting a home is presented, then the analysis
for buying. Examples of analyses over a long term and a short term are
given for both scenarios.
3. Renting a Home.
Step 1: Gather data
You will need:
* monthly rent
* renter's insurance (usually inexpensive)
* term (period of time over which you will rent)
* estimated inflation rate to compute present value
(historically 4.5%)
* estimated annual rate of increase in the rent (can use
inflation rate)
Step 2: Compute present value of payments
You will compute the present value of the cash stream that you will
pay over the term, which is the cost of renting over that term.
This analysis assumes that there are no tax consequences (benefits)
associated with paying rent.
3.1 A long-term example of renting
Rent = 990 / month
Insurance = 10 / month
Term = 30 years
Rent increases = 4.5% annually
Inflation = 4.5% annually
For this cash stream, present value = 348,137.17.
3.2 A short-term example of renting
Same numbers, but just 2 years.
Present value = 23,502.38
4. Buying a Home
Step 1: Gather data.
You need a lot to do a fairly thorough analysis:
* purchase price
* down payment and closing costs
* other regular expenses, such as condominium fees
* amount of mortgage
* mortgage rate
* mortgage term
* mortgage payments (this is tricky for a variable-rate
mortgage)
* property taxes
* homeowner's insurance (Note: this analysis neglects
extraordinary risks such as earthquakes or floods that may
cause the homeowner to incur a large loss due to a high
deductible in your policy. All of you people in California
know what I'm talking about.)
* your marginal tax bracket (at what rate is the last dollar
taxed)
* the current standard deduction which the IRS allows
Other values have to be estimated, and they affect the analysis
critically:
* continuing maintenance costs (I estimate 1/2 of PP over 30
years.)
* estimated inflation rate to compute present value
(historically 4.5%)
* rate of increase of property taxes, maintenance costs, etc.
(infl. rate)
* appreciation rate of the home (THE most important number of
all)
Step 2: Compute the monthly expense
This includes the mortgage payment, fees, property tax, insurance,
and maintenance. The mortgage payment is fixed, but you have to
figure inflation into the rest. Then compute the present value of
the cash stream.
Step 3: Compute your tax savings
This is different in every case, but roughly you multiply your tax
bracket times the amount by which your interest plus other
deductible expenses (e.g., property tax, state income tax) exceeds
your standard deduction. No fair using the whole amount because
everyone, even a renter, gets the standard deduction for free.
Must be summed over the term because the standard deduction will
increase annually, as will your expenses. Note that late in the
mortgage your interest payments will be be well below the standard
deduction. I compute savings of about 5% for the 33% tax bracket.
Step 4: Compute the present value
First you compute the future value of the home based on the
purchase price, the estimated appreciation rate, and the term.
Once you have the future value, compute the present value of that
sum based on the inflation rate you estimated earlier and the term
you used to compute the future value. If appreciation is greater
than inflation, you win. Else you break even or even lose.
Actually, the math of this step can be simplified as follows:
/periods + appr_rate/100\ ^ (periods *
yrs)
prs-value = cur-value * | ----------------------- |
\periods + infl_rate/100/
Step 5: Compute final cost
All numbers must be in present value.
Final-cost = Down-payment + S2 (expenses) - S3 (tax sav) - S4 (prop
value)
4.1 Long-term example Nr. 1 of buying: 6% apprecation
Step 1 - the data
* Purchase price = 145,000
* Down payment etc = 10,000
* Mortgage amount = 140,000
* Mortgage rate = 8.00%
* Mortgage term = 30 years
* Mortgage payment = 1027.27 / mo
* Property taxes = about 1% of valuation; I'll use 1200/yr =
100/mo (Which increases same as inflation, we'll say. This
number is ridiculously low for some areas, but hey, it's just
an example!)
* Homeowner's ins. = 50 / mo
* Condo. fees etc. = 0
* Tax bracket = 33%
* Standard ded. = 5600 (Needs to be updated)
Estimates:
* Maintenance = 1/2 PP is 72,500, or 201/mo; I'll use 200/mo
* Inflation rate = 4.5% annually
* Prop. taxes incr = 4.5% annually
* Home appreciates = 6% annually (the NUMBER ONE critical
factor)
Step 2 - the monthly expense
The monthly expense, both fixed and changing components:
Fixed component is the mortgage at 1027.27 monthly. Present value
= 203,503.48. Changing component is the rest at 350.00 monthly.
Present value = 121,848.01. Total from Step 2: 325,351.49
Step 3 - the tax savings
I use my loan program to compute this. Based on the data given
above, I compute the savings: Present value = 14,686.22. Not much
when compared to the other numbers.
Step 4 - the future and present value of the home
See data above. Future value = 873,273.41 and present value =
226,959.96 (which is larger than 145k since appreciation is larger
than inflation). Before you compute present value, you should
subtract reasonable closing costs for the sale; for example, a real
estate broker's fee.
Step 5 - the final analysis for 6% appreciation
Final = 10,000 + 325,351.49 - 14,686.22 - 226,959.96
= 93,705.31
So over the 30 years, assuming that you sell the house in the 30th year
for the estimated future value, the present value of your total cost is
93k. (You're 93k in the hole after 30 years, which means you only paid
260.23/month.)
4.2 Long-term example Nr. 2 of buying: 7% apprecation
All numbers are the same as in the previous example, however the home
appreciates 7%/year.
Step 4 now comes out FV=1,176,892.13 and PV=305,869.15
Final = 10,000 + 325,351.49 - 14,686.22 - 305,869.15
= 14796.12
So in this example, 7% was an approximate break-even point in the
absolute sense; i.e., you lived for 30 years at near zero cost in
today's dollars.
4.3 Long-term example Nr. 3 of buying: 8% apprecation
All numbers are the same as in the previous example, however the home
appreciates 8%/year.
Step 4 now comes out FV=1,585,680.80 and PV=412,111.55
Final = 10,000 + 325,351.49 - 14,686.22 - 412,111.55
= -91,446.28
The negative number means you lived in the home for 30 years and left it
in the 30th year with a profit; i.e., you were paid to live there.
4.4 Long-term example Nr. 4 of buying: 2% appreciation
All numbers are the same as in the previous example, however the home
appreciates 2%/year.
Step 4 now comes out FV=264,075.30 and PV=68,632.02
Final = 10,000 + 325,351.49 - 14,686.22 - 68,632.02
= 252,033.25
In this case of poor appreciation, home ownership cost 252k in today's
money, or about 700/month. If you could have rented for that, you'd be
even.
4.5 Short-term example Nr. 1 of buying: 6% apprecation
All numbers are the same as long-term example Nr. 1, but you sell the
home after 2 years. Future home value in 2 years is 163,438.17
Cost = down+cc + all-pymts - tax-savgs - pv(fut-home-value - remaining
debt)
= 10,000 + 31,849.52 - 4,156.81 - pv(163,438.17 - 137,563.91)
= 10,000 + 31,849.52 - 4,156.81 - 23,651.27
= 14,041.44
4.6 Short-term example Nr. 2 of buying: 2% apprecation
All numbers are the same as long-term example Nr. 4, but you sell the
home after 2 years. Future home value in 2 years is 150,912.54
Cost = down+cc + all-pymts - tax-savgs - pv(fut-home-value - remaining
debt)
= 10,000 + 31,849.52 - 4,156.81 - pv(150912.54 - 137,563.91)
= 10,000 + 31,849.52 - 4,156.81 - 12,201.78
= 25,490.93
5. A Question
Q: Is it true that you can usually rent for less than buying?
Answer 1: It depends. It isn't a binary state. It is a fairly complex
set of relationships.
In large metropolitan areas, where real estate is generally much more
expensive than elsewhere, then it is usually better to rent, unless you
get a good appreciation rate or if you are going to own for a long
period of time. It depends on what you can rent and what you can buy.
In other areas, where real estate is relatively cheap, I would say it is
probably better to own.
On the other hand, if you are currently at a market peak and the country
is about to go into a recession it is better to rent and let property
values and rent fall. If you are currently at the bottom of the market
and the economy is getting better then it is better to own.
Answer 2: When you rent from somebody, you are paying that person to
assume the risk of homeownership. Landlords are renting out property
with the long term goal of making money. They aren't renting out
property because they want to do their renters any special favors. This
suggests to me that it is generally better to own.
6. Conclusion
Once again, the three important factors that affect the analysis the
most are cash flows, term, and appreciation. If the relative cash flows
are basically the same, then the other two factors affect the analysis
the most.
The longer you hold the house, the less appreciation you need to beat
renting. This relationship always holds, however, the scale changes.
For shorter holding periods you also face a risk of market downturn. If
there is a substantial risk of a market downturn you shouldn't buy a
house unless you are willing to hold the house for a long period.
If you have a nice cheap rent controlled apartment, then you should
probably not buy.
There are other variables that affect the analysis, for example, the
inflation rate. If the inflation rate increases, the rental scenario
tends to get much worse, while the ownership scenario tends to look
better.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - Accredited Investor
Last-revised: 1 May 2000
Contributed-By: Chris Lott ( contact me )
The SEC has established criteria for preventing people who perhaps
should know better from investing in unregistered securities and other
things that are less well known than stocks and bonds. For example, if
you've ever been interested in buying into a privately held company, you
have probably heard all about this. In a nutshell, for an individual to
be considered a qualified investor (also termed an accredited investor),
that person must either have a net worth of about a million bucks, or
have an annual income in excess of 200k. Companies who wish to raise
capital from individuals without issuing registered securities are
forced to limit their search to people who fall on the happy side of
these thresholds.
To read the language straight from the securities lawyers, follow this
link:
http://www.law.uc.edu/CCL/33ActRls/rule215.html
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - Full Disclosure
Last-revised: 30 Jan 2001
Contributed-By: Chris Lott ( contact me )
The full disclosure rules, also known as regulation FD, were enacted by
the SEC to ensure the flow of information to all investors, just just
well-connected insiders. Basically the rule says that publically held
companies must disclose all material information that might affect
investment decisions to all investors at the same time. The intent was
to level the playing field for all investors. Regulation FD became
effective on 23 October 2000.
What was life like before this rule? Basically there was selective
disclosure. Before regulation FD, companies communicated well with
securities analysts who followed the company (the so-called back
channel), but not necessarily as well with individual investors.
Analysts were said to interpret the information from companies for the
public's benefit. So for example, if a company noticed that sales were
weak and that earnings might be poor, the company might call a group of
analysts and warn them of this fact. The analysts in turn could tell
their big (big) clients this news, and then eventually publish the
information for the general public (i.e., small clients). Put simply,
if you were big, you could get out before a huge price drop, or get in
before a big move up. If you were small, you had no chance.
Now, information is made available without any intermediaries like
analysts to interpret (or spin) it before it reaches the public. There
have been some very noticeable consequences of forcing companies to
grant all investors equal access to a company's material disclosures at
the same time. For example, company conference calls that were once
reserved for analysts only are now accessible to the general public.
Another example is that surprises (e.g., earnings shortfalls) are true
surprises to everyone, which leads to more frequent occurrences of large
changes in a stock's price. Finally, now that analysts no longer have
an easy source of information about the companies that they follow, they
are forced to do research on their companies - much harder work than
before. Some have predicted wide-spread layoffs of analysts because of
the change.
Timely information (i.e., disclosures) are filed with the SEC in 8-K
documents. Note that disclosures can be voluntary (i.e., planned) or
involuntary (i.e., goofs). In either case, the new rule says that the
company has to disclose the information to everyone as quickly as
possible. So an 8-K might get filed unexpectedly because a company exec
accidentally disclosed material information during a private meeting.
Here are some sites with more information.
* FDExpress, a service of Edgar. Subscription required to access
company filings.
http://www.fdexpress.com
* CCBN, a company that provides investor relations services.
http://www.ccbn.com/regfd.html
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - Money-Supply Measures M1, M2, and M3
Last-Revised: 4 Jan 2002
Contributed-By: Ralph Merritt
The US Federal Reserve Board measures the money supply using the
following measures.
M1 Money that can be spent immediately. Includes cash, checking
accounts, and NOW accounts.
M2 M1 + assets invested for the short term. These assets include
money- market accounts and money-market mutual funds.
M3 M2 + big deposits. Big deposits include institutional money-market
funds and agreements among banks.
The pamphlet "Modern Money Mechanics," which explains M1, M2, and M3 in
gory detail, was once available free from the Federal Reserve Bank of
Chicago. That pamphlet is no longer in print, and the Chicago Fed
apparently has no plans to re-issue it. However, electronic copies of
it are out there, and here's one:
http://landru.i-link-2.net/monques/mmm2.html
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - Federal Reserve and Interest Rates
Last-Revised: 25 Apr 1997
Contributed-By: Jeffrey J. Stitt, Himanshu Bhatt, Nikolaos Bernitsas,
Joe Lau
This article discusses the interest rates which are managed or
influenced by the US Federal Reserve Bank, a collective term for the
collection of Federal Reserve Banks across the country.
The Discount Rate is the interest rate charged by the Federal Reserve
when banks borrow "overnight" from the Fed. The discount rate is under
the direct control of the Fed. The discount rate is always lower than
the Federal Funds Rate (see below). Generally only large banks borrow
directly from the Fed, and thus get the benefit of being able to borrow
at the lower discount rate. As of April 1997, the discount rate was
5.00%.
The Federal Funds Rate is the interest rate charged by banks when banks
borrow "overnight" from each other. The funds rate fluctuates according
to supply and demand and is not under the direct control of the Fed, but
is strongly influenced by the Fed's actions. As of April 1997, the
target funds rate is 5.38%; the actual rate varies above and below that
figure.
The Fed adjusts the funds rate via "open market operations". What
actually happens is that the Fed sells US treasury securities to banks.
As a result, the bank reserves at the Fed drop. Given that banks have
to maintain at the Fed a certain level of required reserves based on
their demand deposits (checking accounts), they end up borrowing more
from each other to cover their short position at the Fed. The resulting
pressure on intrabank lending funds drives the funds rate up.
The Fed has no idea of how many billions of US treasuries it needs to
sell in order for the funds rate to reach the Fed's target. It goes by
trial and error. That's why it takes a few days for the funds rate to
adjust to the new target following an announcement.
Adjustments in the discount rate usually lag behind changes in the funds
rate. Once the spread between the two rates gets too large (meaning fat
profits for the big banks which routinely borrow from the Fed at the
discount rate and lend to smaller banks at the funds rate) the Fed moves
to adjust the discount rate accordingly. It usually happens when the
spread reaches about 1%.
Another interest rate of significant interest is the Prime Rate, the
interest that a bank charges its "best" customers. There is no single
prime rate, but the commercial banks generally offer the same prime
rate. The Fed does not adjust a bank's prime rate directly, but
indirectly. The change in discount rates will affect the prime rate.
As of April, 1997 the prime rate is 8.5%.
For an in-depth look at the Federal Reserve, get the book by William
Greider titled Secrets of the temple: How the Federal Reserve runs the
country .
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - Margin Requirements
Last-Revised: 26 May 2002
Contributed-By: Chris Lott ( contact me ), John Marucco
This article discusses the rules and regulations that apply to margin
accounts at brokerage houses. The basic rules are set by the Federal
Reserve Board (FRB), the New York Stock Exchange (NYSE), and the
National Asssociation of Securities Dealers (NASD). Every broker must
apply the minimum rules to customers, but a broker is free to apply more
stringent requirements. Also see the article elsewhere in the FAQ for
an explanation of a margin account versus a cash account .
Buying on margin means that your broker loans you money to make a
purchase. But how much can you borrow? As it turns out, the amount of
debt that you can establish and maintain with your broker is closely
regulated. Here is a summary of those regulations.
The Federal Reserve Board's Regulation T states how much money you may
borrow to establish a new position . Briefly, you may borrow 50% of the
cost of the new position. For example, $100,000 of cash can be used to
buy $200,000 worth of stock.
The NYSE's Rule 431 and the NASD's Rule 2520 both state how much money
you can continue to borrow to hold an open position . In brief, you
must maintain 25% equity for long positions and 30% equity for short
positions. Continuing the example in which $100,000 was used to buy
$200,000 of stock, the account holder would have to keep holdings of
$50,000 in the account to maintain the open long position. The best
holding in this case is of course cash; a $200,000 margined position can
be kept open with $50,000 of cash. If the account holder wants to use
fully paid securities to meet the maintenance requirement, then
securities (i.e., stock) with a loan value of $50,000 are required. See
the rule above - you can only borrow up to 50% - so to achieve a loan
value of $50,000, the account holder must have at least $100,000 of
fully paid securities in the account.
If the value of the customer's holdings drops to less than 25% of the
value of open positions (maybe some stocks fell in price dramatically),
than the brokerage house is required to impose a margin call on the
account holder. This means that the person must either sell open
positions, or deposit cash and/or securities, until the account equity
returns to 25%. If the account holder doesn't meet the margin call,
then four times the amount of the call will be liquidated within the
account.
Here are a few examples, showing Long Market, Short Market, Debit
Balance, Credit Balance, and Equity numbers for various situations.
Remember, Equity is the Long Market Value plus the Credit Balance, less
any Short Market Value and Debit Balance. (The Current Market Value of
securities is the Long Market value less the Short Market value.) The
Credit Balance is cash - money that is left over after everything is
paid and all margin requirements are satisfied. This is supposed to
give a feel for how a brokerage statement is marked to market each day.
So in the first example, a customer buys 100,000 worth of some stock on
margin. The 50% margin requirement (Regulation T) can be met with
either stock or cash.
To satisfy the margin requirement with cash , the customer must deposit
50,000 in cash. The account will then appears as follows; the "Equity"
reflects the cash deposit: Long
Market Short
Market Credit
Balance Debit
Balance
Equity
-----------------------------------------------------------------------
100,000 0 0 50,000 50,000
To satisfy the margin requirement with stock , the customer must deposit
marginable stock with a loan value of 50,000 (two times the amount of
the call). The account will then appears as follows; the 200,000 of
long market consists of 100,000 stock deposited to meet reg. T and
100,000 of the stock purchased on margin: Long
Market Short
Market Credit
Balance Debit
Balance
Equity
-----------------------------------------------------------------------
200,000 0 0 100,000 100,000
Here's a new example. What if the account looks like this: Long
Market Short
Market Credit
Balance Debit
Balance
Equity
-----------------------------------------------------------------------
20,000 0 0 17,000 3,000
The maintenance requirement calls for an equity position that is 25% of
20,000 which is 5,000, but equity is only 3,000. Because the equity is
less than 25% of the market value, a maintenance (aka margin) call is
triggered. The call is for the difference between the requirement and
actual equity, which is 5,000 - 3,000 or 2000. To meet the call, either
2,000 of cash or 4,000 of stock must be deposited. Here is what would
happen if the account holder deposits 2,000 in cash; note that the cash
deposit pays down the loan. Long
Market Short
Market Credit
Balance Debit
Balance
Equity
-----------------------------------------------------------------------
20,000 0 0 15,000 5,000
Here is what would happen if the account holder deposits 4,000 of stock:
Long
Market Short
Market Credit
Balance Debit
Balance
Equity
-----------------------------------------------------------------------
24,000 0 0 17,000 7,000
Ok, now what happens if the account holder does not meet the call? As
mentioned above, four times the amount of the call will be sold. So
stock in the amount of 8,000 will be sold and the account will look like
this: Long
Market Short
Market Credit
Balance Debit
Balance
Equity
-----------------------------------------------------------------------
12,000 0 0 9,000 3,000
In the case of short sales, Regulation T imposes an initial margin
requirement of 150%. This sounds extreme, but the first 100% of the
requirement can be satisified by the proceeds of the short sale, leaving
just 50% for the customer to maintain in margin (so it looks much like
the situation for going long). To maintain a short position, rule 2520
requires margin of $5 per share or 30 percent of the current market
value (whichever is greater).
Let's say a person shorts $10,000 worth of stock. They must have
securities with a loan value of at least $5,000 to comply with
regulation T. In this example, to keep things simple, the customer
deposits cash. So the Credit Balance consists of the 10,000 in proceeds
from the short sale plus the 5,000 Regulation T deposit. Remember that
market value is long market value minus short market value, and because
we gave our customer no securities in this example, the "long market"
value is zero, making the market value negative. Long
Market Short
Market Credit
Balance Debit
Balance
Equity
-----------------------------------------------------------------------
0 10,000 15,000 0 5,000
While we're discussing shorting, what about being short against the box?
(Also see the FAQ article about short-against-the-box positions .) When
an individual is long a stock position and then shorts the same stock, a
separate margin requirement is applicable. When shorting a position
that is long in an account the requirement is 5% of the market value of
the underlying stock. Let's say the original stock holding of $100,000
was purchased on margin (with a corresponding 50% requirement). And the
same holding is sold short against the box, yielding $100,000 of
proceeds that is shown in the Credit Balance column, plus a cash deposit
of $5,000. The account would look like this: Long
Market Short
Market Credit
Balance Debit
Balance
Equity
-----------------------------------------------------------------------
Initial position 100,000 50,000 50,000
Sell short 0 100,000 105,000 100,000 5,000
Net 100,000 100,000 105,000 150,000 55,000
Customer accounts are suppsed to be checked for compliance with
Regulation T and Rule 2520 at the end of each trading day. A brokerage
house may impose a margin call on an account holder at any time during
the day, though.
Finally, special conditions apply to day-traders. Check with your
broker.
Here are some additional resources:
* The NASD's Investor Education section has information about margin:
http://www.nasd.com/Investor/Trading/Margin/
* The full text of Regulation T
http://www.access.gpo.gov/nara/cfr/waisidx_99/12cfr220_99.html
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - Securities and Exchange Commission (U.S.)
Last-revised: 22 Dec 1999
Contributed-By: Dennis Yelle
Just in case you want to ask questions, complain about your broker, or
whatever, here's the vital information:
Securities and Exchange Commission
450 5th Street, N. W.
Washington, DC 20549
Office of Public Affairs: +1 202 272-2650
Office of Consumer Affairs: +1 202 272-7440
SEC policy concerning online enforcement:
http://www.sec.gov/enforce/comctr.htm
A web-enabled complaint submission form:
http://www.sec.gov/enforce/con-form.htm
E-Mail address for complaints: enfor...@sec.gov
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - SEC Rule 144
Last-Revised: 6 June 2000
Contributed-By: Bill Rini (bill at moneypages.com), Julie O'Neill
(joneill at feinberglawgroup.com)
The Federal Securities Act of 1933 generally requires that stock and
other securities must be registered with the Securities and Exchange
Commission (the "S.E.C.") prior to their offer or sale. Registering
securities with the S.E.C. can be expensive and time-consuming. This
article offers a brief introduction to SEC Rule 144, which allows for
the sale of restricted securities in limited quantities without
requiring the securities to be registered.
First it's probably appropriate to explain the basics of restricted
securities. Restricted securities are generally those which are first
issued in a private placement exempt from registration and which bear a
restrictive legend. The legend commonly states that the securities are
not registered and cannot be offered or sold unless they are registered
with the S.E.C. or exempt from registration. The restrictive legend
serves to ensure that the initial, unregistered sale is not part of a
scheme to avoid registration while achieving some broader distribution
than the initial sale. Normally, if securities are registered when they
are first issued, then they do not bear any restrictive legend and are
not deemed restricted securities.
Rule 144 generally applies to corporate insiders and buyers of private
placement securities that were not sold under SEC registration statement
requirements. Corporate insiders are officers, directors, or anyone
else owning more than 10% of the outstanding company securities. Stock
either acquired through compensation arrangements or open market
purchases is considered restricted for as long as the insider is
affiliated with the company. For example, if a corporate officer
purchases shares in his or her employer on the open market, then the
officer must comply with Rule 144 when those shares are sold, even
though the shares when purchased were not considered restricted. If,
however, the buyer of restricted securities has no management or major
ownership interests in the company, the restricted status of the
securities expires over a period of time.
Under Rule 144, restricted securities may be sold to the public without
full registration (the restriction lapses upon transfer of ownership) if
the following conditions are met.
1. The securities have been owned and fully paid for at least one year
(there are special exceptions that we'll skip here).
2. Current financial information must be made available to the buyer.
Companies that file 10K and 10Q reports with the SEC satisfy this
requirement.
3. The seller must file Form 144, "Notice of Proposed Sale of
Securities," with the SEC no later than the first day of the sale.
The filing is effective for 90 days. If the seller wishes to
extend the selling period or sell additional securities, a new form
144 is required.
4. The sale of the securities may not be advertised and no additional
commissions can be paid.
5. If the securities were owned for between one and two years, the
volume of securities sold is limited to the greater of 1% of all
outstanding shares, or the average weekly trading volume for the
proceeding four weeks. If the shares have been owned for two years
or more, no volume restrictions apply to non-insiders. Insiders
are always subject to volume restrictions.
The most recent rule change of Feb 1997 reduced the holding periods by
one year. For all the details, visit the SEC's page on this rule:
http://www.sec.gov/rules/final/33-7390.txt
Julie O'Neill offers some insights about the SEC's Rule 144:
http://www.feinberglawgroup.com/rule144.html
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - SEC Registered Advisory Service
Last-revised: 9 Jan 1996
Contributed-By: Paul Maffia (paulmaf at eskimo.com)
Some advisers will advertise with the information that they are an
S.E.C. Registered Advisory Service. This does not mean a damn thing
except that they have obeyed the law and registered as the law requires.
All it takes is filling out a long form, $150 and no convictions for
financial fraud.
If they attempt to imply anything in their ads other than the fact they
are registered, they are violating the law. Basically, this means that
they can inform you that they are registered in a none-too-prominent
way. If the information is conveyed in any other way, such as being
very prominent, or using words that convey any meaning other than the
simple fact of registration; or implying any special expertise; or
implying special approval, etc., they are violating the law and can
easily be fined and as well as lose their registration.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - SEC/NASDAQ Settlement
Last-Revised: 26 Feb 1997
Contributed-By: John Schott (jschott at voicenet.com), Chris Lott (
contact me )
The SEC's settlement with NASDAQ in late 1996 will almost certainly
impact trading and price improvement in a favorable way for small
investors. The settlement resulted in rule changes that are intended to
improve greater access to the market for individual investors, and to
improve the display and execution of orders. The changes will be
implemented in several phases, with the first phase beginning on 10 Jan
1997. Initially only 50 stocks will be in the program, but in
subsequent steps in 1997, the number of stocks will be expanded to cover
all NASDAQ stocks.
This action began after many people complained about very high spreads
in some shares traded on the NASDAQ market. In effect,the SEC
contention was that some market makers possible did not publically post
orders inside the spread because it impacted their profit margins.
Here are some of the key changes that resulted from the settlement.
* All NASDAQ market makers must execute or publicly display customer
limit orders that are (a) priced better than their public quote or
(b) limit orders that add to the size of their quote.
* All investors will have access to prices previously available only
to institutions or professional traders. These rules are expected
to produce more trading inside the spread, so wide spreads may become
less common. But remember, a market maker or broker making a market for
a stock has to be compensated for the risk they take. They have to hold
inventory or risk selling you stock they don't have and finding some
quickly. With a stock that moves about or trades seldom, they have to
make money on the spread to cover the "bad moves" that can leave them
holding inventory at a bad price. Reduced spreads may in fact force
less well capitalized or managed market makers to leave the market for
certain stocks, as there may be less chance for profit.
It will definitely be interesting to see how the spreads change over the
next few months as the NASDAQ settlement is phased in on more and more
stocks.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - Series of Examinations/Registrations
Last-revised: 30 Sep 1999
Contributed-By: Charlie H. Luh, Chris Lott ( contact me )
The National Association of Securities Dealers (NASD) administers a
series of licensing examinations that are used to qualify people for
employment in many parts of the finance industry. For example, the
Series 7 is commonly (although somewhat incorrectly) known as the
stockbroker exam. The following examinations are offered:
* Series 3 - Commodity Futures Examination
* Series 4 - Registered Options Principal
* Series 5 - Interest Rate Options Examination
* Series 6 - Investment Company and Variable Contracts Products Rep.
Translation: qualifies sales representatives to sell mutual funds
and variable annuities.
* Series 7 - Full Registration/General Securities Representative
Translation: qualifies sales representatives to sell stocks and
bonds. Variations include:
* Securities Traders (NYSE)
* Trading Supervisor (NYSE)
* Series 8 - General Securities Sales Supervisor
* Branch Office Manager (NYSE)
* Series 11 - Assistant Representative/Order Processing
* Series 15 - Foreign Currency Options
* Series 16 - Supervisory Analyst
* Series 22 - Direct Participation Program Representative
* Series 24 - General Securities Principal
* Series 26 - Investment Company and Variable Contracts Principal
* Series 27 - Financial and Operations Principal
* Series 28 - Introducing B/D/Financial and Operations Principal
* Series 39 - Direct Participation Program Principal
* Series 42 - Options Representative
* Series 52 - Municipal Securities Representative
* Series 53 - Municipal Securities Principal
* Series 62 - Corporate Securities Representative
* Series 63 - Uniform Securities Agent State Law Examination
* Series 65 - Uniform Investment Advisor Law Examination
The following NASD resources should help.
* The procedures for becoming a member of NASD, including details
about registering personnel through the Central Registration
Depository (CRD).
http://www.nasdr.com/4700.htm
* The NASD's CRD call center: +1 (301) 590-6500
* The NASD home page.
http://www.nasd.com/
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Regulation - SIPC, or How to Survive a Bankrupt Broker
Last-Revised: 26 May 1999
Contributed-By: Art Kamlet (artkamlet at aol.com), Dave Barrett
The U.S. Securities Investor Protection Corporation (SIPC) is a
federally chartered private corporation whose job is to insure
shareholders against the situation of a U.S. stock-broker going
bankrupt.
The National Association of Security Dealers requires all of their
member brokers to have SIPC insurance. Many brokers supplement the
limits that SIPC insures ($100,000 cash and $500,000 total, I think-- I
could be wrong here) with additional policies so you are covered up to
$1 million or more.
If you deal with discount houses, all brokerages, their clearing agents,
and any holding companies they have which can be holding your assets in
street-name had better be insured with the S.I.P.C. You're going to pay
a modest SEC tax (less than US$1) on any trade you make anywhere, so
make sure you're getting the benefit. If a broker goes bankrupt it's
the only thing that prevents a total loss. Investigate thoroughly!
The bottom line is that you should not do business with any broker who
is not insured by the SIPC.
--------------------Check http://invest-faq.com/ for updates------------------
Compilation Copyright (c) 2005 by Christopher Lott.
Christopher Lott
Version: $Id: part02,v 1.62 2005/01/05 12:40:47 lott Exp lott $
Compiler: Christopher Lott
The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance. This is a plain-text
version of The Investment FAQ, part 2 of 20. The web site
always has the latest version, including in-line links. Please browse
http://invest-faq.com/
Terms of Use
Disclaimers
Please send comments and new submissions to the compiler.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Advice - Beginning Investors
Last-Revised: 1 Aug 1998
Contributed-By: Steven Pearson, E. Green, Chris Lott ( contact me )
Investing is just one aspect of personal finance. People often seem to
have the itch to try their hand at investing before they get the rest of
their act together. This is a big mistake. For this reason, it's a
good idea for "new investors" to hit the library and read maybe three
different overall guides to personal finance - three for different
perspectives, and because common themes will emerge (repetition implies
authority?). Personal finance issues include making a budget, sticking
to a budget, saving money towards major purchases or retirement,
managing debt appropriately, insuring your property, etc. Appropriate
books that focus on personal finance include the following (the links
point to Amazon.com):
* Andrew Tobias
The Only Investment Guide You'll Ever Need
* Eric Tyson
Personal Finance for Dummies (4th edn.)
* Janet Bamford et al.
The Consumer Reports Money Book: How to Get It, Save It, and Spend
It Wisely (3rd edn) (out of print; used copies available)
Another great resource for learning about investing, insurance, stocks,
etc. is the Wall Street Journal's Section C front page. Beginners
should make a special effort to get the Friday edition of the WSJ
because a column named "Getting Going" usually appears on that day and
discusses issues in, well, getting going on investments. If you don't
want to spend the dollar or so for the WSJ, try your local library.
What I am specifically NOT talking about is most anything that appears
on a list of investing/stock market books that are posted in
misc.invest.* from time to time. This includes books like Market Logic,
One Up on Wall Street, Beating the Dow, Winning on Wall Street, The
Intelligent Investor, etc. These are not general enough. They are
investment books, not personal finance books.
Many "beginning investors" have no business investing in stocks. The
books recommended above give good overall money management, budgeting,
purchasing, insurance, taxes, estate issues, and investing backgrounds
from which to build a personal framework. Only after that should one
explore particular investments. If someone needs to unload some cash in
the meantime, they should put it in a money market fund, or yes, even a
bank account, until they complete their basic training.
While I sympathize with those who view this education as a daunting
task, I don't see any better answer. People who know next to nothing
and always depend on "professional advisors" to hand-hold them through
all transactions are simply sheep asking to be fleeced (they may not
actually be fleeced, but most of them will at least get their tails
bobbed). In the long run, an individual is the only person ultimately
responsible for his or her own financial situation.
Beginners may want to look further in The Investment FAQ for the
articles that discuss the basics of mutual funds , basics of stocks ,
and basics of bonds . For more in-depth material, browse the Investment
FAQ bookshelf with its recommended books about personal finance and
investments.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Advice - Buying a Car at a Reasonable Price
Last-Revised: 1 Aug 2001
Contributed-By: Kyle Busch (kbusch at velocity.net)
Before making a purchase, especially a large one, most buyers ponder an
equation that goes something like: What is it going to cost me, and will
that equal what I am going to get?
Consider that equation when buying your next vehicle. Naturally, you
want to get the most vehicle for the money you spend. Here are several
tips that will help you to get more for your money.
First, and foremost, consider eliminating some of the steep depreciation
cost incurred during the first three years of vehicle ownership by
purchasing a 2- to 3- year-old used vehicle.
The price can be further reduced by paying cash. However, if you need
to finance your next vehicle purchase, consider doing the following to
keep its cost closer to the "as if you were paying cash" figure.
* Take the time to carefully identify your current and your future
transportation needs, and choose an appropriate
vehicle.Transportation represents different things to different
people. For some drivers, it represents status in society. Other
drivers place greater emphasis on reliably just getting from point
A to points B and C. The more closely that you match your driving
needs with the vehicle you buy, the more driving pleasure you will
experience and the more likely you will want to hold on to the
vehicle.
If you can't fully identify your transportation needs or the
vehicle that can best satisfy them, consult the April issue of
Consumer Reports at a public library. The publication groups
vehicles into categories, provides frequency-of-repair information
for many vehicles, and gives vehicle price information. It is a
good idea to identify 2 or 3 vehicles in a particular category that
meet your transportation needs.This enables some latitude when
shopping for the vehicle. =
* Identify how much you can afford to spend per month on
transportation. A rule of thumb suggests that the cost to rent an
apartment per month should not be greater than 25 percent of your
monthly net pay.The cost of an auto loan should not exceed 10 to 12
percent of your monthly net pay. In some instances, leasing a
vehicle could be a better option than taking out a loan.
* The vehicle down payment should be the largest possible, and the
amount of money borrowed the lowest possible. In addition,
borrowing money for the shortest period of time (i.e., a 24-month
loan rather than a 48-month loan) will reduce the overall cost of
the loan.
* Identify the various loan sources such as banks, savings and loans,
credit unions, and national lenders (i.e., go online to ask
jeeves.com and specify "automobile financing sources"). In regard
to national financing vs. local financing, it can be useful to
determine what the cost of a loan would be from the national
sources, but accept a loan from a local source if the loan cost is
comparable or nearly comparable between the two. Compare the APR
(annual percentage rate) that each of the sources will charge for
the loan. The cost of a loan is negotiable. Therefore, be certain
to inform each source what the others have to offer. In addition
to the loan's APR, remember to also compare the other costs
associated with a loan, such as loan insurance and loan processing
costs.
* Be certain to read and understand any fine print contained in the
loan contract. Insist that the loan contract gives you the option
of making payments early and that the payments will be applied on
the loan principle with no penalty or extra cost if you payoff the
loan early.
* Do not settle for a vehicle that does not entirely meet your
transportation needs because of low dealer or manufacturer
incentive financing.Sometimes dealers or manufactures offer
extremely low APR financing on vehicles that the dealer is having a
hard time selling. That's why it helps to have initially
identified the correct vehicle before encountering the sales
pitches and other influences of buying a vehicle. Kyle Busch is
the author of Drive the Best for the Price: How to Buy a Used
Automobile, Sport-Utility Vehicle, or Minivan and Save Money . To find
out more about the author and this book visit:
http://www.drivethebestbook.com
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Advice - Errors in Investing
Last-Revised: 2 Aug 1999
Contributed-By: Chris Lott ( contact me ), Thomas Price (tprice at
engr.msstate.edu)
The Wall Street Journal of June 18, 1991 had an article on pages C1/C10
on Investment Errors and how to avoid them. As summarized from that
article, the errors are:
* Not following an investment objective when you build a portfolio.
* Buying too many mutual funds.
* Not researching a one-product stock before you buy.
* Believing that you can pick market highs and lows (time the
market).
* Taking profits early.
* Not cutting your losses.
* Buying the hottest {stock, mutual fund} from last year.
Here's a recent quote that underscores the last item. When asked
"What's the biggest mistake individual investors make?" on Wall $treet
Week, John Bogle, founder and senior chairman of Vanguard mutual funds,
said "Extrapolating the trend" or buying the hot stock.
On a final note, get this quote on market timing:
In the 1980s if you were out of the market on the ten best
trading days of the decade you missed one-third of the total
return.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Advice - Using a Full-Service Broker
Last-Revised: 23 Mar 1998
Contributed-By: Bill Rini (bill at moneypages.com), Chris Lott ( contact
me )
There are several reasons to choose a full-service broker over a
discount or web broker. People use a full-service broker because they
may not want to do their own research, because they are only interested
in long-term investing, because they like to hear the broker's
investment ideas, etc. But another important reason is that not
everybody likes to trade. I may want retirement planning services from
my broker. I may want to buy 3 or 4 mutual funds and have my broker
worry about them. If my broker is a financial planner, perhaps I want
tax or estate advice on certain investment options. Maybe I'm saving
for my newborn child's education but I have no idea or desire to work
out a plan to make sure the money is there when she or he needs it.
A huge reason to stick with a full-service broker is access to initial
public offerings (IPOs). These are generally reserved for the very best
clients, where best is defined as "someone who generates lots of
revenue," so someone who trades just a few times a year doesn't have a
chance. But if you can afford to trade frequently at the full-service
commission rates, you may be favored with access to some great IPOs.
And the real big one for a lot of people is quite simply time . Full
service brokerage clients also tend to be higher net worth individuals
as well. If I'm a doctor or lawyer, I can probably make more money by
focusing on my business than spending it researching stocks. For many
people today, time is a more valuable commodity than money. In fact, it
doesn't even have to do with how wealthy you are. Americans, in
general, work some pretty insane hours. Spending time researching
stocks or staying up on the market is quality time not spent with
family, friends, or doing things that they enjoy. On the other hand
some people enjoy the market and for those people there are discount
brokers.
The one thing that sort of scares me about the difference between full
service and discount brokers is that a pretty good chunk of discount
brokerage firm clients are not that educated about investing. They look
at a $20 commission (discount broker) and a $50 commission (full service
broker) and they decide they can't afford to invest with a full service
broker. Instead they plow their life savings into some wonder stock
they heard about from a friend (hey, it's only a $20 commission, why
not?) and lose a few hundred or thousand bucks when the investment goes
south. Not that a broker is going to pick winners 100% of the time but
at least the broker can guide or mentor a beginning investor until they
learn enough to know what to look for and what not to look for in a
stock. I look at the $30 difference in what the two types of brokerage
firms charge as the rebate for education and doing my own research. If
you're not going to educate yourself or do your own research, you don't
deserve the rebate.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Advice - Mutual-Fund Expenses
Last-Revised: 16 Feb 2003
Contributed-By: Austin Lemoine
This article discusses stealth erosion of wealth, more specifically how
mutual-fund expenses erode wealth accumulation.
Mutual fund expense ratios, and similar investment-related fees, can
seriously erode wealth accumulation over time. Those fees and expenses
are stealthy, and they go largely unnoticed by investors while steadily
diminishing the value of their investments in both up and down markets.
What you pay for investing in a mutual fund, exclusive of any sales
charges, is indicated by the "expense ratio" of the fund. The expense
ratio is the percentage of mutual fund assets paid for operating
expenses, management fees, administrative fees, and all other
asset-based costs incurred by the fund, except brokerage costs. Those
expenses are reflected in the fund's net asset value (NAV), and they are
not really visible to the fund investor. The reported net return equals
the fund's gross return minus its costs. (And expense ratios do not
account for every cost mutual fund investors bear: additional costs
include any sales charges, brokerage commissions paid by the fund and
other significant kinds of indirect trading costs.)
Mutual fund expense ratios range from less than 0.20 percent for
low-cost index funds to well over 2 percent for actively managed funds.
The average is 1.40 percent for the more than 14,000 stock and bond
mutual funds currently available, according to Morningstar. In dollar
terms, that's $14 a year in fees for each $1,000 of investment value; or
a net value of $986. That might not seem like a big deal, but over time
fees compound to erode investment value.
Let's say the gross return in real terms (after inflation) of a broadly
diversified stock mutual fund will be 7 percent a year, excluding
expenses. (The 7 percent figure is consistent with returns for the U.S.
stock market from 1802 through 2001, as reported in Jeremy Siegel's
book, Stocks for the Long Run, 3rd edition.) Say the fund has an expense
ratio of 1.25 percent. And say you invest $1,000 in the fund at the
start of every year. (The figure of $1,000 is arbitrary, and investment
values below can be extrapolated to any annual contribution amount.)
Compounding at 7 percent, your gross investment value would be $6,153
after 5 years; $14,783 after 10 years; $43,865 after 20 years; $101,073
after 30 years; and $213,609 after 40 years. But with a 1.25 percent
expense ratio, your investment compounds at 7.0 minus 1.25 or 5.75
percent, not 7 percent. So your investment would actually be worth
$5,931 after 5 years; $13,776 after 10 years; $37,871 after 20 years;
$80,015 after 30 years; and $153,727 after 40 years. Fund expenses
account for the difference in value over time, with greater expenses
(and/or lower returns) having a greater negative impact on net
investment value.
That 1.25 percent expense ratio consumes $222 (or 3.6 percent) of the
$6,153 gross value over 5 years; 6.8 percent of gross value over 10
years; 13.6 percent over 20 years; and 20.8 percent over 30 years. Over
40 years, the $59,882 of fund expenses devour 28.0 percent of the
$213,609 gross value. In other words, only 72.0 percent of gross
investment value is left after 40 years, a withering erosion of wealth.
By contrast, let's say there's a broad-based index fund with 7 percent
real return but a 0.25 percent expense ratio. Putting $1,000 at the
start of each year into that fund, the 0.25 percent expense ratio would
consume just 2.9 percent of gross investment value after 20 years. Over
40 years, index fund expenses would total $13,759, a modest 6.4 percent
of gross value; so that the fund would earn 93.6 percent of gross value.
With expenses included, investment value is 30 percent higher after 40
years with the lower cost fund. (Even lower expense ratios can be found
among lowest-cost index funds and broad-based exchange-traded funds.
And funds with higher expenses do not outperform comparable funds with
lower expenses.)
Over the next ten to twenty years, expense ratios and similar fees could
be a huge millstone on wealth accumulation and wealth preservation. To
see why, let's review what's happened since March 2000.
Like a massive hurricane, the stock market has inflicted damage on
almost every portfolio in its path. From the peak of March 2000 to the
lows of early October 2002, it's estimated that falling stock prices
wiped out over $7 trillion in market value. While the market has moved
off its lows, we hope the worst is over.
How long will the market take to "heal itself?" It could take a long
time. A growing consensus holds that stocks just won't deliver the
returns we grew accustomed to from 1984 to 1999. If history is a guide,
real stock returns could average 2 to 4 percent a year over the 10 to 20
years following March 2000.
If lower expectations for stock returns materialize, mutual fund fees
and expenses will have an even greater adverse impact on wealth
accumulation, and especially on wealth preservation and income security
at retirement.
Let's say you'll want $40,000 income from your 401(k) assets without
drawing down principal. If real investment return is 4 percent you'll
need $40,000 divided by 0.04 or $1 million principal. But if you're
paying 1 percent in fees your real return is 3 percent, so you'll need
$40,000 divided by 0.03 or $1.333 million principal; and if 2 percent,
$2 million. The arithmetic is brutal!
It's clear that mutual fund costs and similar fees can be detrimental to
investment values over time. Fund sales charges exacerbate the problem.
Consider investing in lower-cost funds wherever possible.
For more insights from Austin Lemoine, please visit the web site for
Austin Lemoine Capital Management:
http://www.austinlemoine.com/
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Advice - One-Line Wisdom
Last-Revised: 22 Aug 1993
Contributed-By: Maurice Suhre
This is a collection of one-line pieces of investment wisdom, with brief
explanations. Use and apply at your own risk or discretion. They are
not in any particular order.
Hang up on cold calls.
While it is theoretically possible that someone is going to offer
you the opportunity of a lifetime, it is more likely that it is
some sort of scam. Even if it is legitimate, the caller cannot
know your financial position, goals, risk tolerance, or any other
parameters which should be considered when selecting investments.
If you can't bear the thought of hanging up, ask for material to be
sent by mail.
Don't invest in anything you don't understand.
There were horror stories of people who had lost fortunes by being
short puts during the 87 crash. I imagine that they had no idea of
the risks they were taking. Also, all the complaints about penny
stocks, whether fraudulent or not, are partially a result of not
understanding the risks and mechanisms.
If it sounds too good to be true, it probably is [too good to be true].
Also stated as ``There ain't no such thing as a free lunch
(TANSTAAFL).'' Remember, every investment opportunity competes with
every other investment opportunity. If one seems wildly better
than the others, there are probably hidden risks or you don't
understand something.
If your only tool is a hammer, every problem looks like a nail.
Someone (possibly a financial planner) with a very limited
selection of products will naturally try to jam you into those
which s/he sells. These may be less suitable than other products
not carried.
Don't rush into an investment.
If someone tells you that the opportunity is closing, filling up
fast, or in any other way suggests a time pressure, be very leery.
Very low priced stocks require special treatment.
Risks are substantial, bid/asked spreads are large, prices are
volatile, and commissions are relatively high. You need a broker
who knows how to purchase these stocks and dicker for a good price.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Advice - Paying for Investment Advice
Last-Revised: 25 Apr 1997
Contributed-By: Chris Lott ( contact me )
I'm no expert, but there's a simple rule that you should use to evaluate
all advice that is offered to you, especially advice for which someone
who doesn't know you is asking significant sums of money. Ask yourself
why the person is selling or giving it to you. If it sounds like a sure
ticket to riches, then why is the person wasting their time on YOU when
they could be out there making piles of dough?
Of course I'm offering advice here in this article, so let's turn the
tables on me right now. What's in it for me? Well, if you're reading
this article from my web site, look up at the top of the page. If you
have images turned on, you'll see a banner ad. I get a tiny payment
each time a person loads one of my pages with an ad. So my motivation
is to provide informative articles in order to lure visitors to the
site. Of course if you're reading this from the plain-text version of
the FAQ, you won't see any ads, but please do stop by the site sometime!
;-)
So if someone promises you advice that will yield 10-20% monthly
returns, perhaps at a price of some $3,000, you should immediately get
suspicious. If this were really true - i.e., if you pay for the advice
you'll immediately start getting these returns - you would be making
over 300% annually (compounded). Hey, that would sure be great, I
wouldn't have a day job anymore. And if it were true, wouldn't you
think that the person trying to sell it to you would forget all about
selling and just watch his or her money triple every year? But they're
not doing that, which should give you a pretty good idea about where the
money's being made, namely from you .
I'm not trying to say that you should never pay for advice, just that
you should not overpay for advice. Some advice, especially the sort
that comes from $15 books on personal finance and investments can easily
be worth ten times that sum. Advice from your CPA or tax advisor will
probably cost you a 3 or even 4-digit figure, but since it's specialized
to your case and comes from a professional, that's probably money well
spent.
It seems appropriate to close this article with a quote that I learned
from Robert Heinlein books, but it's probably older than that:
TANSTAAFL - there ain't no such thing as a free lunch.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Advice - Researching a Company
Last-Revised: 3 Jun 1997
Contributed-By: George Regnery (regnery at yahoo.com)
This article gives a basic idea of some steps that you might take to
research a company. Many sites on the web will help you in your quest
for information, and this article gives a few of them. You might look
for the following.
1. What multiple of earnings is the company trading at versus other
companies in the industry? The site http://www.stocksmart.com does
this comparison reasonably well, and they base it on forward
earnings instead of historical earnings, which is also good.
2. Is the stock near a high or low, and how has it done recently.
This is usually considered technical analysis. More sophisticated
(or at least more complicated) studies can also be performed.
There are several sites that will give you historical graphs; one
is Yahoo. http://biz.yahoo.com/r/
3. When compared with other companies in the industry, how much times
the book value or times sales is the company trading? For this
information, the site http://www.marketguide.com is a good place to
start.
4. Does the company have good products, good management, good future
prospects? Are they being sued? Do they have patents? What's the
competition like? Do they have long term contracts established? Is
their brand name recognized? Depending on the industry, some or all
of these questions may be relevant. There isn't a simple web site
for this information, of course. The Hoover's profiles have some
limited information to at least let you get a feel for the basics
of the company. And the SEC has lots of information in their Edgar
databank.
5. Management. Does the company have competent people running it? The
backgrounds of the directors can be found in proxy statements
(14As) in the Edgar database. Note that proxies are written by the
companies, though. Another thing I would suggest looking at is the
compensation structure of the CEO and other top management. Don't
worry so much about the raw figure of how they are paid -- instead,
look to see how that compensation is structured. If the management
gets a big base but bonuses are a small portion, look carefully at
the company. For some industries, like electric utilities, this is
OK, because the management isn't going to make a huge difference
(utilities are highly regulated, and thus the management is
prevented from making a lot of decisions). However, in a high tech
industry, or many other industries, watch your step if the mgmt.
gets a big base and the bonus is insignificant. This means that
they won't be any better off financially if the company makes a lot
of profits vs. no profits (unless, of course, they own a lot of
stock). This information is all in the proxies at the SEC. Also
check to see if the company has a shareholder rights plan, because
if they do, the management likely doesn't give a damn about
shareholder rights, but rather cares about their own jobs. (These
plans are commonly used to defend against unfriendly takeovers and
therefore provide a safety blanket for management.) These
suggestions should get you started. Also check the article elsewhere in
this FAQ on free information sources for more resources away from the
web.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Advice - Target Stock Prices
Last-Revised: 25 Jun 2000
Contributed-By: Uncle Arnie (blash404 at aol.com)
A target price for a stock is a figure published by a securities
industry person, usually an analyst. The idea is that the target price
is a prediction, a guess about where the stock is headed. Target prices
usually are associated with a date by which the stock is expected to hit
the target. With that explanation out of the way..
Why do people suddenly think that the term du jour "target price" has
any meaning?? Consider the sources of these numbers. They're ALWAYS
issued by someone who has a vested interest in the issue: It could be an
analyst whose firm was the underwriter, it could be an analyst whose
firm is brown-nosing the company, it could be a firm with a large
position in the stock, it could be an individual trying to talk the
stock up so he can get out even, or it could be the "pump" segment of a
pump-and-dump operation. There is also a chance that the analyst has no
agenda and honestly thinks the stock price is really going places. But
in all too many cases it's nothing more than wishful guesswork (unless
they have a crystal ball that works), so the advice here: ignore target
prices, especially ones for internet companies.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Analysis - Amortization Tables
Last-Revised: 16 Feb 2003
Contributed-By: Hugh Chou
This article presents the formula for computing monthly payments on
loans. A listing of thed full series of payments (principal and
interest) that show how a loan is paid off is known as a loan
amortization table. This article will explain how these tables are
generated for the U.S. system in which interest is compounded monthly.
First you must define some variables to make it easier to set up:
P = principal, the initial amount of the loan
I = the annual interest rate (from 1 to 100 percent)
L = length, the length (in years) of the loan, or at least the length
over which the loan is amortized.
The following assumes a typical conventional loan where the interest is
compounded monthly. First I will define two more variables to make the
calculations easier:
J = monthly interest in decimal form = I / (12 x 100)
N = number of months over which loan is amortized = L x 12
Okay now for the big monthly payment (M) formula, it is:
J
M = P x ------------------------
1 - ( 1 + J ) ^ -N
where 1 is the number one (it does not appear too clearly on some
browsers).
So to calculate it, you would first calculate 1 + J then take that to
the -N (minus N) power, subtract that from the number 1. Now take the
inverse of that (if you have a 1/X button on your calculator push that).
Then multiply the result times J and then times P. Sorry for the long
way of explaining it, but I just wanted to be clear for everybody.
The one-liner for a program would be (adjust for your favorite
language):
M = P * ( J / (1 - (1 + J) ** -N))
So now you should be able to calculate the monthly payment, M. To
calculate the amortization table you need to do some iteration (i.e. a
simple loop). I will tell you the simple steps :
1. Calculate H = P x J, this is your current monthly interest
2. Calculate C = M - H, this is your monthly payment minus your
monthly interest, so it is the amount of principal you pay for that
month
3. Calculate Q = P - C, this is the new balance of your principal of
your loan.
4. Set P equal to Q and go back to Step 1: You thusly loop around
until the value Q (and hence P) goes to zero. Programmers will see
how this makes a trivial little loop to code, but I have found that many
people now surfing on the Internet are NOT programmers and still want to
calculate their mortgages!
Note that just about every PC or Mac has a spreadsheet of some sort on
it, and they are very good tools for doing mortgage analysis. Most of
them have a built-in PMT type function that will calculate your monthly
payment given a loan balance, interest rate, and the number of terms.
Check the help text for your spreadsheet.
Please visit Hugh Chou's web site for a calculator that will generate
amortization tables according to the forumlas discussed here. He also
offers many other calculators:
http://www.hughchou.org/calc/
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Analysis - Annual Reports
Last-Revised: 31 Oct 1995
Contributed-By: Jerry Bailey, Chris Lott ( contact me )
The June 1994 Issue of "Better Investing" magazine, page 26 has a
three-page article about reading and understanding company annual
reports. I will paraphrase:
1. Start with the notes and read from back to front since the front is
management fluff.
2. Look for litigation that could obliterate equity, a pension plan in
sad shape, or accounting changes that inflated earnings.
3. Use it to evaluate management. I only read the boring things of
the companies I am holding for long term growth. If I am planning
a quick in and out, such as buying depressed stocks like BBA, CML,
CLE, etc.), I don't waste my time.
4. Look for notes to offer relevant details; not "selected" and
"certain" assets. Revenue and operating profits of operating
divisions, geographical divisions, etc.
5. How the company keeps its books, especially as compared to other
companies in its industry.
6. Inventory. Did it go down because of a different accounting
method?
7. What assets does the company own and what assets are leased?
If you do much of this, I really recommend just reading the article.
The following list of resources may also help.
* John A. Tracy has written an an easy-to-read and informative book
named How to Read a Financial Report (4th edn., Wiley, 1993). This
book should give you a good start. You won't become a graduate
student in finance by reading it, but it will certainly help you
grasp the nuts and bolts of annual reports.
* IBM offers a web site with much information about understanding
financial reports:
http://www.ibm.com/FinancialGuide/
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Analysis - Beta and Alpha
Last-Revised: 22 Oct 1997
Contributed-By: Ajay Shah ( www.igidr.ac.in/~ajayshah ), R. Shukla
(rkshukla at som.syr.edu), Bob Pierce (rbp at investor.pgh.pa.us)
Beta is the sensitivity of a stock's returns to the returns on some
market index (e.g., S&P 500). Beta values can be roughly characterized
as follows:
* b less than 0
Negative beta is possible but not likely. People thought gold
stocks should have negative betas but that hasn't been true.
* b equal to 0
Cash under your mattress, assuming no inflation
* beta between 0 and 1
Low-volatility investments (e.g., utility stocks)
* b equal to 1
Matching the index (e.g., for the S&P 500, an index fund)
* b greater than 1
Anything more volatile than the index (e.g., small cap. funds)
* b much greater than 1 (tending toward infinity)
Impossible, because the stock would be expected to go to zero on
any market decline. 2-3 is probably as high as you will get.
More interesting is the idea that securities MAY have different betas in
up and down markets. Forbes used to (and may still) rate mutual funds
for bull and bear market performance.
Alpha is a measure of residual risk (sometimes called "selecting risk")
of an investment relative to some market index. For all the gory
details on Alpha, please see a book on technical analysis.
Here is an example showing the inner details of the beta calculation
process:
Suppose we collected end-of-the-month prices and any dividends for a
stock and the S&P 500 index for 61 months (0..60). We need n + 1 price
observations to calculate n holding period returns, so since we would
like to index the returns as 1..60, the prices are indexed 0..60. Also,
professional beta services use monthly data over a five year period.
Now, calculate monthly holding period returns using the prices and
dividends. For example, the return for month 2 will be calculated as:
r_2 = ( p_2 - p_1 + d_2 ) / p_1
Here r denotes return, p denotes price, and d denotes dividend. The
following table of monthly data may help in visualizing the process.
(Monthly data is preferred in the profession because investors' horizons
are said to be monthly.)
Nr. Date Price Div.(*) Return
0 12/31/86 45.20 0.00 --
1 01/31/87 47.00 0.00 0.0398
2 02/28/87 46.75 0.30 0.0011
. ... ... ... ...
59 11/30/91 46.75 0.30 0.0011
60 12/31/91 48.00 0.00 0.0267
(*) Dividend refers to the dividend paid during the period. They are
assumed to be paid on the date. For example, the dividend of 0.30 could
have been paid between 02/01/87 and 02/28/87, but is assumed to be paid
on 02/28/87.
So now we'll have a series of 60 returns on the stock and the index
(1...61). Plot the returns on a graph and fit the best-fit line
(visually or using some least squares process):
| * /
stock | * * */ *
returns| * * / *
| * / *
| * /* * *
| / * *
| / *
|
|
+------------------------- index returns
The slope of the line is Beta. Merrill Lynch, Wells Fargo, and others
use a very similar process (they differ in which index they use and in
some econometric nuances).
Now what does Beta mean? A lot of disservice has been done to Beta in
the popular press because of trying to simplify the concept. A beta of
1.5 does not mean that is the market goes up by 10 points, the stock
will go up by 15 points. It doesn't even mean that if the market has a
return (over some period, say a month) of 2%, the stock will have a
return of 3%. To understand Beta, look at the equation of the line we
just fitted:
stock return = alpha + beta * index return
Technically speaking, alpha is the intercept in the estimation model.
It is expected to be equal to risk-free rate times (1 - beta). But it
is best ignored by most people. In another (very similar equation) the
intercept, which is also called alpha, is a measure of superior
performance.
Therefore, by computing the derivative, we can write:
Change in stock return = beta * change in index return
So, truly and technically speaking, if the market return is 2% above its
mean, the stock return would be 3% above its mean, if the stock beta is
1.5.
One shot at interpreting beta is the following. On a day the (S&P-type)
market index goes up by 1%, a stock with beta of 1.5 will go up by 1.5%
+ epsilon. Thus it won't go up by exactly 1.5%, but by something
different.
The good thing is that the epsilon values for different stocks are
guaranteed to be uncorrelated with each other. Hence in a diversified
portfolio, you can expect all the epsilons (of different stocks) to
cancel out. Thus if you hold a diversified portfolio, the beta of a
stock characterizes that stock's response to fluctuations in the market
portfolio.
So in a diversified portfolio, the beta of stock X is a good summary of
its risk properties with respect to the "systematic risk", which is
fluctuations in the market index. A stock with high beta responds
strongly to variations in the market, and a stock with low beta is
relatively insensitive to variations in the market.
E.g. if you had a portfolio of beta 1.2, and decided to add a stock
with beta 1.5, then you know that you are slightly increasing the
riskiness (and average return) of your portfolio. This conclusion is
reached by merely comparing two numbers (1.2 and 1.5). That parsimony
of computation is the major contribution of the notion of "beta".
Conversely if you got cold feet about the variability of your beta = 1.2
portfolio, you could augment it with a few companies with beta less than
1.
If you had wished to figure such conclusions without the notion of beta,
you would have had to deal with large covariance matrices and nontrivial
computations.
Finally, a reference. See Malkiel, A Random Walk Down Wall Street , for
more information on beta as an estimate of risk.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Analysis - Book-to-Bill Ratio
Last-Revised: 19 Aug 1993
Contributed-By: Timothy May
The book-to-bill ration is the ratio of business "booked" (orders taken)
to business "billed" (products shipped and bills sent).
A book-to-bill of 1.0 implies incoming business = outgoing product.
Often in downturns, the b-t-b drops to 0.9, sometimes even lower. A
b-t-b of 1.1 or higher is very encouraging.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Analysis - Book Value
Last-Revised: 23 Mar 1998
Contributed-By: Art Kamlet (artkamlet at aol.com)
In simplest terms, Book Value is Assets less Liabilities.
The problem is Assets includes, as stated, existing land & buildings,
inventory, cash in the bank, etc. held by the company.
The problem in assuming you can sell off these assets and receive their
listed value is that such values are accounting numbers, but otherwise
pretty unrealistic.
Consider a company owning a 40 year old building in downtown Chicago.
That building might have been depreciated fully and is carried on the
books for $0, while having a resale value of millions. The book value
grossly understates the sell-off value of the company.
On the other hand, consider a fast-changing industry with 4-year-old
computer equipment which has a few more years to go before being fully
depreciated, but that equipment couldn't be sold for even 10 cents on
the dollar. Here the book value overstates the sell-off value.
So consider book value to be assets less liabilities, which are just
numbers, not real items. If you want to know how much a company should
be sold off for, hire a good investment banker, which is often done on
take-over bids.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Analysis - Computing Compound Return
Last-Revised: 12 Dec 2004
Contributed-By: Paul Randolph (paulr22 at juno dot com), Chris Lott (
contact me )
This article discusses how to compute the effective annual percentage
rate earned by a single investment after a number of years have passed.
A related concept called "average annual return" is frequently seen when
reading about mutual funds but is computed very differently; it is
discussed briefly at the end of this article. Another related concept
called "internal rate of return" is used to calculate the percentage
rate earned by an investment made as a series of purchases, such as
monthly investments in a mutual fund; also see the article on that topic
elsewhere in this FAQ.
To calculate the compound return on an investment, just figure out the
factor by which the original investment multiplied. For example, if
$1,000 became $3,200 in 10 years, then the multiplying factor is
3,200/1,000 or 3.2. Now take the 10th root of 3.2 (the multiplying
factor) and you get a compound return of 1.1233498, which means
approximately 12.3% per year. To see that this works, note that
1.233498 raised to the 10th power equals 3.2.
Here is another way of saying the same thing. This calculation assumes
that all gains are reinvested, so the following formula applies:
TR = (1 + AR) ** YR
where TR is total return (present value/initial value), AR is the
compound annualized return, and YR is years. The symbol '**' is used to
denote exponentiation (e.g., 2 ** 3 = 8).
To calculate annualized return, the following formula applies:
AR = (TR ** (1/YR)) - 1
Thus a total return of 950% in 20 years would be equivalent to an
annualized return of 11.914454%. Note that the 950% includes your
initial investment of 100% (by definition) plus a gain of 850%.
For those of you using spreadsheets such as Excel, you would use the
following formula to compute AR for the example discussed above (the
common computer symbol used to denote exponentiation is the caret or hat
on top of the 6).
= TR ^ (1 / YR) - 1
where TR = 9.5 and YR = 20. If you want to be creative and have AR
recalculated every time you open your file, you can substitute something
like the following for YR:
( (*cell* - TODAY() ) / 365)
Of course you will have to replace '*cell*' by the appropriate address
of the cell that contains the date on which you bought the security.
Don't confuse a compound return with something called an average annual
return, which is a simple arithmetic mean (also see the FAQ article on
this topic). That method simply adds the annual rates and divides by
the number of years. For example, 5% one year and 10% the next year,
average is 7.5% over those two years.
Let's compare the two methods with a contrived example. You invest
$100. After one year, you have $200, which means in that first year,
the investment returned 100%. At the end of the second year, you have
$100, which means in that second year, the investment lost 50%. (In
short, you're back where you started.) Do the calculations for the
compound return and you'll get 0%. Calculate the average annual return
and you get 25%. So this contrived example yields a big difference.
However, common scenarios yield less striking differences, and the
average annual return is a useful approximation.
Here's the one thing to remember from this article. When you read an
investment company's statements about their "average return", you should
check carefully just exactly what they calculated.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Analysis - Future and Present Value of Money
Last-Revised: 28 Jan 1994
Contributed-By: Chris Lott ( contact me )
This note explains briefly two concepts concerning the
time-value-of-money, namely future and present value. Careful
application of these concepts will help you evaluate investment
opportunities such as real estate, life insurance, and many others.
Future Value
Future value is simply the sum to which a dollar amount invested today
will grow given some appreciation rate.
To compute the future value of a sum invested today, the formula for
interest that is compounded monthly is:
fv = principal * [ (1 + rrate/12) ** (12 * termy) ]
where
fv = future value
principal = dollar value you have now
termy = term, in years
rrate = annual rate of return in decimal (i.e., use .05 for
5%)
Note that the symbol '**' is used to denote exponentiation (2 ** 3 = 8).
For interest that is compounded annually, use the formula:
fv = principal * [ (1 + rrate) ** (termy) ]
Example:
I invest 1,000 today at 10% for 10 years compounded monthly.
The future value of this amount is 2707.04.
Note that the formula for future value is the formula from Case 1 of
present value (below), but solved for the future-sum rather than the
present value.
Present Value
Present value is the value in today's dollars assigned to an amount of
money in the future, based on some estimate rate-of-return over the
long-term. In this analysis, rate-of-return is calculated based on
monthly compounding.
Two cases of present value are discussed next. Case 1 involves a single
sum that stays invested over time. Case 2 involves a cash stream that
is paid regularly over time (e.g., rent payments), and requires that you
also calculate the effects of inflation.
Case 1a: Present value of money invested over time.
This tells you what a future sum is worth today, given some rate of
return over the time between now and the future. Another way to
read this is that you must invest the present value today at the
rate-of-return to have some future sum in some years from now (but
this only considers the raw dollars, not the purchasing power).
To compute the present value of an invested sum, the formula for
interest that is compounded monthly is:
future-sum
pv = ------------------------------
(1 + rrate/12) ** (12 * termy)
where
* future-sum = dollar value you want to have in termy
years
* termy = term, in years
* rrate = annual rate of return that you can expect,
in decimal
Example:
I need to have 10,000 in 5 years. The present value of
10,000 assuming an 8% monthly compounded rate-of-return
is 6712.10. I.e., 6712 will grow to 10k in 5 years at
8%.
Case 1b: Effects of inflation
This formulation can also be used to estimate the effects of
inflation; i.e., compute the real purchasing power of present and
future sums. Simply use an estimated rate of inflation instead of
a rate of return for the rrate variable in the equation.
Example:
In 30 years I will receive 1,000,000 (a megabuck). What
is that amount of money worth today (what is the buying
power), assuming a rate of inflation of 4.5%? The answer
is 259,895.65
Case 2: Present value of a cash stream.
This tells you the cost in today's dollars of money that you pay
over time. Usually the payments that you make increase over the
term. Basically, the money you pay in 10 years is worth less than
that which you pay tomorrow, and this equation lets you compute
just how much less.
In this analysis, inflation is compounded yearly. A reasonable
estimate for long-term inflation is 4.5%, but inflation has
historically varied tremendously by country and time period.
To compute the present value of a cash stream, the formula is:
month=12 * termy paymt * (1 + irate) ** int ((month - 1)/
12)
pv = SUM
---------------------------------------------
month=1 (1 + rrate/12) ** (month - 1)
where
* pv = present value
* SUM (a.k.a. sigma) means to sum the terms on the
right-hand side over the range of the variable
'month'; i.e., compute the expression for month=1,
then for month=2, and so on then add them all up
* month = month number
* int() = the integral part of the number; i.e., round
to the closest whole number; this is used to compute
the year number from the month number
* termy = term, in years
* paymt = monthly payment, in dollars
* irate = rate of inflation (increase in
payment/year), in decimal
* rrate = rate of return on money that you can expect,
in decimal
Example:
You pay $500/month in rent over 10 years and estimate
that inflation is 4.5% over the period (your payment
increases with inflation.) Present value is 49,530.57
Stefan Heizmann offers a calculator for NPV on the web.
http://www.IRRQ.com/us
Two small C programs for computing future and present value on a PC are
also available, which may be convenient if you have a large amount of
data. See the article Software - Archive of Investment-Related Programs
in this FAQ for more information.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Analysis - Goodwill
Last-Revised: 18 Jul 1993
Contributed-By: John Keefe
Goodwill is an asset that is created when one company acquires another.
It represents the difference between the price the acquiror pays and the
"fair market value" of the acquired company's assets. For example, if
JerryCo bought Ford Motor for $15 billion, and the accountants
determined that Ford's assets (plant and equipment) were worth $13
billion, $2 billion of the purchase price would be allocated to goodwill
on the balance sheet. In theory the goodwill is the value of the
acquired company over and above the hard assets, and it is usually
thought to represent the value of the acquired company's "franchise,"
that is, the loyalty of its customers, the expertise of its employees;
namely, the intangible factors that make people do business with the
company.
What is the effect on book value? Well, book value usually tries to
measure the liquidation value of a company -- what you could sell it for
in a hurry. The accountants look only at the fair market value of the
hard assets, thus goodwill is usually deducted from total assets when
book value is calculated.
For most companies in most industries, book value is next to
meaningless, because assets like plant and equipment are on the books at
their old historical costs, rather than current values. But since it's
an easy number to calculate, and easy to understand, lots of investors
(both professional and amateur) use it in deciding when to buy and sell
stocks.
--------------------Check http://invest-faq.com/ for updates------------------
Compilation Copyright (c) 2005 by Christopher Lott.
Christopher Lott
Version: $Id: part18,v 1.62 2005/01/05 12:40:47 lott Exp lott $
Compiler: Christopher Lott
The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance. This is a plain-text
version of The Investment FAQ, part 18 of 20. The web site
always has the latest version, including in-line links. Please browse
http://invest-faq.com/
Terms of Use
Disclaimers
Please send comments and new submissions to the compiler.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Direct Investing and DRIPs
Last-Revised: 24 Aug 2000
Contributed-By: John Levine (johnl at iecc.com), Paul Randolph (paulr22
at juno dot com), Bob Grumbine (rgrumbin at nyx.net), Cliff (cliff at
StockPower.com), Thomas Price (tprice at engr.msstate.edu), David
Sanderson (dws at ora.com), John Belt, Brett Kottmann (bkottmann at
webteamone.com)
DRIP stands for Dividend (sometimes Direct) Re-Investment Plan. The
basic idea is that an investor can purchase shares of a company directly
from that company without paying any commission. This is most commonly
done in a traditional DRIP by having all dividends paid on shares
immediately used to purchase more of the same shares (i.e., the
dividends are reinvested). Most plans also allow the investor to
purchase additional shares directly from the company every quarter.
Thus the two names for DRIP: Dividend/Direct Re-Investment Plan. But
note the "re" in re-investment: most DRIPs do not provide a way for an
investor to buy the first share.
DRIPs offer an easy, low-cost way for buying common stocks and
closed-end mutual funds. DRIPs are also a great way to invest a small
amount each month (dollar-cost averaging). Since most of us try to set
aside a little each month, this can work extraordinarily well. Yet
another good use of a DRIP is to give a small amount of stock as a gift.
You may not want to set up a brokerage account for your niece, but you
may want to give her 10 shares of Mattel. A DRIP account (structured as
a UTMA, see the article elsewhere in the FAQ) helps a minor benefit from
stock ownership and lets someone make additional purchases relatively
easily.
When you sell shares that were acquired via a DRIP, your cost basis is
simply the sum of the amounts you invested plus your reinvested
dividends. But because you have four small purchases per year, at
different prices, for as long as you own the stock, the actual
calculation of your cost basis can quickly become an accounting
nightmare. A program like Quicken or Microsoft Money can make this a
lot easier for you. (There's no reason the broker can't do it for you
since they have all the data, but no broker I know does.) Of course if
the DRIP is structured as a retirement account, a sale is not a taxable
event, and you don't need to calculate the cost basis. That leads
nicely to the next caveat. In order to participate in a DRIP inside an
IRA, the DRIP sponsor has to be willing to serve as IRA custodian. Some
will, some won't. That information is available in the DRIP prospectus,
from the company's IR department, or the transfer agent.
Traditional DRIPs are available as company-sponsored plans and from
large brokerage houses. These two arrangements are both similar and
different:
Company-sponsored DRIP
In this arrangement, once you have purchased at least one share,
dividends paid on all holdings are used to buy new shares. That
first share must be registered in your name, not in street name. A
common feature is that you can make additional purchases each
quarter at little or no additional cost (i.e., no commission or
fees). When you sell the shares, the company buys the shares back.
Note that a company-sponsored DRIP might be run by the company
directly, or by a bank. The latter arrangement tends to lead to
fees that quickly become onerous for small investors (more later).
Many companies sponsor DRIPs; lists are available through NAIC and
some brokerages.
Brokerage-house DRIP
In this arrangement, you pay a commission to buy the original
shares in your brokerage account (even retirement accounts), and
the brokerage buys new shares with the dividends paid by the stock
at no additional charge. Thus, your investment accumulates a
little at a time with no commission. When you sell the stock, they
sell the full shares (for a commission) and give you cash in lieu
for the fraction. Many brokerage houses offer this arrangement
today, including (just to name a couple) Charles Schwab and
Waterhouse.
Brokerage-house DRIP arrangements are pretty simple when compared to
company-sponsored DRIPs. The remainder of this article focuses on
company-sponsored DRIPs.
Once you've found a company with a DRIP, check out the plan terms.
Usually the transfer agent or company's investor relations (IR)
department will send you a copy of the plan information (the company's
IR department may be more responsive). Two transfer agents, American
Stock Transfer and Trust ( http://www.amstock.com ) and Chase Mellon (
http://www.chasemellon.com ) have extensive plan info available online.
Although most of the information is available there, always verify any
details that are important to you with the transfer agent or IR
department before investing.
Here is a partial list of the things to check in the terms and
conditions of a DRIP. Some DRIPs are exactly and only that, a Dividend
Reinvestment Plan. If you intend to send in additional investments,
make sure that the plan allows optional cash payments. Also, some DRIPs
only accept contributions on a quarterly basis (when the dividend is
paid) or even annually or semi-annually. Plans that allow optional
investments at least monthly are much more convenient. Some DRIPs
charge you up to $5 (or more) per contribution. If you are interested
in one of those companies, then you may do just as well with a discount
brokerage account at $8/trade. Still, if you want to give stock to a
child or family member who doesn't have a brokerage account, paying
$5/purchase through a DRIP may not be a bad idea. Finally, check
whether the company issues new shares for your contribution or buys on
the open market. Issuing new shares dilutes shareholder value and is
therefore less appealing than buying on the open market.
Let's say the terms and conditions seem fair, and you want to get
started. So you need that first share and it must be registered in your
name. Once the shares are bought and issued to you, you then have to
get enrolled on your own. To purchase the first share at modest cost,
you have several options, as follows.
* If you have a brokerage account, you can just buy a few shares and
have the certificate issued (shares have to be in your name, not
held in street name in a brokerage account). This may or may not
be a low-cost approach. At Fidelity, a limit purchase order costs
you a $30 commission, and it's $15 to have a certificate issued.
If you have a Vanguard brokerage account, you can buy the stock for
a $20 commission, then have them issue the certificate for free.
Several brokerage houses (A G Edwards and Dean Witter, for example)
offer a special commission rate for purchases of single shares.
* Many clubs and other organizations will help you buy the first
share for a very reasonable charge. Naturally they all have web
sites; a partial list appears at the bottom of this article.
* A handful of companies sell their stock directly to the public
without requiring you to go through an exchange or broker even for
the first share. In that case, just get a copy of the form from
the IR department or transfer agent and send in a check. These
companies are all exchange listed as well, and tend to be
utilities.
Last but certainly not least, you may have asked yourself why all
companies don't sponsor direct investment plans. The short answer is
that it costs them too much. And now for the long answer..
Most companies, most of the time, aren't selling stock at all. For one
thing, issuing new shares requires registration with the SEC, at least
of the shelf variety, and that definitely costs money. Years ago, when
postage, supplies, and all the rest weren't so costly, a lot of
companies went ahead and did the necessary shelf registration for a
Dividend Reinvestment and Stock Purchase Plan, for the benefit of those
who already had at least a few shares registered in their own names, so
that those shareholders could increase their holdings over time. A
DRIP/SPP is a company-sponsored benefit for the shareholders, pure and
simple.
In recent years, legal fees have skyrocketed, postage alone has gone to
33c for an envelope in which to send a statement of account which costs
a bunch more to print than it used to, and the clerks and accountants
needed to keep track of such a program have also gotten a lot more
expensive. DRIP fees have gone up in existing DRIPs and there have been
very few companies actually setting up their own new DRIPs, most with
some kind of fee structure.
Many of these are designed much more for the purpose of generating fees
for the several large banking institutions that run them than for the
purpose of facilitating really small investors' interest in acquiring
fixed dollar amounts of stock. Let's face it, when they take $15 just
to open an account, insist on minimum investments in the mid-three to
low-four digit range, and then demand huge percentage fees every time a
dividend gets reinvested, a small investor gets a pretty bad deal.
Always (always) check the plan terms to make sure that you can't do
better with a DRIP arrangement at a discount brokerage house.
Here is a list of DRIP resources, including sources of information as
well as companies that will help you buy shares at very low cost.
* ShareBuilder.com, a service of Netstock Direct, lets you make
automatic periodic investments in over 4,000 companies and 68 Index
shares for just $4 per transaction. This is sometimes called
dollar-based investing, because you set the dollar amount to be
invested rather than the number of shares. Like any other DRIP,
you can own partial shares. The company bundles the orders from
members and makes bulk purchases once a week. The commission to
sell shares is $16 for market orders and $20 for limit orders. The
following "ShareBuilder" link will take you to their web site. If
you use the link and sign up with them, Chris Lott, the compiler of
The Investment FAQ, will earn a small commission.
http://www.ShareBuilder.com (referral)
* PortfolioBuilder lets you make unlimited automatic repeat purchases
of over 550 stocks. Your investments are made in dollar amounts,
not shares, allowing for the purchase of fractional shares. Fees
are $150 annually (unlimited purchases that year), or $15 monthly
(unlimited purchases that month), or just $3 for a single
transaction.
http://www.portfoliobuilder.net/
* First Share is a buying club that helps investors obtain a single
share so they can participate in DRIPS. The annual membership fee
is $24. Members receive a membership handbook containing
information about direct investing, transferring shares and
registration of shares. For more information about First Share,
call 800-683-0743, +1 719-783-2929, or visit their web site.
http://www.firstshare.com
* StockPower offers StockClick, a product that allows investors to
enroll in a direct stock purchase plan, purchase and sell stock,
and manage company stock online.
http://www.stockpower.com/
* The Moneypaper offers lists of DRIPs, an enrollment service, and
several publications. You can buy their Guide to Dividend
Reinvestment Plans, including a list of over one hundred companies
that offer DRIP's ($9). Call them at 800-388-9993 or visit their
web site.
http://www.moneypaper.com/
* The Rothery Report from Norman Rothery includes a list of companies
that offer DRIPs and SPPs, compiled from a variety of publications,
with special emphasis on Canadian companies.
http://www.stingyinvestor.com/SI/DRPs.shtml
* The DRIP Advisor provides information and advice on Dividend
Reinvestment Programs.
http://www.DRIPAdvisor.com
* Buying Stocks Without a Broker by Charles B. Carlson
This book lists 900 companies/closed end funds that offer DRIPS.
Included is a profile of the company and some plan specifics.
These are: if partial reinvestment of dividends are allowed,
discounts on stock purchased with dividends, optional cash payment
amount and frequency, fees, and approximate number of shareholders
in the plan.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Electronically and via the Internet
Last-Revised: 8 Sep 1998
Chris Lott ( contact me )
Many brokerage houses offer an electronic communications path for
placing orders on the equities and options markets. In the past many
services offered dial-up access, but with the Internet reaching ever
larger numbers of people, access today is primarily via the 'net and
secure HTTP connections. Some of the services offer both, which can be
a big advantage if "www" translates into "world-wide wait" for you.
The primary motivation for using one of these services is lowering
commissions. Competition among the on-line brokerages has become
intense, and rates have dropped as low as $8 per trade. The only caveat
is that many on-line brokerages require a significant cash balance, even
as much as $10,000, before you can place trades.
Here's a few web resources with more information:
* The Securities Industry Association offers a brochure for investors
titled Online Investing Tips . Although it has only about 5 short
pages of information, the file is over 1Mb, and you will need a
copy of the free Adobe Acrobat reader to view it. It's available
from this page:
http://www.sia.com/publications/html/education.html
* The links page on the FAQ web site about trading has links to many
brokerage houses.
http://invest-faq.com/links/trading.html
* If you'd like to compare the response times of the web brokers,
visit Keynote Systems and look for the Keynote Web Watch of broker
trading.
http://www.keynote.com/
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Free Ride Rules
Last-Revised: 12 Jul 1997
Contributed-By: Karl Denninger (karl at mcs.com), Timothy M. Steff (tim
at navillus.com)
When trading stocks, a "free ride" describes the case when you buy a
security at 10 and sell it a day later (or an hour later) at 12, without
having the free funds to cover the settlement of the trade at 10. This
activity is prohibited by the exchanges (e.g., NYSE Rule 431 forbids
member organizations from allowing their customers to day-trade in cash
accounts). If you trade in a cash account, you must be able to settle
the trade, even if you would take the profit from it in the same day.
Example:
Buy 1000 XXX at $10 on 7/10
Requires $10,000 free cash available to settle the trade.
Sell 1000 XXX at $15 on 7/11
It's a day later, and you will get $15,000 from the sale, but you
still must be able to settle the original purchase without the
proceeds of the sale for the first trade to be legit.
The rule on free rides should in no way be interpreted as a prohibition
on "day trading" (i.e., trading very rapidly in and out of a stock).
You can "day-trade" as much as you want, provided that you can settle
the trade. The short answer is that you must use a margin account if
you want to day-trade.
Being able to settle the trade means that you either have sufficient
cash in your account to pay for the shares, or sufficient reserve in
your margin account to cover the shares. Note that equity trades settle
3 market days after execution. Therefore, the window on short-term
trading is not one day but rather three; i.e., any close of a position
before settlement occurs would run into the same issue.
If you use cash, note that in a cash account you can spend a dollar only
once. That is to say if you start the day in cash, you can buy stock
and sell that stock -- and then are done trading for the day. If you
start in stock you can sell it, spend the cash for another position,
sell that position and then you are done.
If you use margin, keep in mind that your broker is allowed to delay the
credit for your sale until settlement if they so choose, keeping you
from using those funds for three days. If they are a market-making firm
or are selling their order flow they will likely obstruct your intra-day
and short term trading since it cuts into their bottom line. To
day-trade using a margin account, you need a broker that uses NYSE
day-trading rules for margin. Chances are your broker will have no idea
what you are talking about if you ask about this.
Unlike stocks, options settle the next day, which is both good and bad.
Option trading basically requires that the funds be there before you
place the trade, unless you like wiring funds around (and paying for the
privilege of doing so).
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - By Insiders
Last-Revised: 20 Oct 1996
Contributed-By: John R. Mashey (mash at senseipartners.com)
Insider trading refers to transactions in the securities of some company
executed by a company insider. Although a company insider might
theoretically be anyone who knows material financial information about
the company before it becomes public, in practice, the list of company
insiders (on whom newspapers print information) is normally restricted
to a moderate-sized list of company officers and other senior
executives. Smart companies normally warn all employees to be careful
when they trade, "just in case". The U.S. Securities and Exchange
Commission (SEC) has strict rules in place that dictate when company
insiders may execute transactions in their company's securities. All
transactions that do not conform to these rules are, in general,
prosecutable offenses under US securities law.
This article offers a primer on the rules that govern insider trading.
It focuses on a common insider's mechanism, namely stock options. While
I make no claim to be an expert on this, I was an officer for a few
years at a company that was private and went public, but that was in
1992, so a few rules may have changed since then.
Newspapers and other sources publish data about trades executed by
insiders. These sources include the following.
* Bloomberg.com publishes a column called "Insider Focus" that offers
information about people's insider transactions:
http://www.bloomberg.com/columns/index.html?sidenav=front
* The SEC
http://www.sec.gov
* Thomson Market Edge
http://www.marketedge.com In general, interpreting the data taken
solely from any of these sources is difficult. To do a thorough job,
you need the last couple years of annual reports so you can read the
fine print about executive compensation, special loans, extra covenants
about non-sale of stock around IPO, merger, acquisitions, etc. In fact,
the insider-trading sections of newspapers can be very misleading if you
don't know how to interpret them. Here are some examples that show why.
Insider purchases and sales are closely watched, for better or worse.
If you see insiders buying a lot of stock on the open market, this might
be worth investigating as a BUY signal ... although insiders are often
wrong. Another example is insider sales. If you see insiders in fairly
young companies selling stock, either by selling very cheap stock
they've had a while, or by same-day exercise of a stock option and
selling the resulting stock, this rarely means very much.
The list of stock still owned strangely doesn't mean very much either.
That is, sometimes readers get very excited if they see that Joe Blow,
CEO, has sold 10,000 shares and now owns 0. What is not obvious from
the paper is whether our friend Joe has no options left, is cashing out,
and about to leave. However, Joe might have vested options on a million
shares, and has thus sold 1% of his stock to buy a new house.
Obviously, the imputed meanings are rather different
The timing of sales also means relatively little. Silicon Valley
financial advisors tell people to sell some stock every year for tax
reasons. (More on this later in this article.) Normally, there are at
most 4 times during a year when an insider can sell stock anyway, and it
is easy for other events to knock this down to 1-2, or even 0. I've
heard of cases where people got stuck for 2 years post-IPO not being
able to sell any stock.
Now it's time for some detailed explanations.
If you are a founder of a company, or even an early employee, you will
likely get some stock options, or own stock at minuscule prices (i.e.,
like $.10/share on stock you hope will be worth at least $10 at IPO.) I
don't know how the rules are now, but they used to strongly encourage
actual purchase of some of that stock, at least 2 years in advance of a
potential IPO, in order to have stock that could get favorable capital
gains handling when sold 6 months after IPO. [When a company is
founded, of course, no one has the foggiest clue of the likely increase
in value ... although there are many hopes :-)]
When you get closer to IPO, stock option pricing gets closer to an IPO
price, which is usually adjusted via splits or reverse-splits to be in
the $10-$30 range.
Many companies continue to grant stock options after IPO, although the
prices are of course much higher, which tends to force some different
strategies. From tax-treatment, it is advantageous to spread this out,
as only a certain amount per year gets the favorable Incentive Stock
Option (ISO) treatment, any above gets a Non-Qualified Option treatment.
Silicon Valley companies use stock options extensively, and usually,
broadly across employees, not just for executives. [Which is why the
Valley went berserk with the proposed law that required charging the
bottom line for the "expected future value of stock options" :-) If
anyone can predict such a thing, they are really smart ... but even
worse, it would have discouraged broad use of stock options, which would
have been truly sad.]
If you have been in a high-tech startup, or even fairly early in, it is
likely that much of your net worth exists in stock ownership and options
of that company. It is far more complicated, and takes longer than
you'd expect, to get that money out without giving it to the IRS :-) [I
do first-in-first-out on option exercises ... I'm still working on some
I got in 1985...]
It is especially difficult to get money out if you are an insider, given
SEC rules, tax laws such as alternate minimum taxes, and lawsuit issues.
Company officers must be especially careful about lawsuit issues, and
should ask the lawyers about extra rules that aren't laws but offer some
insurance against lawsuits.
Insiders usually do no trades in month 1 and month 3 of a quarter for
the following reasons. (This leaves insiders just 4 months per year.)
During month 1, no trades are permitted until the quarterly report
appears, plus a few days for market to digest the results.
Theoretically, by the beginning of month 3 you know how the quarter will
be. This may be actually true in some businesses, but not others. In
some parts of the computer business, an awful lot of business is booked
during month 3, and shipped in the last 2 weeks, so people quite often
have no idea at this time whether they'll make the numbers or not. This
is especially true for high-end machines (like supercomputers, where
pure-supercomputer companies have occasionally had crazed fluctuations
because some $20M machine got held up a week). Right now, the
government shutdown and its effects on buying and export licenses is a
bit strange. Similar weirdnesses go on, for example, in some retail
businesses, where the Christmas season is crucial.
Insiders should avoid trades when in possession of material information
that might affect the stock, and is not yet public, at least partly
because it might or might not happen. For instance, somebody might be
negotiating a merger or some really major sale, and the lawyers will
tell you that you shouldn't trade then, to avoid lawsuits. This may
knock out some of the 4 months, and may be difficult to predict a year
in advance; that is, it is personally dangerous to say: "I expect to
sell stock 9 months from now." Don't count on it.
Insiders may make no trades when forbidden by covenants that are part of
IPOs or merger deals. There is usually a minimum of a 6-month block
after an IPO, and probably 3 after a merger.
I don't know if this rule is still around, but insiders do not usually
both buy and sell their stock in within the same 6 months. I think the
rule has been mellowed to allow purchase of options and sell them off,
but there used to be a terrible trap where you (a) sold some stock (b)
then, slightly less than 6 months later, were reminded that you had
options expiring. You exercised the options ... and blam some computer
at SEC nails you for illegal trading. [Years ago, advisors mentioned
some horror stories, whose details I forget, but whose import stuck.]
When considering the rules mentioned above, plus some other rules about
tax-treatment on pre-IPO stock options, the whole mess might be
paraphrased as: "You are in a maze of twisty little rules, all alike."
But in general, the rules (explicit and implicit) strongly discourage
insiders from trading (mixtures of buying and selling) their own stock
very often; since insiders usually have stock options, that means they
mostly sell.
Finally, some executive employment contracts have some really
complicated agreements, often involving loans made the company to the
executive to buy stock (so they can buy it when they aren't allowed to
sell any to get the money to buy it with), but also placing restrictions
on buying or selling stock.
Further complicating the picture for an ousider trying to interpret the
moves of insiders, financial advisors tell people that, no matter how
well they think the stock will do over the long run, they should sell
some % of what they have left every year. They advise this for
diversification, so they have the cash available, and to spread it out
to lessen the effects of the alternative minimum tax. We once had a
"class" in this, and the recommended percentage was 10%, but that was
years ago, and was not a hard rule, just a general idea.
Unlike "regular" people, if an insider needs some money quickly, s/he
cannot call their broker and sell some stock in the company on the spur
of the moment. In fact, they cannot even be guaranteed that a window of
opportunity to do so will necessarily be predictable. It may be that
with the changes to stockholder lawsuit rules, this will get a little
more rational; as it has been, lawyers have recommended extreme paranoia
regarding lawsuits, for good reason. (So, what insiders do is use
existing money, or quite often, borrow money with the options as
security ... which has often caused people trouble later on.)
Now on to the mechanics of exercising options as an insider. When you
exercise an option (i.e., purchase the stock), you can do one of two
things. First, you might do a same-day exercise, that is, purchase the
stock and immediately sell it, keeping the difference, and of course,
incurring a normal tax liability on the difference between option price
and exercise price. Non-qualified option treatment forces this. Or,
you might purchase the stock and keep it for a year, then sell it, thus
getting more favorable capital-gains treatment (at least sometimes) on
any gain. Of course, in doing so, you are subject to later price
fluctuations. If you are an insider, note that you may not be allowed
to sell when you'd like to, as described above.
So if the current stock price is $20, and you have 10,000 options, you
might go either route. If your option price is $.10, you might buy
shares and hold them, i.e., spend $1000. But if your option price is
$10 and you want to buy and hold the shares, then you need to come up
with $100,000. The only way to get that might be to sell some shares
you already own. If what you have is vested options, then you might
exercise some, and sell less, thus keeping some shares. This gets
tricky, as you have to sell enough to cover the purchase, cover the tax
liabilities, AND get some actual cash out! I'll continue with the
example, assuming you want to buy and hold the shares. You get $200K
(sell 10,000 shares @ $20), pay $100K (exercise the options @ $10),
leaving $100K. Probably approximately 40% goes to IRS and (here)
California, leaving $60K in cash to actually do something with.
Bottom line: founders often actually own lots of stock, sometimes so do
early employees. But, for many insiders (and in fact, not just legal
insiders, but other officers and actually, any employees who have
significant stock positions and/or legal advice that restricts the
timing of sales), the natural state of affairs gets to be (as the
absolute cost of options goes up):
* Have a bunch of vested options that account for a big chunk of
one's net worth.
* Do same-day exercise once or twice a year.
* Actually own zero shares.
And these are basically driven by SEC rules, legal advice, and tax laws,
not by short-term price fluctuations. [Note: anyone in high-tech
investing who doesn't expect short-term stock price fluctuations ... is
crazy :-)].
Thus, moderate sales by insiders ... simply don't mean much. It takes
work to know whether or not a sale is substantial. For instance, an
executive may have an employment contract that includes an $X loan
(where I've heard of $X in the millions), where they moved to the area,
wanted to buy a nice house, and the deal is that within N months of
being allowed to exercise options, they are required (or encouraged by
interest on the loan) to do so. This means that they'd better sell off
enough stock to cover the loan, and the taxes incurred from selling the
stock. The only way to figure this stuff out is to backtrack through
the annual reports and read the fine print.
OF COURSE, there have been cases where some insider sold a ton of stock
and should have known better... but by-and-large, the pattern in young
high-tech companies is that insiders gradually sell over time to move
more of their net worth into more diversified holdings and be able to
enjoy it :-)
A slightly different pattern shows up in more-established companies
where stock options are not as widespread, insiders were not founders or
early employees. Here, there are often key executives who do not have
large stock positions (either owned or vested options), and they may
decide their stock is undervalued and buy a bunch on the open market.
You can get lists of reported insider trades at Barron's Online (free,
but registration is required). Visit their site at
http://www.barrons.com
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Introducing Broker
Last-Revised: 31 Mar 1997
Contributed-By: Craig Harris
An Introducing Broker (IB) is a futures broker who delegates the work of
the floor operation, trade execution, accounting, etc. to a Futures
Commission Merchant (FCM). In this relationship, the FCM maintains the
floor operation and the IB maintains the relationship with retail
clients. This is efficient because the work of a floor operation vs.
the work of maintaining relationships and meeting the needs of retail
customers have different requirements.
Another way to think of an IB is that of a segmented firm. The IB is
not a middleman, but is in a partnership with the clearing firm. The
clearing firm manages the floor and back office ops, and the IB is free
to concentrate on his/her customers and their trading.
Several myths concerning IBs need debunking. First of all, the notion
that an introducing broker is a "middleman" or that fees or commissions
are necessarily higher is wrong. It's also wrong to say that an IB is a
branch office. Yes, an IB may have branch offices, but an IB is not a
branch office of a FCM. The IB is in a business partnership with an
FCM, each handling their own piece of the work.
When it comes to ordering, if you are trading through an IB, it need not
be any less efficient than trading with a vertically oriented firm that
does everything. When you call an IB with an order, s/he can relay that
order directly to the trading floor, or even give clients direct access
to the floor themselves. If you call one of the big, vertically
integrated firms your order is likely to take as many or more steps than
it would with an IB.
In terms of commissions, an IB may maintain a low overhead and that lets
him/her charge reasonable fees while maintaing a lot of support and
specialized service that a big discount firm simply can't provide.
There's more to trading than commissions, although most novices don't
understand that.
I would say that the bottom line in choosing a broker depends on several
factors:
* The type of trading you do
* The level of assistance and support you require
* Your ability to watch the markets all day Pick someone you are
comfortable with. Make sure you know who the clearing firm is. Call
the NFA and ask about any complaints or the disciplinary history of the
firm. Don't ever let yourself fall victim to a high pressure sales
pitch; that is in fact illegal. There are a lot of brokers out there,
take your time and make sure that the one you choose is a good fit for
you. There are plenty of good brokers out there.
There is one wrinkle, however. Your trades may experience price
improvement -- or may not -- depending on the large brokerage firm that
executes the trades you submit via your introducing broker. See the
article on price improvement in this FAQ for more details.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Jargon and Terminology
Last-Revised: 23 Feb 2000
Contributed-By: Ed Krol (e-krol at uiuc.edu), Brook F. Duerr, Art
Kamlet (artkamlet at aol.com), Bob Grumbine (rgrumbin at nyx.net), Chris
Lott ( contact me ), Arthur Gibbs, Jason Hsu
Some common jargon that you should understand about trading equities is
explained here briefly. See other articles in the FAQ for more detailed
explanations on most of these terms.
AON, "all or none"
A buy or sell order with this designation loses normal order
priority if the amount of shares available doesn't match or exceed
the order size. There may be some specialized circumstances where
it could be useful, such as late in the day on a GTC entry (to
avoid a fractional fill such as 100 shares of a 1000 share order,
with resulting doubling of total commissions when the rest of the
order fills the following morning).
blue-chip stock
A valuable stock that has proven itself; i.e., has been around for
many years and has made piles of money. Examples are IBM, GE,
Ford, etc. The name derives from the chips used in poker, blue
always being the most valuable.
bottom fishing
Purchasing of stock declining in value, or of stocks that have
suffered drastic declines in their prices.
breakpoint
Mutual fund companies give volume-based percentage discounts in the
load fee charged to purchase shares. A breakpoint is the level of
investment, like $100,000, required to qualify for a discount.
broker
The term was first used around 1622 to mean an agent in financial
transactions. Originally, it referred to wine retailers - those
who broach (break) wine casks.
call money rate
Also called the broker loan rate, this is the interest rate that
banks charge brokers to finance margin loans to investors. The
broker charges the investor the call money rate plus a service
charge. Investors who buy on margin will pay this rate.
day order
Order to buy/sell securities at a certain price that expires if not
executed on the day it is placed.
diluted shares
A way of characterizing the number of outstanding shares that a
publically held company could have. The diluted shares measure is
the sum of the company's normally outstanding shares, the shares
that would be outstanding if every warrant & stock option were
exercised, and the shares that would be outstanding if every
security convertible into the stock (e.g., certain preferred
shares) were converted. This is sometimes used when computing
earnings per share numbers. A larger number of outstanding shares
means lower earnings per share, rather obviously; this is known as
"dilution of earnings" or computation of "fully diluted" earnings.
DNR, "do not reduce"
This is usually assumed unless you specify otherwise, but different
brokers may have different practices and some may require you to
specify DNR if you want it. What it deals with is how the order is
to be/not adjusted when dividends or other distributions occur.
For example a $1/share dividend on a stock for which you have
entered an order DNR brings the price closer to your bid or takes
it further away from your offer. Without the DNR specification, on
the ex-dividend date your order price is reduced by the amount of
the distribution.
elves index
Louis Rukeyser's index of the opinions on the general stock market
for the next 6 months. He polls 10 analysts, the same ones every
week, to ask what they think the general trend will be, namely
bullish (+1), neutral (0), or bearish (-1). The index range is -10
to +10.
FOK, "fill or kill"
This means do it now if the stock is available in the crowd or from
the specialist, otherwise kill the order altogether. I never have
found a situation to make use of that designation..
going long
Buying and holding stock.
going short
Selling stock short, i.e., borrowing and selling stock you do not
own with the intention of buying it later for less.
GTC, "good till cancelled"
Order to buy/sell securities at a certain price (a limit order);
the limit order stays in the market until you call specifically to
cancel it. Some brokers restrict the length of time a GTC can
remain open to "end of same month", "no more than 30 days" or some
such thing, but with most it becomes a permanent part of the book
until it gets executed or you cancel.
MIT, "market if touched"
Frequently used in the commodity futures pits. I seem to recall it
being available on exchange-traded stocks as well, but I've never
been such a hotshot as to use the designation *as such*. Instead,
when I see serious overhead resistance at some point and have
sufficient reason to want to unwind my position, I'll respond with
a limit order below the resistance to close out my position.
Similarly, when I see serious support and want to get into a
position, I'll respond with a limit order above the support to gain
entry. What I don't want to be doing is chasing the stock wildly
(what market orders tend to do) just because some specific price
got touched.
MKT, "at the market"
It doesn't matter how much you have to pay to buy nor how little
you get on a sale, just do it now .
overbought [oversold]
Judgemental adjective describing a market or stock implying That
people have been wildly buying [selling] it and that there is very
little chance of it moving upward [downward] in the near term.
Usually it applies to movement momentum rather than what the
security should cost.
over valued, under valued, fairly valued
Judgmental adjectives describing that a market or stock is
over/under/fairly priced with respect to what people believe the
security is really worth.
uptick
Uptick means the next trade is at a higher price than the previous
trade. Meaningful for the NYSE and AMEX; not so meaningful for OTC
markets (NASDAQ). Certain transactions can only be executed on an
uptick (e.g., shorting).
downtick
Downtick means the next trade is at a lower price than the previous
trade. See uptick.
plc An abbreviation of Public Limited Corporation. This means that the
company is not American, where "Inc." is used instead. PLC is used
by companies in many different countries, including Great Britain,
South Africa, Australia, Hong Kong, etc.
tender
tender (v), to provide, to offer for delivery. Frequently used as
a short version of "tender offer," which is a public invitation
extended to shareholders of a company by an organization that
wishes to buy the company (i.e., a bid to take control of the
company). Following a tender offer, shareholders who have accepted
the offer surrender ("tender") their shares in exchange for
payment.
treasury shares
Shares taken from the company treasury (not the US Treasury!).
Often occurs in the context of discussions about how companies
fulfill share purchases within DRIP accounts.
underwriting
When an investment banker brings a company to market in an IPO.
The banker agrees to purchase so many shares of ABC corp at $XX per
share, less fees, and will resell them to the public immediately.
However, the banker does not go it alone; just like an insurance
company, the banker often seeks others to share risk. The
companies that participate are collectively termed the
underwriters, since the job of the subsidiary investment bankers is
to lessen the banker's exposure to the risk that he cannot sell all
the shares he agreed to purchase. The group is collectively
referred to as the underwriting syndicate.
For more definitions of terms, visit these on-line gloassaries of
investment and finance-related terms:
* InvestorWords
http://www.investorwords.com
* The Washington Post's Business Glossary
http://www.washingtonpost.com/wp-srv/business/longterm/glossary/glossary.htm
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - NASD Public Disclosure Hotline
Last-Revised: 15 Aug 1993
Contributed-By: vkochend at nyx.cs.du.edu, yozzo at watson.ibm.com
The number for the NASD Public Disclosure Hotline is (800) 289-9999.
They will send you information about cases in which a broker was found
guilty of violating the law.
I believe that the information that the NASD provides has been enhanced
to include pending cases. In the past, they could only mention cases in
which the security dealer was found guilty. (Of course, "enhanced" is
in the eye of the beholder.)
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Buy and Sell Stock Without a Broker
Last-Revised: 27 Sep 1993
Contributed-By: Franklin Antonio, Henry Chan Desu (henryc at panix.com)
Yes, you can buy/sell stock from/to a friend, relative or acquaintance
without going through a broker. Call the company, talk to their
investor relations person, and ask who the Transfer Agent for the stock
is. The Transfer Agent is the person who accomplishes the transfer,
i.e., by issuing new certificates with the buyer's name on them. The
transfer agent is paid by the company to issue new certificates, and to
keep track of who owns the company's stock. The name of the Transfer
Agent is probably printed on your stock certificates, but it might have
changed, so it is best to call and check.
The back of the certificate contains a stock power, i.e., those words
that say you want the shares to be transferred. Fill out the transferee
portion with the desired name, address, and tax id number to be
registered. Sign the stock power exactly as the certificate is
registered: joint tenancy will require signatures from all the people
listed, stock that was issued in maiden name must be signed as such,
etc. In addition to signing, you must get your signature(s) guaranteed.
The signature guarantee is an obscure ritual. It is similar to a notary
public, but different. The people who can provide a signature guarantee
are banks and stock brokers who are members of an exchange. Now, your
stock broker might not be too happy to see you and help you when you are
trying to avoid paying a commission, so I suggest you get the guarantee
from your bank. It's very easy. Someone at the bank checks your
signature card to see if your signature looks right and then applies a
little rubber stamp. Also, if you have the time, have the transferee
fill out a W-9 form to avoid any TEFRA withholding. W-9 forms are
available from any bank or broker.
Then send it all to the transfer agent. The agent will usually
recommend sending securities registered mail and insuring for 2% of the
total value. For safety, many people send the endorsement in a separate
envelope from the stock certificate, rather than using the back of the
stock certificate (if you do this, include a note that says so.) SEC
regulations require transfer agents to comply with a 3 business day
turn-around time for 90% of the stock transfers received in good
standing. In a few days, the buyer gets a stock certificate in the
mail. Poof!
There is no law requiring you to use a broker to buy or sell stock,
except in certain very special circumstances, such as restricted stock,
or unregistered stock. As long as the stock being sold has been
registered with the SEC (and all stock sold on the exchanges, NASDAQ,
etc. has been registered by the company), then the public can buy and
sell it at will. If you go out and create yourself a corporation
(Brooklyn Bridge Inc), do not register your stock with the SEC, and then
start selling stock in your company to a bunch of individuals,
advertising it, etc, then you can easily violate many SEC regulations
designed to protect the unsuspecting public. But this is very different
than selling the ordinary registered stuff. If you own stock in a
company that was issued prior to the time the company went public,
depending on a variety of conditions in the SEC regulations, that stock
may be restricted, and restricted stock requires some special procedures
when it is sold.
In brief: I do not believe that the guy who offers on the net to sell
people 1 share of Disney stock is violating any rules. Just for full
disclosure: I'm not a lawyer.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Non-Resident Aliens and US Exchanges
Last-Revised: 29 May 2002
Contributed-By: Chris Lott ( contact me ), Enzo Michelangeli (em at
who.net)
It is perfectly legal for non-resident aliens to trade equities on
exchanges in the United States using US brokerage houses directly. (A
"non-resident alien" (NRA) is the US government's name for a citizen of
a country other than the US who also lives outside the US.) The current
surge in availability of on-line brokerage services has effectively
eliminated the problems of different time zones and high telephone
charges, and has made it really easy for people living outside the US to
trade on US exchanges. This route is generally far cheaper as compared
to using any bank or brokerage house in the foreign country, and
therefore very attractive to many people.
Of course there are certain formalities concerning tax treatment of such
accounts, and these formalities must be clarified with the brokerage
house when the account is opened. Individuals who are not US citizens
must complete a W-8 form, which is a certificate of foreign status, and
return it to the brokerage house.
The specific rules of how these accounts are taxed are described in IRS
Publication 515 (Withholding of tax on non-resident aliens) and IRS
Publication 901 (Tax treaties). The tax treaty is especially important.
If the individual's country of residence has an agreement (tax treaty)
with the US government, those rules apply. For example, residents of
Germany should not have any tax withheld on interest or capital gains,
only for dividend payments. However, if the individual's country of
residence has no agreement with the US, then the individual should
complete the 1001 form (exemption form), and no tax will be withheld at
all.
I'm fairly certain that US citizens and green-card holders living abroad
are not required to fill out either of these forms, since these
individuals are required to report their world-wide income to the US
annually. And none of this applies to bona fide residents of the US,
regardless of citizenship, who are automatically subject to the US
taxation laws.
To avoid overseas telephone charges, the internet brokerages are clearly
the most attractive option. Most large brokerage firms accept foreign
clients, although some brokerage houses that offer trading via the
internet still require their customers to be US residents.
The following brokers once accepted non-resident aliens as customers:
Ameritrade, Datek, NDB, J.B. Oxford, and Schwab.
Various instruments sold by the US Treasury are also available for
purchase by NRAs. NRAs can buy, hold, and sell normal Treasury
instruments through the TreasuryDirect program, and will not be charged
any tax as long as they file a Form W-8BEN. However, the NRA must first
get an individual tax identification number (ITIN) by submitting a Form
W-7, which is required for opening a TreasuryDirect account. Second,
the account holder should really have an account at a US bank to allow
for direct payment of purchases and direct credit of interest and sales
proceeds. Finally, note that US Savings Bonds are not available to
NRAs.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Off Exchange
Last-Revised: 20 June 1999
Contributed-By: John Schott (jschott at voicenet.com)
Anyone can trade stocks off the current set of stock exchanges, if only
on a person-to-person deal. This is not a far cry from the original
trading under the Buttonwood tree in New York in the 18th century.
Today, over 20% of the total volume on stocks traded on the NYSE and
NASDAQ exchanges occurs off the official exchanges. However, the
dealing is often on the 'non-exchanges' (often called electronic
communication networks or ECNs). INSTINET is perhaps the best known of
several ECNs now functioning. Most of these operations are members-only
operations that function both during and after the normal exchange
hours. All are electronic - that is, non-physical exchanges. Almost
all are direct, in that there are no intermediaries such as specialists
and market makers as on the NYSE and NASDAQ, respectively. So they
function much like two people meeting in a person-to-person deal. One
sells, the other buys. This sort of trade is efficient and economical
in that no intermediaries need to paid, but because there are no
intermediaries, there is much less liquididy than the traditional
exchanges where a third party can serve as a volume buffer. Thus ECNs
are ideally suited for the large block, sophisticated trader who wants
efficient execution with a minimal distruption in the trade price that
would occurr with public trading.
In todays internet world, several firms are planning to open such
off-exchange trading to the public. Much of the focus is toward after
hours trading. But once started, there is no limit to providing
24-hour, 7-day access. Perspective particiants range from Schwab to new
startups. The SEC promises that some of the organized off-exchange
operations can qualify as official exchanges. It was recently reported
that Datek's Island ECN had filed with the SEC to be recognized as an
official exchange.
One computerized system is even designed to provide total annomity:
neither the buyer or seller or the operator of the computer system knows
the identity of the two participants until after the system puts the two
in contact.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Opening Prices
Last-Revised: 26 Feb 1997
Contributed-By: Chris Lott ( contact me ), John Schott (jschott at
voicenet.com)
The previous day's close, as well as any after-hour trading in a
security may have significant effects on the opening price, but that
isn't the whole story. Here's a quick summary of how the process for
determining the opening price works.
The basic problem is that the closing price from the previous trading
day is no longer a valid indicator of a stock's perceived value. News
may have appeared since the previous close, there may have been trading
on foreign exchanges that open before US domestic exchanges, and there
surely has been a flow of new and changed orders since the previous
close.
On the NYSE and ASE, the specialist determines the opening price by
looking at his/her "book." The specialists are supposed to select the
one price that clears out the maximum number of orders; i.e. by looking
at the buy and sell offers and choosing a single price will execute the
most orders (shares). But it is possible that today's book contains no
orders from yesterday - or at least none that might affect the opening.
So the specialist may have to make an educated guess to kick off initial
trading.
As a multi-market maker exchange, NASDAQ's computerized system opens
differently. Market makers perform a two stage round-robin opening.
First, each posts a single bid and asked price pair. This price can
signal each firms view of the security, its current desire to buy or
sell, or it may indicate that a firm is out of calibration with others
in the market. After all have seen the first round, each firm may
revise their postings once and trading starts as the executions flow to
"best" postings. And off the day's trading goes.
You may read about "gaps" in the opening price, or that trading in a
security began late. This commonly happens when news that was released
after the previous market close impacts a security's price. The opening
price in these cases differs sharply from the previous day's close,
either higher or lower. For example, a company may release unexpectedly
good earnings early in the morning just before the market opening. If
there is a potential price impact expected, the firm, its
specialist/market makers, or the exchange itself may delay the opening
to allow the news to reach as many people as possible before an opening
is made.
An extreme example of what a specialist may have to deal with happened
in February 1997. Mercury Finance (MFN) closed around 15 and opened the
next day near 1 1/2 due to extremely bad news overnight. (I am ignoring
what might have happened in after hours trading - but that would have
some effect.) Some poor souls might not have heard the bad news and left
open their old buy or sell orders at 14-15. The NYSE specialist could
potentially have opened the stock at $14, taken out those orders and
then done the next trades at 1 1/2 (or where-ever it did open: 1-3/8 or
1-5/8). But looking at the books, he eventually decided on a delayed
opening, allowing people time to assess the news and adjust open and new
orders accordingly. Once a pattern of orders emerged, the opening
occurred according to normal procedures. An unrevised open buy order
from yesterday executed at todays far lower price... An inattentive
market-price seller from yesterday would get today's sharply reduced
price, too.
--------------------Check http://invest-faq.com/ for updates------------------
Compilation Copyright (c) 2005 by Christopher Lott.
Christopher Lott
Version: $Id: part17,v 1.62 2005/01/05 12:40:47 lott Exp lott $
Compiler: Christopher Lott
The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance. This is a plain-text
version of The Investment FAQ, part 17 of 20. The web site
always has the latest version, including in-line links. Please browse
http://invest-faq.com/
Terms of Use
Disclaimers
Please send comments and new submissions to the compiler.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Technical Analysis - Information Sources
Last-Revised: 12 Dec 1996
Contributed-By: (Original author unknown), Chris Lott ( contact me )
This article lists some sources of information for technical analysis,
including books, magazines, and courses.
Books on Technical Analysis:
* Design, Testing, and Optimization of Trading Systems by Robert
Pardo. Published by John Wiley & Sons, Inc.
* The Disciplined Trader by Mark Douglas of NYIF - 1990. ISBN
0-13-215757-8
* Elliott Wave Principle by A. J. Frost and Robert Prechter, New
Classics Library, ISBN: 0-932750-07-9.
* Encyclopedia of Technical Market Indicators by Robert Colby and
Thomas Meyers, Dow Jones Irwin.
* Market Wizards by Jack Swager
* The Mathematics of Technical Analysis by Clifford Sherry, 1992
Probus Publishing, ISBN 1-55738-462-2
* New Market Wizards by Jack Swager
* Patterns for Profits by Sherman McClellan, Foundation for the Study
of Cycles, 900 W. Valley Rd. Suite 502, Wayne, PA 19087,
215-995-2120.
* Proceedings, Second Annual conference on Artificial Intelligence
Applications on Wall Street, Roy S. Freedman, Ed. NYC, April
19-22, 1993, Pub: Software Engineering Press, 973C Russell Ave,
Gaithersburg, MD 20879, (301) 948-5391.
* Secrets for Profiting in Bull and Bear Markets, by Stan Weinstein,
Dow Jones-Irwin.
* Technical Analysis, by Clifford Sherry, 1992 Probus Publishing,
ISBN 1-55738-462-2.
* Technical Analysis Explained, by Martin J. Pring, McGraw-Hill, 3rd
ed. 1991, ISBN 0-07-051042-3.
* Technical Analysis of the Futures Markets, by John J. Murphy of NY
Institute of Finance, Prentice Hall, 1986, ISBN 0-13-898008-X.
* Study Guide for Technical Analysis of the Futures Markets: A
self-training manual, by John Murphy (the most comprehensive book
on the subject).
* Technical Analysis of Stock Trends, by Edwards and Magee (a serious
study of classical charting techniques).
* The Major Works of R. N. Elliott, edited by Robert Prechter, New
Classics Library.
* Timing the Market: HOW TO PROFIT IN BULL AND BEAR MARKETS WITH
TECHNICAL ANALYSIS, by Weiss Research (a good introductory text for
those using METASTOCK PROFESSIONAL and want to make money with it).
Sources for books on technical analysis:
* TRADERS PRESS, INC., P.O. BOX 10344, Greenville, S.C. 29603,
(800)927-8222, (803)-298-0222, FAX: (803)-298-0221. Offer a 40+
page catalog, nice folks, great service. VI/MC/AX accepted.
* TRADER'S WORLD, 2508 Grayrock Street, Springfield, MO 65810,
(800)288-4266, (417) 298-0221. Puts out a quarterly magazine
(mostly junk) with discounted Technical Analysis books (usually 10%
cheaper than elsewhere). VI/MC/AX accepted.
* New Classics Library, Inc., P.O. Box 1618, Gainesville, GA 30503.
Books on options pricing:
* Continuous Time Finance, by Robert Merton
* The Elements of Successful Trading, by Rotella, Robert P., 1992
* Options as a Strategic Investment, by McMillan, Lawrence G., New
York Inst. of Finance, 2nd edition, 1986, ISBN 0-13-638347-5.
* Options Markets, by Cox, J.C and Rubenstein, M., Prentice-Hall,
1985.
* Options: Essential Trading Concepts and Trading Strategies, Edited
by The Options Intsitute, 1990, Business One Irwin, ISBN
1-55623-102-4.
* Options, Futures, and Other Derivative Securities, by Hull, J.,
Prentice-Hall, 1989.
* Options: Theory, Strategy, and Apllications, by Ritchken, P, Scott,
Foresman, 1987.
* Option Pricing, by Jarrow, R. A., Irwin, 1983.
* Option Volatility and Pricing Strategies, by Natenberg, Shelly
* Theory of Financial Decision Making, by Ingersoll
Magazines on technical analysis:
* Technical Analysis of Stocks & Commodities
4757 California Ave. SW, Seattle, WA 98116-4499, 800-832-4642,
(206) 938-0570. 1 yr. - $64.95 -- 12 issues
Everything explained at the level of the beginner, however you
should complete a course before getting this magazine. Best part
is building a library by buying the bound back issues -- worth
every penny.
* Futures - commodities, options & derivatives
800-221-4352 Ext. 1000
1 yr. - $39.00 - 12 issues
* NeuroVe$t Journal
Pub. by Randall B. Caldwell, PO Box 764, Haymarket, VA
22069-0764, email: rbcal...@delphi.com
$75(US)/yr, published bi-monthly
* Traders Cataloge and Resource Guide
619-930-1050
$39.50 year.
* Traders World Magazine
1-800-288-4266
Published every 3 months, $15 per year
A self-paced course on technical analysis:
The Technical Analysis Course by Thomas Meyers
An introductory course covering: Stochastics, RSI, Trendline/chanels,
Support/resistance, Point and Figure, Oscillators, Moving averages,
Volume & Open Interest, Chart construction, Gaps, Reversal Patterns, and
Consolidation formations. Easy read for someone new that doesn't want
to be intimidated.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Technical Analysis - MACD
Last-Revised: 25 Nov 1998
Contributed-By: (Original author unknown), Chris Lott ( contact me ),
Jack Hershey (jhershey at primenet.com)
The Moving Average Convergence/Divergence (MACD) was invented by Gerald
Appel sometime in the sixties and comes in various flavors, but most are
based on a technique developed by McClellan (which he based on a
technique developed by Haurlan). The technique is to take the
difference between two exponential moving averages (EMA's) with
different periods. This produces what's generally referred to as an
oscillator. An oscillator is so named because the resulting curve
swings back and forth across the zero line.
Appel's version used the difference between a 12-day EMA and a 25-day
EMA to generate his primary series. This series was plotted as a solid
line. Then he took a 9-day EMA of the difference and plotted that as a
dotted line. The 9-day EMA trails the primary series by just a bit, and
trades are signalled whenever the solid line crosses the dotted line.
For more volatile markets, you may want to shorten the periods of the
EMA's. I seem to remember one trader that used an MACD on futures data
with 7-day and 13-day for the primary series and a 5-day EMA of that for
the trailing curve. I also know a fellow who runs an MACD on the adline
(advancing issues minus declining issues).
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Technical Analysis - McClellan Oscillator and Summation Index
Last-Revised: 23 Dec 1997
Contributed-By: Tom McClellan
In 1969, Sherman and Marian McClellan developed the McClellan Oscillator
and its companion tool the McClellan Summation Index to gain an
advantage in selecting the better times to enter and exit the stock
market. This article gives a brief overview of the McClellan Oscillator
and Summation Index.
Every day that stocks are traded, financial publications list the number
of stocks that closed higher (advances) and that closed lower
(declines). The difference between these numbers is called the daily
breadth. The running cumulative total of daily breadth is known as the
Daily Advance-Decline Line. It is important because it shows great
correlation to the movements of the stock market, and because it gives
us another way to quantify the movements of the market other than
looking at the price levels of indices.
Another indicator is called the daily breadth. Each tick mark on a
daily breadth chart represents one day's reading of advances minus
declines. In order to identify the trend that is taking place in the
daily breadth, we smooth the data by using a special type of calculation
known as an exponential moving average (EMA). It works by weighting the
most recent data more heavily, and older data progressively less. The
amount of weighting given to the more recent data is known as the
smoothing constant.
We use two different EMAs: one with a 10% smoothing constant, and one
with a 5% smoothing constant. These are known as the 10% Trend and 5%
Trend for brevity. The numerical difference between these two EMAs is
the value of the McClellan Oscillator.
The McClellan Oscillator offers many types of structures for
interpretation, but there are two main ones. First, when the Oscillator
is positive, it generally portrays money coming into the market;
conversely, when it is negative, it reflects money leaving the market.
Second, when the Oscillator reaches extreme readings, it can reflect an
overbought or oversold condition.
While these two characteristics are very important, they merely scratch
the surface of what interpreting the Oscillator can reveal about the
stock market. Many more important structures are outlined in the book
Patterns For Profit by Sherman and Marian McClellan, available from
McClellan Financial Publications.
If you add up all of the daily values of the McClellan Oscillator, you
will have an indicator known as the McClellan Summation Index. It is
the basis for intermediate and long term interpretation of the stock
market's direction and power. When properly calculated and calibrated,
it is neutral at the +1000 level. It generally moves between 0 and
+2000. When outside these levels, the Summation Index indicates that an
unusual condition is taking place in the market. As with the
Oscillator, the Summation Index offers many different pieces of
information in order to interpret the market's action.
Among the most significant indications given by the Summation Index are
the identification of the end of a bear market and the confirmation of a
new bull market. Bear markets typically end with the Summation Index
below -1200. A strong rise from such a level can signal initiation of a
new bull market. This is confirmed when the Summation Index rises above
+2000. Past examples of such a confirmation have resulted in bull
markets lasting at least 13 months, with the average ones lasting 22-24
months.
The McClellans publish a stock market newsletter called The McClellan
Market Report. Sherman McClellan and his wife Marian McClellan were the
originators of the McClellan Oscillator; Tom McClellan is their son.
For more information, please contact Tom McClellan at (800) 872-3737, or
visit the web site at http://www.mcoscillator.com .
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Technical Analysis - On Balance Volume
Last-Revised: 27 Feb 1997
Contributed-By: Y. D. Charlap, Scott A. Thompson (satulysses at
aol.com)
On Balance Volume is a momentum indicator that relates volume to price
changes. It is calculated by adding the day's volume to the cumulative
total when the security's price closes up, and subtracting the day's
volume when the price closes down. The scale is not of any value; only
the slope (i.e., the direction) of the line is of value.
The theory is that the trend of this indicator precedes price changes.
This indicator was pioneered by that famous (?) market maven Joseph
Granville.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Technical Analysis - Relative Strength Indicator
Last-Revised: 17 July 2000
Contributed-By: (Original author unknown), Chris Lott ( contact me ), C.
K. Krishnadas (ckkrish at cyberspace.org)
The Relative Strength Indicator (RSI) was developed by J. Welles Wilder
in 1978. This indicator is one of a family of indicators called
oscillators because it varies (oscillates) between fixed upper and lower
bounds. This particular indicator is supposed to track price momentum.
Wilkder's relative strength indicator is based on the observation that a
stock which is advancing will tend to close nearer to the high of the
day than the low. The reverse is true for declining stocks.
It's easy to confuse Wilder's relative strength indicator with other
relative strength figures that are published. Wilder's indicator
compares the price performance of a stock to that of itself and might be
more appropriately called an "internal strength index". Other similarly
named indicators compare a stock's price to some stock market index or
to another stock.
This indicator has evolved into several forms, but Wilder's RSI is
generally regarded as the most useful. The oscillator is indexed from 0
to 100, and like all oscillators it indicates overbought and oversold
readings. The RSI oscillator is most useful in a trading channel,
especially those with deeply pronounced crests and troughs. Trending
prices tend to distort overbought and oversold signals because indicator
readings will be skewed off-center from a neutral reading of "50".
Very basically, "buy" signals are considered to be readings of 30 or
less (the security is considered oversold) and "sell" signals are
considered to be RSI values of 70 or greater (the security is considered
overbought). Depending on the technician and price volatility, there
are various other qualifiers and nuances that can be incorporated into a
signal. For example, in very volatile markets, the bounds of 20 and 80
might be used to judge oversold and overbought conditions.
Another aspect of this indicator that is commonly varied is the period
over which the indicator is calculated. Wilder began with 14 periods,
but other values are common (e.g., 9 and 25).
The formula is as follows:
Average price change on up days
Relative Strength = ---------------------------------
Average price change on down days
The indicator (RSI) is calculated from the RS value as follows:
100
RSI = 100 - ------
1 + RS
Now that you have the general idea, you probably want to calculate some
RSI values for stocks you're following. Perhaps the easiest way is to
visit one of the web sites shown at the end of this article. But if
you're really determined to compute it yourself, here's one way to do
so.
RS = P / N
P = PS / n1 N = NS / n2
PS = Total of PCi values NS = Total of NCi values
PCi = positive price change NC = negative price change
for period i for period i
Pp = previous value of P Np = previous value of N
(initially 0) (initially 0)
n1 = number of times the price changed in the positive
direction in the last n periods. There will be n1 PCi
values to add together to get PS.
n2 = number of timee the price changed in the negative
direction in the last n periods. There will be n2 NCi
values to add together to get NS.
n = n1 + n2 (the number of periods in the RSI calculation)
Basically you can calculate both PCi and NCi for every day. One or both
of PCi and NCi will be zero. This makes it fairly straightforward to
enter the computation in a spreadsheet. To make it easy to count the
values in a spread sheet, use an "if" statement for each that will yield
blank if appropriate. Then use Excel's count() macro, which counts only
cells with numbers and ignores blanks. Here are the formulas; of course
you will have to replace "this_price" and "previous_price" by approprate
cell references.
* PCi:
IF( this_price - previous_price > 0, this_price - previous, "" )
* NCi:
IF( this_price - previous_price < 0, this_price - previous, "" )
The first non-zero period of PS and NS is computed by doing a simple
moving average of the PC and NC of the previous n periods according to
Wilder's formula.
Remember to skip the first n points before starting the RSI
calculations. Also remember that the first time PS and NS are
calculated, they are simple moving averages of the last n PC's and NC's
respectively. That's where most mistakes are made.
Here are some resources on RSI.
* The May 2000 issue of AAII Journal included a 5-page article about
RSI with examples (they have a two-week free trial membership).
http://www.aaii.com
* BigCharts offers a free interactive charting feature that includes
(among many others) RSI.
http://www.bigcharts.com
* The original book by J. Welles Wilder
New Concepts in Technical Trading Systems
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Technical Analysis - Stochastics
Last-Revised: 25 Nov 1998
Contributed-By: (Original author unknown), Chris Lott ( contact me )
This article gives the formula for stochastics. The raw stochastic is
computed as the position of today's close as a percentage of the range
established by the highest high and the lowest low of the time period
you use. The raw stochastic (%K) is then smoothed exponentially to
yield the %D value. These calculations produce the original or fast
stochastics.
%K = 100 [ ( C - L5 ) / ( H5 - L5 ) ]
where: C is the latest close, L5 is the lowest low for the last five
days, and H5 is the highest high for the same five days
%D = 100 x ( H3 / L3 )
where: H3 is the three day sum of ( C - L5 ) and L3 is the 3-day sum of
( H5 - L5 )
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Basics
Last-Revised: 1 Jan 2004
Contributed-By: Chris Lott ( contact me )
This article offers a very basic introduction to stock trading. It goes
through the steps of buying and selling shares, and explains the
fundamental issues of how an investor can make or lose money by buying
and selling shares of stock. This article will simplify and generalize
quite a bit; the goal is to get across the basic idea without cluttering
the issue with too many details. In some places I've included links to
other articles in the FAQ that explain the details, but feel free to
skip those links the first time you read over this.
You may know already that a share of stock is essentially a portion of a
company. The stock holders are the owners of a company. In theory, the
owners (stock holders) make money when the company makes money, and lose
money when the company loses money. Once there was age of internet
stocks where companies lost lots of money but the shareholders still
made lots of money (and then lost money themselves), but let's just say
that the main trick is to buy only stocks that go up.
Next we will walk through a stock purchase and sale to illustrate how
you, an investor in stocks, can make money--or lose money--by buying and
selling stocks.
1. One fine day you decide to buy shares of some stock, let's pick on
AT&T. Maybe you think that company will soon return to being the
all-powerful, highly profitable "Ma Bell" that it once was. Or you
just think their ads are cool. So now what?
2. Although there are many ways to buy shares of stock, you decide to
take the old-fashioned route of using an old-fashioned stock broker
who has an office in your town and (imagine!) takes your phone
calls. You open an account with your friendly broker and deposit
some good old-fashioned cash. Let's say you deposit $1,000.
3. You ask your broker about the current market price quoted for AT&T
shares. Your broker is a good broker, and like any good broker he
knows that AT&T's ticker symbol is the single letter 'T'. He
punches T into his quote request system and asks for the current
market price (supplied from the New York Stock Exchange, where T is
primarily traded), and out pops a price of 20.25 (stocks were once
quoted as fractions like 1/4 but are now done with decimals).
Looks like your $1,000 will buy almost 50 shares, but because this
is your very first stock trade, you decide to buy just 10 shares.
4. You ask your broker to buy 10 shares for you at the current market
price. In the lingo of your broker, you give a market order for 10
shares of T. Your broker is a nice guy and only charges a
commission on a single stock trade of $30 (not too bad for someone
who takes your phone calls). Your broker enters the order, and his
computer then figures the price you will ultimately pay for those
10 shares, which is 10 (the number of shares) times 20.25 (the
current price for the shares on the open market) for a total of
202.50, plus 30 (the broker's commission, don't forget he has to
eat too), for a grand total of $232.50.
5. Then magic happens: your broker instantly finds someone willing to
sell you 10 shares at the current market price of 20.25 and buys
them for you from that someone. Your broker takes money from your
account and sends it off to that someone who sold you the shares.
Your broker also takes his $30 commission from your account. In
the end, your hard-earned money is gone, and your account has 10
shares of AT&T. A (very small) fraction of the company, as
represented by those 10 shares, is now in your hands!
Now it's time for a few details, which you can safely skip if you
choose. The person who sold you the shares was a specialist
("spec") on the NYSE; for more information, look into the NYSE's
auction trading system . Roughly, a specialist is a type of
middleman and a member (like your broker) of the financial services
industry. After you give the order, the shares do not appear
instantly; they appear in your account three business days after
you gave the order (called "T+3"). In other words, trades settle
in three business days.
Please pardon a fair amount of oversimplification here, but the
trade and settlement procedures involved with making sure those 10
shares come to your account can happen in many, many different
ways. You're paying that commission so things are easy for you,
and indeed they are: for a relatively modest fee, your broker got
you the shares.
It may be important to point out here that AT&T, that big company
from Bedminster, New Jersey, did not participate in this stock
trade. Sure, their shares changed hands, but that's all. Shares
of publicly traded companies that are bought on the open market
never come from the company. Further, the money that you pay for
shares bought on the open market does not go to the company. Sure,
the company sold shares to the public at one point (an event called
a public offering), but your trade was done on the open market.
After the trade settles, then what? Your broker keeps some of the
$30 commission personally, and some goes to the company he works
for. The shares are in your brokerage account. This is called
holding shares "in street name." If you really want to hold the
stock certificates, your broker will be happy to arrange this, but
he will probably charge you about another $30. Since you feel
you've paid your broker enough already (and you're right), you
decide to leave the shares in your account ("in street name").
6. The next day, AT&T shares close at a price of 21, which is a rise
of $0.75. Great, you think, I just made $7.50. And in some sense
you're right. The value of your holdings has increased by that
amount. This is a paper gain or unrealized gain; i.e., on paper,
you're $7.50 wealthier. That money is not in your pocket, though,
and you do not need to tell the IRS. The IRS only cares about
actual (realized) gains, and you don't have any, not yet.
7. The following day, AT&T shares close at a price of 22. which is
another rise over the price you paid and a rise over the previous
day. Fantastic, you think, boy can I pick them, today I made
another $10! At this point, you have a paper gain of 10 times 1.75
which is 17.50. Not too bad for two days.
8. That evening you decide that maybe AT&T really isn't such a great
wireless phone company after all and it's time to sell. You make a
call the next morning, and although your broker is a bit surprised
to hear from you again so soon, he's obliging (after all, it's your
money). Again your broker asks for a quote of the current market
price for 'T.' The current market price for AT&T on the NYSE is
22.50 (wow, another rise). Your broker accepts your order to sell
T at the market. Again his computer figures the money you will
receive from the sale: 10 (the number of shares) times 22.50 (the
current market price) for a total of 225, less his commission of
30, for a grand total of 195.
9. Magic happens again: instantly your broker finds someone willing to
buy the 10 shares of AT&T from you at the current price, and sells
your shares to that someone. That someone sends you $225. Your
broker deducts his commission of $30 from the proceeds of the sale,
so eventually the shares of AT&T disappear from your account and a
credit of $195 appears. Note again that the company did not
participate in this trade, although shares (and fractional
ownership of the company represented by those 10 shares) changed
hands.
As explained above, that someone was a person at the NYSE called a
specialist ("spec"), a member of the financial services industry.
The trade will be settled in exactly 3 business days (upon
settlement, the shares are gone and you have the cash). Again I
apologize for the oversimplification here.
10. So you calculate the result. Gee, you think, the stock went up
every day.. and I paid $232.50.. but I only received $195.. and
pretty quickly you come to the inescapable conclusion that you lost
$37.50, even though you had a paper gain every day. This is the
problem with commissions: they reduce your returns. You paid over
15% of your capital in commissions, so although the share price
rose about that much in just a couple of days, you lost money
because the commissions exceeded the gains.
11. Eventually you do your taxes. You have a short-term capital loss
of $37.50 from this pair of trades. Depending on your tax
situation, you may be able to deduct your loss from your gross
income.
Now you should understand the basic mechanics of buying and selling
shares of stock, and you see the importance of commissions.
Just for comparison, let's run the numbers if you had bought 50 shares
instead of just 10 (maybe you found another few dollars). The purchase
price of (50 * 20.25) + 30 is 1042.50. The sales price of (50 * 22.50)
- 30 is 1095. The difference is $52.50 in your favor. What this says
is that commissions can really hurt the small investor, and is a good
reason for really small investors to consider investing via no-load
mutual funds or direct investment plans (DRIPs) .
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - After Hours
Last-Revised: 12 Feb 2004
Contributed-By: John Schott (jschott at voicenet.com), Chris Lott (
contact me ), P. Healy, James Owens
After-hours trading has traditionally referred to securities trading
that occurs after the major U.S. exchanges close. Until 1999,
after-hours trading in the U.S. was mostly restricted to big-block
trading among professionals and institutions. Much of this sort of
trading was supported by electronic trading networks (ECNs). One of the
oldest and best known ECN is Instinet, a network operated by Reuters
that helps buyers meet sellers (there's no physical exchange where
someone like a specialist works). Another is Island ECN, a relatively
new network that (interestingly) has applied to the SEC to be a new
stock exchange. With the advent of these ECNs where trades can take
place at any hour of any day, time and place have taken on a reduced
meaning.
Anyhow, until summer 1999, individual investors had no access to these
trading venues. And it was only natural that some investors clamored
for equal access to what the professionals had. Perhaps individuals
felt that they would be able to pick up bargins in the after-hours
trading as news announcements filter out and before stocks reopen on the
following day. While that is highly unlikely (prices fluctuate after
hours just as they do during the regular trading day), their wishes for
equal access have been granted.
As of early 2003, there are basically three types of before-hours and
after-hours markets, as follows.
U.S. exchange after-hour markets
The NYSE and ASE provide crossing sessions in which matching buy
and sell orders can be executed at 5:00 p.m. based on the
exchanges' 4:00 p.m. closing prices. The BSE and PSE have
post-primary sessions that operate from 4:00 to 4:15. CHX and PCX
operate their post-primary sessions until 4:30 p.m. Additionally
CHX has an "E-Session" to handle limit orders from 4:30 to 6:30p.m.
Foreign exchange after-hour markets
Several foreign exchanges also trade certain NYSE-listed stocks.
Hours are governed by those individual markets.
ECN after hour markets.
Electronic communication networks (ECNs) have allowed institutions
to participate in after-market trades since 1975; individuals
joined the party in 1999. Typically, extended-hour trades must be
done with limit orders.
A short list of typical brokers that offer ECN access and the extended
hours available is listed below. This list is meant to be illustrative,
not exhaustive.
* Ameritrade (via Island ECN)
Hours: 8am-8pm Eastern; limit orders only during extended hours.
* E*Trade (via Archipelago ECN)
Hours: 8am-8pm Eastern; limit orders only during extended hours.
Note that eextended-hours orders can be placed even during regular
market hours; these orders may be filled during normal or
extended-trading hours.
* Fidelity (via Redibook)
Hours: 7:30-915am and 4:15-8:00pm EST; restrictions on order types.
* Harris Direct (via Redibook ECN)
Hours: 8-9:15am and 4:15-7pm Eastern; limit orders only; round
lots.
* Schwab (via Redibook ECN)
Hours: 7:30-9:15am and 4:15-8pm Eastern, Monday - Friday; limit
orders only.
* TD Waterhouse (via ???)
Hours: 7:30-9:30am and 4:15-7:00pm EST
Most of the after-hours markets function as crossing markets. That is,
your order and my opposing order are filled only if they can be matched
(i.e., crossed). In an extreme example, the new Market XT requires ONLY
limit orders.
The concept of trading after exchange hours seems attractive, but it
brings with it a new set of problems. Most importantly, the traditional
liquidity that the daily market offers could suffer.
I want to digress into a quick review of the mechanisms on the NYSE and
NASDAQ that provide for liquidity and buffering, mechanisms that are
mostly absent on the ECNs. In the case of the New York exchange, the
specialist ("specs") there are required to act as buffers by buying and
selling for their own accounts. This serves to smooth out market
action. (Whether they do in times of stress is doubtful, but that's
another matter entirely.) In the case of the NASDAQ, an all-electronic
exchange, many firms may offer to "make a market" in a specific stock.
They post buy and sell offers on a computer system and when there is a
matching counter offer, the trade is made. Meanwhile, onlookers can see
the trading potential of all available bid and ask quotations - a
decidedly different situation than on the NYSE. But note that the
NASDAQ system has no buffering built in (no market maker is required to
buy or sell).
Now, in the new, non-exchange operations with limited information,
limited participation, and what is effectively unbuffered,
person-to-person trading, it's quite reasonable to expect that liquidity
will be poor. Unlike the NYSE's specialist system and the NAQDAQ’s
market-maker system, where the daily market can readily accomodate small
orders, the after-hours market will be quite different -- operations are
quite literally in the dark. What we can see is effectively a reduction
in apparent liquidity in normal trading as we slide down the trading
scale (from the NYSE to the after-hours ECNs). On the NYSE there
theoretically is always a bid and ask about the present market price,
but may not be the case in less liquid markets. Ultimately, as seems to
be the case on some ECNs today, we get to the basest market - you and I
trading privately. Either we agree or there is no transaction. It can
get to be a jungle.
Furthermore, Instinet, Island and all the other ECNs don't have a common
reporting structure as do NASDAQ and NYSE. That is, the prices and
volumes on one ECN might be different from that on another ECN. Since
only a few of the biggies have access to multiple ECNs there can be a
chance for arbitrage, which means buying in one place at one price and
selling substantially the same thing somewhere else for a different
price, all in essentially the same time frame in the case of ECNs.
The effect is widened spreads, irregular trading, and a chance for the
unwary (read you and me) to get slightly whacked.
There are other issues as well, of course. At night, the information
resources and public attention that the established exchanges offer
today will be operating at a low level. Today, Microsoft, Intel, or
Dell likely make important announcements during the quiet hours after
the exchanges close. That gives the investment community time to access
and evaluate the news. Now drop the same announcement into an
environment of several uncoordinated after-hours exchanges. Favorable
news may create such demand that it overwhelms the supply offered by now
reluctant sellers. Prices could zoom, only to crash back as more
sellers show up. Lack of full information and considered analysis could
make the daily gyrations of hot stocks like Amazon.com and new IPOs look
boring.
Making things yet less transparent, if I understand it correctly, trades
made on these markets are not part of the reported closing prices you
see in the newspapers. The data is apparently reported separately, at
least on professional-level data systems.
Finally, consider the effect on both the industry and private traders
who now face an extended trading day. Presumably the extended day will
offer even less time for reflection, research, and consideration. Do
the pros stay glued to the tube while eating carryout? Do they employ a
night shift to babysit things? And what about the day workers who now
come home to an evening of trading stress? Thus expanded market hours
may not be the blessing that some expect, only another hazard in today's
stressful life.
Meanwhile the SEC is pushing for some rules and regularity. To get the
blessing as a recognized exchange, expect that the SEC will insist on a
public ticker system (ultimately I’d expect ONE unified quote system
incorporating all of todays exchange's and the ECNs.) Logically, this
leads to expectation of a unified market, and represents a significant
threat to existing markets like the NYSE.
Certain indications suggest that extended hours will become even more
extended (possibly approximating a 24 hour market) in the foreseeable,
though perhaps remote, future. In the past few years, market forces
have constricted efforts to further extend trading hours, but a strong
enough future bull market would almost certainly reverse that trend.
Finally, the term "after-hours" trading is becoming rapidly out of date.
Consider DCX (Daimler-Chrysler), which is traded in identical form on 11
worldwide exchanges in Asia, Europe, and the Americas. For this stock,
the winding down of the day's trading in New York seems an anticlimax to
a day that's already over in Tokyo.
Here are a few more resources with information.
* Instinet runs a site with some information about their operations.
http://www.instinet.com
* The Wall Street Journal gave an update on Friday, 27 August 1999 on
the front page of the Money and Investing section.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Bid, Offer, and Spread
Last-Revised: 1 Feb 1998
Contributed-By: Chris Lott ( contact me ), John Schott (jschott at
voicenet.com)
If you want to buy or sell a stock or other security on the open market,
you normally trade via agents on the market scene who specialize in that
particular security. These people stand ready to sell you a security
for some asking price (the "offer") if you would like to buy it. Or, if
you own the security already and would like to sell it, they will buy
the security from you for some price (the "bid"). The difference
between the bid and offer is called the spread. Stocks that are heavily
traded tend to have very narrow spreads (as little as a penny), but
stocks that are lightly traded can have spreads that are significant,
even as high as several dollars.
So why is there a spread? The short answer is "profit." The long answer
goes to the heart of modern markets, namely the question of liquidity.
Liquidity basically means that someone is ready to buy or sell
significant quantities of a security at any time. In the stock market,
market makers or specialists (depending on the exchange) buy stocks from
the public at the bid and sell stocks to the public at the offer (called
"making a market in the stock"). At most times (unless the market is
crashing, etc.) these people stand ready to make a market in most stocks
and often in substantial quantities, thereby maintaining market
liquidity.
Dealers make their living by taking a large part of the spread on each
transaction - they normally are not long term investors. In fact, they
work a lot like the local supermarket, raising and lowering prices on
their inventory as the market moves, and making a few cents here and
there. And while lettuce eventually spoils, holding a stock that is
tailing off with no buyers is analogous.
Because dealers in a security get to keep much of the spread, they work
fairly hard to keep the spread above zero. This is really quite fair:
they provide a valuable service (making a market in the stock and
keeping the markets liquid), so it's only reasonable for them to get
paid for their services. Of course you may not always agree that the
price charged (the spread) is appropriate!
Occasionally you may read that there is no bid-offer spread on the NYSE.
This is nonsense. Stocks traded on the New York exchange have bid and
offer prices just like any other market. However, the NYSE bars the
publishing of bid and offer prices by any delayed quote service. Any
decent real-time quote service will show the bid and offer prices for an
issue traded on the NYSE.
Related topics that are covered in FAQ articles include price
improvement (narrowing the spread as much as possible), stock crossing
by discount brokers (narrowing the spread to zero by having buyer meet
seller directly), and trading on the NASDAQ (in the past, that
exchange's structure encouraged spreads that were significantly higher
than on other exchanges).
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Brokerage Account Types
Last-Revised: 23 Jul 2002
Contributed-By: Rich Carreiro (rlcarr at animato.arlington.ma.us), Chris
Lott ( contact me ), Eric Larson
Brokerage houses offer clients a number of different accounts. The most
common ones are a cash account, a margin account (frequently called a
"cash and margin" account), and an option account (frequently called a
"cash, margin, and option" account). Basically, these accounts
represent different levels of credit and trustworthiness of the account
holder as evaluated by the brokerage house.
A cash account is the traditional brokerage account (sometimes called a
"Type 1" account). If you have a cash account, you may make trades, but
you have to pay in full for all purchases by the settlement date. In
other words, you must add cash to pay for purchases if the account does
not have sufficient cash already. In sleepier, less-connected times
than the year 2002, most brokerage houses would accept an order to buy
stock in a cash account, and after executing that order, they would
allow you to bring the money to settle the trade a few days later. In
the age of internet trading, however, most brokers require good funds in
the account before they will accept an order to buy. Just about anyone
can open a cash account, although some brokerage houses may require a
significant deposit (as much as $10,000) before they open the account.
A margin account is a type of brokerage account that allows you to take
out loans against securities you own (sometimes called a "Type 2"
account). Because the brokerage house is essentially granting you
credit by giving you a margin account, you must pass their screening
procedure to get one. Even if you don't plan to buy on margin, note
that all short sales ("Type 5") have to occur in a margin account. Note
that if you have a margin account, you will also have a cash account.
An option account is a type of brokerage account that allows you to
trade stock options (i.e., puts and calls). To open this type of
account, your broker will require you to sign a statement that you
understand and acknowledge the risks associated with derivative
instruments. This is actually for the broker's protection and came into
place after brokers were successfully sued by clients who made large
losses in options and then claimed they were unaware of the risks. It's
my understanding that otherwise an option account is identical to a
margin account.
Please don't confuse the type of account with the stuff in your account.
For example, you will almost certainly have a bit of cash in a brokerage
account of any type, perhaps because you received a dividend payment on
a share held by your broker. This cash balance may be carried along as
pure cash (and you get no interest), or the cash may be swept into a
money market account (so you get a bit of interest). Presumably if you
have a margin account, the cash will appear there and not in your cash
account (see below for more details). It's an unfortunate fact that the
words are overloaded and confusing.
Margin accounts are the most interesting, so next we'll go into all the
gory details about those.
Access to margin accounts is more restrictive when compared to cash
accounts. When you ask for a margin account, your broker will (if he or
she hasn't already) run a credit check on you. You will also have to
sign a separate margin account agreement. The agreement says that the
broker can use as collateral any securities held in the margin account
whenever you have a debit balance (i.e., you owe the broker money).
Note that if you have a cash account with the same broker, securities
held in the cash account (often non-marginable securities) do not help
(nor can the broker sell them) if you have a debit balance in the margin
account. Conversely, securities in the cash account do not count
towards margin requirements.
Another key feature of the margin account agreement is the
"hypothecation and re-hypothecation" clause. This clause allows the
broker to lend out your securities at will. So the ability to borrow
money always comes with the trade-off that the broker can lend out
("hypothecate") securities that you hold to short-sellers. Although you
will pay the brokerage when you borrow money from them, the brokerage
house will *not* pay you (or in fact even notify you) if they borrow
your shares. This seems to be just the way things work. Also see the
article elsewhere in this FAQ about short selling for more information.
As a general rule, a margin account will have all marginable securities,
and a cash account will have all non-marginable securities. At some
brokerage houses, non-marginable securities can be held inside a margin
account (Type-2); however, those securities will not be included in the
calculation of margin buying power. The insidious element here is that
even though the non-marginable securities contribute nothing of value to
the margin calculation, those same securities -- if there is even $1 of
debit balance in the margin account -- will become registered as
"type-2" by virtue of simply residing within a Type-2 acount, and, thus,
can be made lendable to brokers for clients wishing to short-sell the
stock.
Having a margin account makes it possible to take a margin loan. You
can use a margin loan for anything you want. The primary uses are to
buy securities (called "buying on margin") or to extract cash from an
equity position without having to sell it (thus avoiding the tax bite or
the chance of missing a run-up). Some brokers will even give you debit
cards whose debit limit is equal to your maximum margin borrowing limit
(which is determined daily).
The terms under which you borrow the money (i.e., the interest rate you
must pay and the payment schedule) are determined by your portfolio.
Subject to various rules on the amount you can borrow (discussed later),
you just buy some securities and a loan will be automatically be
extended to you. Or if you need cash, you just tell your broker to send
you a check or you can use your margin account debit card. The interest
rate charged is rather low. It is usually 0-2% above the "broker call
rate" (which is usually at or below prime) quoted in the WSJ and other
papers. It can change monthly, and possibly more often, depending on
the details of your margin account agreement. It is probably lower than
the rate on any credit card you'll be able to find. Further, there is
no set payment schedule. Often, you don't even have to pay the
interest. However, your margin account agreement will probably say that
the loan can be called in full at any time by the broker. It will
probably also say that the broker can demand occasional payments of
interest. Your agreement will also give the broker the right to
liquidate any and all securities in your margin account in order to meet
a margin call against you.
The interest rate is so low because the loan is fairly low-risk to the
broker. First, the loan is collateralized by the securities in your
margin account. Second, the broker can call the loan at any time.
Finally, there are rules that set your maximum equity to debt ratio,
which further protects your broker. If you fall below the requirements,
you will have to deposit cash or securities and/or liquidate securities
to get back to required levels.
So you probably understand that it could be useful to get cash out of
your account without having to sell your holdings, but why would you
want to borrow money to buy more securities? Well, the reason is
leverage. Let's say you are really sure that XYZ is going to go up 20%
in 6 months. If you put $10000 into XYZ, and it performs as expected,
you'll have $12000 at the end of six months. However, let's say you not
only bought $10000 of XYZ but bought another $10000 on margin, and paid
8% interest. At the end of 6 months the stock would be worth $24000.
You could sell it and pay off the broker, leaving you with $14000 minus
$400 in interest = $13600 which is a 36% profit on your $10000. This is
significantly better than the 20% you got without margin.
But keep in mind what happens if you are wrong. If the stock goes down,
you are losing borrowed money in addition to your own. If you buy on
margin and the stock drops 20% in 6 months, it'll be worth $16000.
After paying off the debit balance and interest you'd be left with
$5600, a 44% loss as compared to a 20% loss if you only used your own
money. Don't forget that leverage works both ways.
The amount you can borrow depends on the two types of margin
requirements -- the initial margin requirement (IMR) and the maintenance
margin requirement (MMR). The IMR governs how much you can borrow when
buying new securities. The MMR governs what your maximum debit balance
can be subsequently.
The IMR is set by Regulation T of the Federal Reserve Board. It states
the minimum equity to security value ratio that must exist in your
account when buying new securities. Right now it is 50% of marginable
securities. This number has been as low as 40% and as high as 100%
(thus preventing buying on margin). What this means is that your equity
has to be at least 50% of the value of the marginable securities in your
account, including what you just bought. If your equity is less than
this, you have to put up the difference.
The definition of marginable stock varies from one brokerage house to
another. Many consider any listed security priced above $5 to be
marginable, others may use a price threshold of $6, etc.
Let's look at an example. If you have $10000 of marginable stock in
your account and no debit balance [thus you have $10000 in equity --
remember that MARKET VALUE = EQUITY + DEBIT BALANCE, a variant of the
standard accounting equation ASSETS = OWNER'S CAPITAL + LIABILITIES],
and buy $20000 more, your market value including the purchase is $30000.
Your initial required equity is 50% of $30000, or $15000. However, you
only have $10000 in equity, so you have a $5000 equity deficit. You
could send in a check for $5000 and you'd then be properly margined.
Let E and MV be equity and market value immediately after the purchase,
respectively (but before you make arrangements to be properly margined).
Let the equity deficit ED be the difference between the required equity
(which is MV*IMR) and current equity (E). Let E1 and MV1 be equity and
market value, respectively, after making arrangements to be properly
margined. The initial requirement means that E1/MV1 >= IMR. Let C, S,
and L be the amount of a cash deposit, a securities deposit, and a
securities liquidation, respectively.
1. You deposit cash:
E1 = E + C
MV1 = MV
So you need to solve (E+C)/MV >= IMR for C.
2. You deposit securities:
E1 = E + S
MV1 = MV + S
So you need to solve (E+S)/(MV+S) >= IMR for S.
3. You sell securities:
E1 = E
MV1 = MV - L
So you need to solve E/(MV-L) >= IMR for L.
Using ED [which we previously defined as (IMR*MV - E)], the answers are:
1. C = ED
2. S = ED/(1-IMR)
3. L = ED/IMR
If ED is negative (you have more equity than is required), then that
makes C, S, and L negative, meaning that you can actually take out cash
or securities, or buy more securities and still be properly margined.
So, now you know how much you can borrow to buy securities. Having
bought securities there is now a MMR you have to continue to meet as
your market value fluctuates or you pull cash out of your account. The
MMR sets the minimum equity to market value ratio that you can have in
your account. If you fall below this you will get a "margin call" from
your broker. You must meet the call by depositing cash and/or
securities and/or liquidating some securities. If you do not, your
broker will liquidate enough securities to meet the call. The MMR is
set by individual brokers and exchanges. The MMR set by the NYSE is
25%. Most brokers set their MMR higher, perhaps 30% or 35%, with even
higher MMRs on accounts that are concentrated in a particular security.
The MMR calculations are very similar to the IMR calculations. In fact,
just substitute MMR for IMR in the above equations to see what you'll
have to do to meet a margin call. However, here a negative ED does NOT
necessarily imply that you can make withdrawals -- the IMR rules govern
all withdrawals (though the Special Memorandum Account (SMA) adds some
flexibility).
For more details and examples of margin accounts, see the FAQ article
about margin requirements .
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Discount Brokers
Last-Revised: 26 Jul 1998
Contributed-By: Many net.people; compiled by Chris Lott ( contact me )
A discount broker offers an execution service for a wide variety of
trades. In other words, you tell them to buy, sell, short, or whatever,
they do exactly what you requested, and nothing more. Their service is
primarily a way to save money for people who are looking out for
themselves and who do not require or desire any advice or hand-holding
about their forays into the markets. This article focuses on brokers
who accept orders for stock, stock option, and/or futures trades.
Discount brokering is a highly competitive business. As a result, many
of the discount brokers provide virtually all the services of a
full-service broker with the exception of giving you unsolicited advice
on what or when to buy or sell. Then again, some do provide monthly
newsletters with recommendations. Virtually all will execute stock and
option trades, including stop or limit orders and odd lots, on the NYSE,
AMEX, or NASDAQ. Most can trade bonds and U.S. treasuries. Most will
not trade futures; talk to a futures broker. Most have margin accounts
available. Most will provide automatic sweep of (non-margin) cash into
a money market account, often with check- writing capability. All can
hold your stock in "street-name", but many can take and deliver stock
certificates physically, sometimes for a fee. Some trade precious
metals and can even deliver them!
Many brokers will let you buy "no-load" mutual funds for a low (e.g.
0.5%) commission. Increasingly, many even offer free mutual fund
purchases through arrangements with specific funds to pay the commission
for you; ask for their fund list. Many will provide free 1-page
Standard & Poor's Stock reports on stocks you request and 5-10 page full
research reports for $5-$8, often by fax. Some provide touch-tone
telephone stock quotes 24 hours / day. Some can allow you to make
trades this way. Many provide computer quotes and trading; others say
"it's coming".
The firms can generally be divided into the following categories:
1. "Full-Service Discount"
Provides services almost indistinguishable from a full-service
broker such as Merrill Lynch at about 1/2 the cost. These provide
local branch offices for personal service, newsletters, a personal
account representative, and gobs and gobs of literature.
2. "Discount"
Same as "Full-Service," but usually don't have local branch offices
and as much literature or research departments. Commissions are
about 1/3 the price of a full-service broker.
3. "Deep Discount"
Executes stock and option trades only; other services are minimal.
Often these charge a flat fee (e.g. $25.00) for any trade of any
size.
4. Computer or Electronic
Same as "Deep Discount", but designed mainly for computer users
(either dial-up or via the internet). Note that some brokers offer
an online trading option that is cheaper than talking to a broker.
Examples of firms in all categories:
Full-Svc. Discount Discount Deep Discount Computer
Fidelity Aufhauser Brown Datek
Olde Bidwell Ceres E-broker
Quick and Reilly Discover National E-trade
Charles Schwab Scottsdale Pacific JB Online
Vanguard Waterhouse Stock Mart Wall St. Eq.
Jack White Scottsdale
The rest often fall somewhere between "Discount" and "Deep Discount" and
include many firms that cater to experienced high-volume traders with
high demands on quality of service. Those are harder to categorize.
All brokerages, their clearing agents, and any holding companies they
have which can be holding your assets in "street-name" had better be
insured with the S.I.P.C. You're going to be paying an SEC "tax" (e.g.
about $3.00) on any trade you make anywhere , so make sure you're
getting the benefit; if a broker goes bankrupt it's the only thing that
prevents a total loss. Investigate thoroughly!
In general, you need to ask carefully about all the services above that
you may want, and find out what fees are associated with them (if any).
Ask about fees to transfer assets out of your account, inactive account
fees, minimums for interest on non-margin cash balances, annual IRA
custodial fees, per-transaction charges, and their margin interest rate
if applicable. Some will credit your account for the broker call rate
on cash balances which can be applied toward commission costs.
You may have seen that price competition has driven the cost of a trade
below $10 at many web brokers. How can they charge so little?
Discounters that charge deeply discounted commissions either make
markets, sell their order flow, or both. These sources of revenue
enable the cheap commission rates as they profit handsomely from trading
with your order or selling it to another. Market making is the answer.
In contrast, Datek is one of a kind. Datek owns the Island, an
electronic system that functions as a limit order book that gives great
order visibility and crosses orders within it as well as showing them to
the Nasdaq via Level II. Datek charges a fee from Island subscribers to
enter orders into their system. Island is their outside revenue, and is
far superior to selling order flow. Island is good for the customer,
selling order flow like the others is not.
Here are a few sources for additional information:
* The links page on the FAQ web site about trading has links to many
brokerage houses.
http://invest-faq.com/links/trading.html
* "Delving Into the Depths of Deep Discounters," The Wall Street
Journal , Friday, February 3, 1995, pp. C1, C22.
* A free report on a broker's background can be requested from the
National Association of Securities Dealers; phone (800) 289-9999
* An 85 page survey of 85 discount brokers revised each October and
issued each January is available for $34.95 + $3.00 shipping from:
Andre Schelochin / Mercer Inc. / 379 W. Broadway, Suite 400 / New
York, NY 10012 / +1 (212) 334-6212
--------------------Check http://invest-faq.com/ for updates------------------
Compilation Copyright (c) 2005 by Christopher Lott.
Christopher Lott
Version: $Id: part19,v 1.62 2005/01/05 12:40:47 lott Exp lott $
Compiler: Christopher Lott
The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance. This is a plain-text
version of The Investment FAQ, part 19 of 20. The web site
always has the latest version, including in-line links. Please browse
http://invest-faq.com/
Terms of Use
Disclaimers
Please send comments and new submissions to the compiler.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Order Routing and Payment for Order Flow
Last-Revised: 25 Nov 1999
Contributed-By: Bill Rini (bill at moneypages.com), Terence Bergh, Chris
Lott ( contact me ), W. Felder
A common practice among brokerage firms is to route orders to certain
market makers. These market makers then "rebate" 1 to 4 cents per share
back to the brokerage firm in exchange for the flow of orders. These
payments are known as "payment for order flow" (PFOF). (The account
executive does not receive this compensation.) Order routing and PFOF
occurs in stocks traded on the NYSE, AMEX and NASDAQ. NYSE and AMEX
stocks traded away from the exchange are said to be traded "Third
Market."
Payment for order flow has been a mechanism that for many years has
allowed firms to centralize their customers' orders and have another
firm execute them. This allowed for smaller firms to use the economies
of scale of larger firms. Rather than staffing up to handle 1,000,
5,000 or so orders a day, a firm can send it's 1,000 or 5,000 orders to
another firm that will combine this with other firm's orders and in turn
provide a quality execution which most of the time is automated and is
very broad in nature. Orders are generally routed by computer to the
receiving firm by the sending firm so there is little manual
intervention with orders. This automation is an important part of this
issue. Most small firms cannot handle the execution of 3,000 or more
different issues with automation, so they send their orders to those
firms that can.
For example, Firm A can send it's retail agency orders to a NASDAQ
market maker or Third Market dealer (in the case of listed securities)
and not have to have maintain day-in and day-out the infrastructure to
"handle" their orders. In return for this steady stream of retail order
the receiving firm will compensate Firm A for it's relationship. This
compensation will generally come in the form of payment per share. In
the NASDAQ issues this is generally 2 cents, while in NYSE issues its 1
cent per share. Different firms have different arrangements, so what I
have offered is just a rule of thumb.
These "rebates" are the lifeblood of the deep discount brokerage
business. Discount brokerage firms can afford to charge commissions
that barely cover the fixed cost of the trade because of the payments
they receive for routing orders. But understand that payment for order
flow is not limited to discounters, many firms with all types of MO's
use payment for order flow to enhance their revenues while keeping their
costs under control. Also understand that if you require your discount
broker to execute your orders on the NYSE (in the case of listed
securities), you will find that the broker you are using will eventually
ask you to pay more in commissions.
Firms that pay for order flow provide a very important function in our
marketplace today. Without these firms, there would be less liquidity
in lower tier issues and in the case of the Third Market Dealers, they
provide an alternative to a very expensive primary market place i.e.
NYSE and ASE. For example if you take a look at Benard Madoff (MADF)
and learn what their execution criteria is for the 500 to 600 listed
issue that they make a market in, you would be hard pressed to find ANY
difference between a MADF execution and one executed on the NYSE. In
some cases it will even be superior. There are many Third Market Firms
that provide quality execution services to the brokerage community, DE
Shaw, Trimark are two others that do a great job in this field.
However, please realize that the third market community would have a
hard time existing without the quote, size and prints displayed by the
primary exchanges.
The firm that receives payment for its order flow must disclose this
fact to you. It is generally disclosed on the back of your customer
confirmation and regularly on the back of your monthly statement. This
disclosure will not identify the exact amount (as it will vary depending
on the order involved, affected by variables such as the market, limit,
NMS, spread, etc.), but you can contact your broker and ask how much was
received for your order if in fact payment was received for your order.
You will probably get a very confused response from a retail broker
because this matter (the exact amount i.e., 2 cents or 1.5 cents ) will
generally not be disclosed to your individual broker by the firm he/she
is employed by.
It is hard to "tell" if your order has been subject to payment. Look
closely at your confirmation. For example if the indicated market is
NYSE or ASE then you can be rest assured that no other payment was
received by your firm. If the market is something like "other" coupled
with a payment disclosure, your order may in fact be subject to payment.
There are two schools of thought about the quality of execution that the
customer receives when his/her order is routed. The phrase "quality of
execution" means how close was your fill price to the difference between
the bid/ask on the open market. Those who feel that order routing is
not detrimental argue that on the NASDAQ, the market maker is required
to execute at the best posted bid/ask or better. Further, they argue,
many market making firms such as Mayer Schweitzer (a division of Charles
Schwab) execute a surprising number of trades at prices between the
bid/ask. Others claim that rebates and conflict of interest sometimes
have a markedly detrimental affect on the fill price. For a lengthy
discussion of these hazards, read on.
To realize the lowest overall cost of trading at a brokerage firm, you
must thoroughly research these three categories:
1. The broker's schedule of fees.
2. Where your orders are directed.
3. If your NYSE orders are filled by a 19c-3 trading desk.
Category 1 includes "hidden" fees that are the easiest costs to
discover. Say a discount broker advertises a flat rate of $29.00 to
trade up to 5,000 shares of any OTC/NASDAQ stock. If the broker adds a
postage and handling fee of $4.00 for each transaction it boosts the
flat rate to $33.00 (14% higher). Uncovering other fees that could have
an adverse impact on your ongoing trading expenses requires a little
more digging. By comparing your broker's current fees (if any) for
sending out certificates, accepting odd-lot orders or certain types of
orders (such as stops, limits, good-until-canceled, fill-or-kill,
all-or-none) to other brokers' schedules of fees, you'll learn if you're
being charged for services you may not have to pay for elsewhere.
Category 2 is often overlooked. Many investors, especially those who
are newer to the market, are not aware of the price disparities that
sometimes exist between the prices of listed stocks traded on the
primary exchanges (such as the NYSE or AMEX), and the so-called "third
marketplace." The third marketplace is defined as listed stocks that are
traded off the primary exchanges. More than six recent university
studies have concluded that trades on the primary exchanges can
sometimes be executed at a better price than comparable trades done on
the third market.
Although there is nothing intrinsically wrong with the third market, it
may not be in your best interest for a broker to route all listed orders
to that marketplace. If you can make or save an extra eighth of a point
on a trade by going to the primary exchange, that's where your order
should be directed. After all, an eighth of a point is $125.00 for each
1,000 shares traded.
Here's how the third market can work against you: Say you decide to
purchase 2,000 shares of a stock listed on the NYSE. The stock
currently has a spread of 21 to 21 1/4. Your order, automatically
routed away from the NYSE to the third market, is executed at 21 1/4.
Yet at the NYSE you could have gone in-between the bid-ask and gotten
filled at 21 1/8, a savings of $250.00.
Only a few of the existing deep discount brokers will route your listed
stock orders to the primary exchanges. Most won't as a matter of
business practice even if asked to do so. The only way to be sure that
your listed stock orders are being filled on the primary exchanges is to
carefully scrutinize your confirmations. If your confirmation does not
state your listed order was filled on the NYSE or AMEX then it was
executed on the third market.
You run the greatest risk of receiving a bad fill -- or sometimes
missing an opportunity completely -- whenever you trade any of the
stocks added to the NYSE since April 26, 1979, and your trade is routed
away from the primary exchange onto the third market. Almost all AMEX
stocks run this risk.
Category 3 was understood only by the most sophisticated of investors
until recently. A 19c-3 trading desk is a (completely legal) method of
filling NYSE orders in-house, without exposing the orders to the public
marketplace at all. Yes, you'll get your orders filled, but not
necessarily at the best prices. NYSE stocks listed after April 26,
1979, sector funds (primarily "country" funds such as the Germany Fund
or Brazil Fund), and publicly-traded bond funds are the securities
traded at these in-house desks. Recently, the NYSE approached the
Securities Exchange Commission asking that Rule 19c-3, that allows this
trading practice, be repealed. Edward Kwalwasser, the NYSE's regulatory
group executive vice president stated flatly that, "The rule hasn't done
what the Commission thought it would do. In fact, it has become a
disadvantage for the customer."
Here's a scenario that helps explain the furor that has developed over
the 19c-3 wrinkle. Let's say that XYZ stock is trading with a spread of
9 1/2 to 9 3/4 per share on the floor of the NYSE. An investor places
an order to buy the stock and the broker routes that order away from the
NYSE to the internal 19c-3 desk. The problem emerges when the order
reaches this desk, namely that the order is not necessarily filled at
the best price. The desk may immediately fill it from inventory at 9
3/4 without even attempting to buy it at 9 5/8 for the customer's
benefit -- this is the spread's midpoint on the floor of the exchange.
Then, after filling the customer's order internally, the firm's trader
may then turn around and buy the stock on the exchange, pocketing the
extra 12 1/2 cents per share for the firm. Project this over millions
of shares per year and you can get an idea of the extra profits some
brokers are squeezing out at the expense of their trusting, but
ignorant, customers.
You can most likely resolve this dilemma between low commissions and
quality of execution by examining the volume of trades you do. If you
buy a few shares of AT&T once a year for your children, then the
difference in fees between a trade done by a discount broker as compared
to a full-service wire house will most likely dominate an 1/8 or even a
1/4 improvement in the fill price. However, if you work for Fidelity
(why are you reading this?) and regularly trade large amounts, then you
certainly have negotiated nicely reduced commissions for yourself and
care deeply about getting a good fill price.
Finally, the whole issue may become much less important soon. Under the
new rules for handling limit orders on the NASDAQ market, payment for
order flow is becoming more and more burdensome on execution firms.
With the advent of day trading, specialty firms that use the NASDAQ's
SOES execution system, along with other systems to "game" the market
makers, the ability of firms to pay others for their orders is becoming
increasingly difficult. This "gaming" of the market place is due to
different trading rules for different market participants (this issue by
itself can take hours to explain and has many different viewpoints).
Many firms have discontinued paying for limit orders as they have become
increasingly less profitable than market orders.
As of November 1999, the Wall Street Journal that payment for order flow
is a practice that is dying out fairly rapidly.
Note: portions of this article are copyright (c) 1996 by Terrence Bergh,
and are taken from an article that originally appeared in Personal
Investing News, March 1995.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Day, GTC, Limit, and Stop-Loss Orders
Last-Revised: 5 May 1997
Contributed-By: Art Kamlet (artkamlet at aol.com)
Day/GTC orders, limit orders, and stop-loss orders are three different
types of orders you can place in the financial markets. This article
concentrates on stocks. Each type of order has its own purpose and can
be combined.
* Day and GTC orders:
An order is canceled either when it is executed or at the end of a
specific time period. A day order is canceled if it is not
executed before the close of business on the same day it was
placed. You can also leave the specific time period open when you
place an order. This type of order is called a GTC order (good
'til cancelled) and has no set expiration date.
* Limit orders:
Limit orders are placed to guarantee you will not sell a stock for
less than the limit price, or buy for more than the limit price,
provided that your order is executed. Of course, you might never
buy or sell, but if you do, you are guaranteed that price or
better.
For example, if you want to buy XYZ if it drops down to $30, you
can place a limit buy @ $30. If the price falls to $30 the broker
will attempt to buy it for $30. If it goes up immediately
afterwards you might miss out. Similarly you might want to sell
your stock if it goes up to $40, so you place a limit sell @ $40.
* Stop-loss orders:
A stop-loss order, as the name suggests, is designed to stop a
loss. If you bought a stock and worry about it falling too low,
you might place a stop-loss sell order at $20 to sell that stock
when the price hits $20. If the next trade after it hits $20 is 19
1/2, then you would sell at 19 1/2. In effect the stop loss sell
turns into a market order as soon as the exchange price hits that
figure.
Note that the NASDAQ does not officially accept stop loss orders
since each market maker sets his own prices. Which of the several
market makers would get to apply the stop loss? However, many
brokers will simulate stop-loss orders on their own internal
systems, often in conjunction with their own market makers. Their
internal computers follow one or perhaps several market makers and
if one of them quotes a bid which trips the simulated stop order,
the broker will enter a real order (perhaps with a limit - NASDAQ
does recognize limits) with that market maker. Of course by that
time the price might have fallen, and if there was a limit it might
not get filled. All these simulated stop orders are doing is
pretending they are entering real stops (these are not official
stop loss orders in the sense that a stock exchange stop order is),
and some brokers who work for the firms that offer this service
might not even understand the simulation issue.
If you sell a stock short, you can protect yourself against losses
if the price goes too high using a stop-loss order. In that case
you might place a stop-loss buy order on the short position, which
turns into a market order when the price goes up to that figure.
Example:
Let's combine a stop loss with a limit sell and a day order.
XYZ - Stop-Loss Sell Limit @ 30 - Day Order Only
The day order part is simple -- the order expires at the end of the day.
The stop-loss sell portion by itself would convert to a sell at market
if the price drops down to $30. But since it is a stop-loss sell limit
order, it converts to a limit order @ $30 if the price drops to $30.
It is possible the price drops to 29 1/2 and doesn't come back to $30
and so you never do sell the stock.
Note the difference between a limit sell @ $30 and a stop-loss sell
limit @ $30 -- the first will sell at market if the price is anywhere
above $30. The second will not convert to a sell order (a limit order
in this case) until the price drops to $30.
You can also work these same combinations for short sales and for
covering losses of short stock. Note that if you want to use limit
orders for the purpose of selling stock short, there is an exchange
uptick rule that says you cannot short a stock while it is falling - you
have to wait until the next uptick to sell. This is designed to prevent
traders from forcing the price down too quickly.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Pink Sheet Stocks
Last-Revised: 2 Sep 1999
Contributed-By: Art Kamlet (artkamlet at aol.com)
A company whose shares are traded on the so-called "pink sheets" is
commonly one that does not meet the minimal criteria for capitalization
and number of shareholders that are required by the NASDAQ and OTC and
most exchanges to be listed there. The "pink sheet" designation is a
holdover from the days when the quotes for these stocks were printed on
pink paper. "Pink Sheet" stocks have both advantages and disadvantages.
Disadvantages:
1. Thinly traded. Can make it tough (and expensive) to buy or sell
shares.
2. Bid/Ask spreads tend to be pretty steep. So if you bought today
the stock might have to go up 40-80% before you'd make money.
3. Market makers may be limited. Much discussion has taken place in
this group about the effect of a limited number of market makers on
thinly traded stocks. (They are the ones who are really going to
profit).
4. Can be tough to follow. Very little coverage by analysts and
papers.
Advantages:
1. Normally low priced. Buying a few hundred share shouldn't cost a
lot.
2. Many companies list in the "Pink Sheets" as a first step to getting
listed on the National Market. This alone can result in some price
appreciation, as it may attract buyers that were previously wary.
In other words, there are plenty of risks for the possible reward, but
aren't there always?
The National Quotation Bureau maintains the list of pink-sheet stocks.
Their site gives the history of the pink-sheet listing service and
information about real-time quotes for OTC issues.
http://www.nqb.com/
Online quotes are offered by the National Quotation Bureau for
registered users only.
http://www.otcquote.com/
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Price Improvement
Last-Revised: 26 Feb 1997
Contributed-By: John Schott (jschott at voicenet.com), Chris Lott (
contact me )
In a nutshell, price improvement means that your broker filled an order
at a price better than you might have expected from the bid and asked
prices prevailing at the time you placed the order. More concretely,
you were able to pay less than the asked price if you bought, and you
received better than the bid price if you sold. Two of the ways that
this happens imply extra work by your broker, the third is just luck.
First, a market order may be filled inside the spread. For example, a
market order for 100 sh of IBM means that your broker should just buy
the shares for you at the current asking price. If the price you pay is
less than the current asking price, you experienced price improvement
Second, a limit order may be filled better than the limit. For example,
if you wanted to buy 100 sh of IBM at a maximum price of 150, and you
were filled at 149 7/8, that's price improvement also.
And third, the market may simply have moved in your favor during the
time it took to route your order to the exchange, resulting in a lucky
saving for you.
Price improvement is extremely important to people who frequently trade
large blocks of stocks. These people care more about superior
executions (i.e., price improvement) than the brokerage house's
commission. After all, a 1/8-point improvement on a 1000-share trade
makes a $125 difference. So beware saving a penny on the commission and
losing a pound on the execution price.
It is difficult for the small investor to determine independently
whether his or her order was filled with price improvement or not. (I'm
assuming that the average small investor doesn't have access to a
live/delayed data feed.) However, there are several sources on the net
for intraday price charts that may help you analyze your fills. On a
lightly traded stock, spotting you own trade crossing the tape is easy -
and a minor thrill.
In theory, when you place an order with a broker, the broker should
search all possible places (be they markets or market makers) to get the
best possible execution price for you. This is especially true with
NASDAQ, where a host of market makers may trade in a given stock. In
fact, many brokers (especially discounters or so-called "introducing
brokers") simply dump their order on another firm for execution. This
broker may not be so diligent in checking out all possible sources, due
to a custom called "Payment for Order Flow" (PFOF). PFOF is a small
(typically $0.03-0.06/share) payment made by the executing broker to the
your broker for the privilege of handling the order. If you think about
it, the money can only come from someone's pocket - and it might be from
yours via a less than top-flight execution.
For many stocks, remember that there are a lot of places it may trade
beyond the exchange it is listed on. Some large firms are trade on
exchanges from Tokyo to London. Domestically, the same is true. For
example, the Philadelphia stock exchange specialists make a market
(i.e., offer quotes) on any stock listed on the NYSE. And then there
are alternate (mostly electronic markets), like Reuters' Instinet.
Moreover, big brokers often have a small inventory of actively traded
stocks they make a market in and can effectively cut-off (cross) an
order before it hits the exchanges. A brokerage house can also program
its computer to recognize when two orders flowing in from their regional
offices make a pairing that can be summarily crossed. Generally, the
broker keeps the spread, but some brokers give the advantage to the
customer. Most notable in this respect is Schwab's new "no spread"
trading system which crosses customer orders for participants. Instead
of executing your order on the normal markets immediately, Schwab routes
it to their "waiting room". If there is another order there that mates
with yours the trade is immediate - if not, you sit there until that
mating order shows up. In either case, Schwab takes its commission and
splits the spread with the two customers. It remains to be seen how
well this idea works. Evaluating the potential for a delayed trade and
the price volatility of the stock itself versus the spread savings will
make it difficult for an individual to decide whether to participate.
Due to the need for speed, your broker might be more interested in
moving the order (and generating some PFOF revenue) than delaying the
trade while looking around for a better price. For example, if you are
trying to beat an anticipated market move, paying an extra 1/8th to get
immediate execution can be a good investment.
Some regular and discount brokerage houses now advertise that they
automatically attempt price improvement on all orders placed with them.
One small West Coast discounter recently advertised that about 38% of
its order flow achieved price improvement.
All this discussion shows that price improvement requires a little more
work (and perhaps a little less profit) for the dealing brokers when
compared to straight trading. It also shows that you should understand
your broker's normal practice when you consider how and where to place
your orders.
Related topics include the recent SEC-NASDAQ settlement.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Process Date
Last-Revised: 23 Oct 1997
Contributed-By: Art Kamlet (artkamlet at aol.com), Chris Lott ( contact
me )
Transaction notices from any broker will generally show a date called
the process date. This is when the trade went through the broker's
computer. This date is nearly always the same as the trade date, but
there are exceptions. One exception is an IPO; the IPO reservation
could be made a week in advance and until a little after the IPO has
gone off, the broker might not know how many shares his firm was
allocated so doesn't know how many shares a buyer gets. A day or two
after the IPO has gone off, things might settle down. (The IPO
syndicate might be allowed to sell say 10% more shares than obligated to
sell - and might sell those even after the IPO date "as of" the IPO
date.) So a confirmation might list a trade date that is two days before
the process date. Other times the broker might have made an error and
admit to it, and so correct it "as of" the correct date. So the
confirmation slip might show August 15 as the process date of a trade
"as of" a trade date of August 12. It happens.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Round Lots of Shares
Last-Revised: 21 Mar 1998
Contributed-By: Art Kamlet (artkamlet at aol.com), buddyryba at
pipeline.com, Uncle Arnie (blash404 at aol.com)
There are some advantages to buying round lots, i.e., multiples of 100
shares, but if they don't apply to you, then don't worry about it.
Possible limitations on odd lots (i.e., lots that are not multiples of
100) are the following:
* The broker might add 1/8 of a point to the price -- but usually the
broker will either not do this, or will not do it when you place
your order before the market opens or after it closes.
* Some limit orders might not be accepted for odd lots.
* If these shares cover short calls, you usually need a round lot.
* If you want to write covered calls, you'll need a round lot. Other
than that, there's just nothing magic about selling 100 shares or 59
shares or any other number.
Don't be concerned that your order to buy or sell 59 shares won't be
considered until all 100-share orders are run. Your order doesn't just
sit there waiting for an exact match on stocks that trade actively.
Your order will likely just be swept into the specialist/market
makers/brokers trading account along with other items.
If you're buying very small numbers of stocks priced under $100 or so,
your biggest problem is to find a broker who will bother with the order
and give reasonable commission. The discounters may not touch the small
order or charge more - and a lot of bigger firms have minimum
commissions of $35 - 75 or so. Many firms want a minimum size account
to open one, too.
If you're trading penny stocks (commonly defined as having a price under
$5 per share), there may be additional restrictions. For example, one
reader reports that on the Toronto exchange, a round lot for an issue
priced under CDN$1 is 500 shares.
This seems like a good place to mention the terminology for very big
orders. Block trades are large trading orders (very round lots?), where
large is defined by the stock exchange. On the NYSE, a block trade is
any transaction in which 10,000 shares or more of a single stock are
traded, or a transaction with a value of $200,000 and up.
So why does an investor still hear so much about odd lots? Well, once
upon a time, there was a difference. At that time, if you wanted to
sell 100 shares, your order would be forwarded to an NYSE or AMEX floor
broker, who would then trek over to the trading area for that particular
stock and try to find a buyer. If you wanted to sell only 50 shares,
the floor broker would instead hoof it over to an odd lot broker. If
you were in a hurry and specified "no print," the odd lot broker would
buy the 50 shares at one eighth of a point below the posted bid price
for the stock. Otherwise, the trade would go through at one eighth off
the next trade (one quarter point if over $40/share). But all this is
ancient history.
The "odd lot differential" of one eighth or one quarter of a point was
one of the ways that the odd lot broker made money. But these days,
there are no odd lot brokers--and hence no odd lot differentials. Small
stock trades, whether for 50 shares or 100 shares, are handled by
computer rather than by people.
The only thing that's left of the odd lot broker system is a reluctance
by many people to place orders for less than 100 shares. At one time,
these orders were subject to the odd lot differential, so people learned
to avoid them whenever possible. The notion that orders of less than
100 shares were bad entered the investment world's folk lore, and like
many other sorts of folk wisdom, it has a remarkable ability to persist
even though it is no longer justified by the facts.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Security Identification Systems
Last-Revised: 8 Aug 2000
Contributed-By: Chris Lott ( contact me ), Peter Andersson (peter at
ebiz.com.sg)
This article lists some of the identification systems used to assign
unique numbers to securities that are traded on the various exchanges
around the world.
* CUSIP
A numbering system used to identify securities issued by U.S. and
Canadian companies. Every stock, bond, and other security has a
unique, 9-digit CUSIP number chosen according to this system. The
first six digits identify the issuer (e.g., IBM); the next two
identify the instrument that was issued by IBM (e.g., stock, bond);
and the last digit is a check digit. The system was developed in
the 1960's by the Committee on Uniform Security Identification
Procedures (CUSIP), which is part of the American Banker's
Association. For a full history and all the gory details of the
numbering system, see their web site:
http://www.cusip.com
* CINS
The CUSIP International Numbering System (CINS) is a close cousin
to CUSIP. Like CUSIP, it is a 9-digit numbering scheme that is
used by the US finance industry. Unlike CUSIP, the numbers are
used to identify securities that are traded or issued by companies
outside the US and Canada.
* EPIC
Commonly used on the UK stock market.
* ISID
The International Securities Identification Directory (ISID) is a
cross reference for the many different identification schemes in
use. ISID Plus seems to be an expanded version of ISID (allowing
more characters in the identifier).
* ISIN
An International Securities Identification Number (ISIN) code
consists of an alpha country code (ISO 3166) or XS for securities
numbered by CEDEL or Euroclear, a 9-digit alphanumeric code based
on the national securities code or the common CEDEL/Euroclear code,
and a check digit.
The Association of National Numbering Agencies (ANNA) makes
available International Securities Identification Numbers (ISIN) in
a uniform structure. More information is available at:
http://www.anna-nna.com/
* QUICK
A numbering system used in Japan (anyone know more?).
* RIC
Reuters Identification Code, used within the Reuters system to
identify instruments worldwide. Contains an X character market
specific code (can be the CUSIP or EPIC codes) followed by .YY
where YY stand for the two digit country code. i.e IBM in UK would
be IBM.UK. More information is available at http://www.reuters.com
* SEDOL
Stock Exchange Daily Official List. The stock code used to
identify all securities issued in the UK or Eire. This code is the
basis of the ISIN code for UK securities and consists of a 7-digit
number allocated by the master file service of the London Stock
Exchange.
* SICOVAM
A 5-digit code allocated to French securities (Socie'te'
Interprofessionelle pour la Compensation des Valeurs Mobili`eres).
* Valoren
Telekurs Financial, the Swiss numbering agency, assigns Valoren
numbers to identify financial instruments. This seems to be the
CUSIP of Switzerland. For much more information, visit the
handbook of world stock, derivative and commodity exchanges
(subscription required):
http://www.exchange-handbook.co.uk/
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Shorting Stocks
Last-Revised: 9 Mar 2000
Contributed-By: Art Kamlet (artkamlet at aol.com), Rich Carreiro (rlcarr
at animato.arlington.ma.us)
Shorting means to sell something you don't own.
If I do not own shares of IBM stock but I ask my broker to sell short
100 shares of IBM I have committed shorting. In broker's lingo, I have
established a short position in IBM of 100 shares. Or, to really
confuse the language, I hold 100 shares of IBM short.
Why would you want to short?
Because you believe the price of that stock will go down, and you can
soon buy it back at a lower price than you sold it at. When you buy
back your short position, you "close your short position."
The broker will effectively borrow those shares from another client's
account or from the broker's own account, and effectively lend you the
shares to sell short. This is all done with mirrors; no stock
certificates are issued, no paper changes hands, no lender is identified
by name.
My account will be credited with the sales price of 100 shares of IBM
less broker's commission. But the broker has actually lent me the stock
to sell. No way is he going to pay interest on the funds from the short
sale. This means that the funds will not be swept into the customary
money-market account. Of course there's one exception here: Really big
spenders sometimes negotiate a full or partial payment of interest on
short sales funds provided sufficient collateral exists in the account
and the broker doesn't want to lose the client. If you're not a really
big spender, don't expect to receive any interest on the funds obtained
from the short sale.
If you sell a stock short, not only will you receive no interest, but
also expect the broker to make you put up additional collateral. Why?
Well, what happens if the stock price goes way up? You will have to
assure the broker that if he needs to return the shares whence he got
them (see "mirrors" above) you will be able to purchase them and "close
your short position." If the price has doubled, you will have to spend
twice as much as you received. So your broker will insist you have
enough collateral in your account which can be sold if needed to close
your short position. More lingo: Having sufficient collateral in your
account that the broker can glom onto at will, means you have "cover"
for your short position. As the price goes up you must provide more
cover.
When you short a stock you are essentially creating a new shareholder.
The person who held the shares in a margin account (the person from whom
the broker borrowed the shares on the short seller's behalf) considers
himself or herself a shareholder, quite justifiably. The person who
bought the (lent) shares from the the short seller also considers
himself or herself a shareholder. Now what happens with the dividend
and the vote? The company sure as heck isn't going to pay out dividends
to all of these newly created shareholders, nor will it let them vote.
It's actually fairly straightforward.
If and when dividends are paid, the short seller is responsible for
paying those dividends to the fictitious person from whom the shares
were borrowed. This is a cost of shorting. The short seller has to pay
the dividend out of pocket. Of course the person who bought the shares
might hold them in a margin account, so the shares might get lent out
again, and so forth; but in the end, the last buyer in the chain of
borrowing and shorting transactions is the one who will get the dividend
from the company Tax-wise, a short seller's expense of paying a dividend
to the lender is treated as a misc investment expense subject to the 2%
of AGI floor. It does not affect basis (though I believe there is an
exception that if a short position is open for 45 days or less, any
dividends paid by the short seller are capitalized into basis instead of
being treated as an investment expense -- check the latest IRS Pub 550).
Voting of shares is also affected by shorting. The old beneficial owner
of a share (i.e., the person who lent it) and the new beneficial owner
of the share both expect to cast the vote, but that's impossible--the
company would get far more votes than shares. What I have heard is that
in fact the lender loses his chance to vote the shares. The lender
doesn't physically have the shares (he's not a shareholder of record)
and the broker no longer physically has the shares, having lent them to
the short seller (so the broker isn't a shareholder of record anymore,
either). Only a shareholder-of-record can vote the shares, so that
leaves the lender out. The buyer, however, does get to vote the shares.
Implicit in this is that if you absolutely, positively want to guarantee
your right to vote some shares, you need to ask your broker to journal
them into the cash side of your account in time for the record date of
the vote. If a beneficial owner whose broker lent out the shares
accidentally receives the proxy materials (accidentally because the
person is not entitled to them), the broker should have his computers
set up to disallow that vote.
Even if you hold your short position for over a year, your capital gains
are taxed as short-term gains.
A short squeeze can result when the price of the stock goes up. When
the people who have gone short buy the stock to cover their previous
short-sales, this can cause the price to rise further. It's a death
spiral - as the price goes higher, more shorts feel driven to cover
themselves, and so on.
You can short other securities besides stock. For example, every time I
write (sell) an option I don't already own long, I am establishing a
short position in that option. The collateral position I must hold in
my account generally tracks the price of the underlying stock and not
the price of the option itself. So if I write a naked call option on
IBM November 70s and receive a mere $100 after commissions, I may be
asked to put up collateral in my account of $3,500 or more! And if in
November IBM has regained ground and is at $90, I would be forced to buy
back (close my short position in the call option) at a cost of about
$2000, for a big loss.
Selling short is seductively simple. Brokers get commissions by showing
you how easy it is to generate short term funds for your account, but
you really can't do much with them. My personal advice is if you are
strongly convinced a stock will be going down, buy the out-of-the-money
put instead, if such a put is available.
A put's value increases as the stock price falls (but decreases sort of
linearly over time) and is strongly leveraged, so a small fall in price
of the stock translates to a large increase in value of the put.
Let's return to our IBM, market price of 66 (ok, this article needs to
be updated). Let's say I strongly believe that IBM will fall to, oh, 58
by mid-November. I could short-sell IBM stock at 66, buy it back at 58
in mid-November if I'm right, and make about net $660. If instead it
goes to 70, and I have to buy at that price, then I lose net $500 or so.
That's a 10% gain or an 8% loss or so.
Now, I could buy the IBM November 65 put for maybe net $200. If it goes
down to 58 in mid November, I sell (close my position) for about $600,
for a 300% gain. If it doesn't go below 65, I lose my entire 200
investment. But if you strongly believe IBM will go way way down, you
should shoot for the 300% gain with the put and not the 10% gain by
shorting the stock itself. Depends on how convinced you are.
Having said this, I add a strong caution: Puts are very risky, and
depend very much on odd market behavior beyond your control, and you can
easily lose your entire purchase price fast. If you short options, you
can lose even more than your purchase price!
One more word of advice. Start simply. If you never bought stock start
by buying some stock. When you feel like you sort of understand what
you are doing, when you have followed several stocks in the financial
section of the paper and watched what happens over the course of a few
months, when you have read a bit more and perhaps seriously tracked some
important financials of several companies, you might -- might -- want to
expand your investing choices beyond buying stock. If you want to get
into options (see the article on options ), start with writing covered
calls. I would place selling stock short or writing or buying other
options lower on the list -- later in time.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Shorting Against the Box
Last-Revised: 5 Jul 1998
Contributed-By: Rich Carreiro (rlcarr at animato.arlington.ma.us)
This article discusses a strategy that once helped investors delay a
taxable event with relative ease. Revisions made to the tax code by the
act of 1997 effectively eliminated the "Short Against The Box" strategy
as of July 27, 1997 (although not totally - see the bottom of this
article for a caveat).
Shorting-against-the-box is the act of selling short securities that you
already own. For example, if you own 200 shares of FON and tell your
broker to sell short 200 shares of FON, you have shorted against the
box. Note that when you short against the box, you have locked in your
gain or loss, since for every dollar the long position gains, the short
position will lose and vice versa.
An alternative way to short against the box is to buy a put on your
stock. This may or may not be less expensive than doing the short sale.
The IRS considers buying a put against stock the same as shorting
against the box.
The name comes from the idea of selling short the same stock that you
are holding in your (safety deposit or strong) box. The term is
somewhat meaningless today, with so many people holding stock in street
name with their brokers, but the term persists.
The obvious way to close out any short-against-the-box position is to
buy to cover the short position and to sell off the long. This will
cost you two commissions. The better way is to simply tell your broker
to deliver the shares you own to cover the short. This transaction is
free of commission at some brokers.
The sole rationale for shorting-against-the-box is to delay a taxable
event. Let's say that you have a big gain on some shares of XYZ. You
think that XYZ has reached its peak and you want to sell. However, the
tax on the gain may leave you under-withheld for the year and hence
subject to penalties. Perhaps next year you will make a lot less money
and will thus be in a lower bracket and therefore would rather take the
gain next year. Or maybe you have some other reason.
Or perhaps you think, "This is great! I have a stock that I've held for
9 months but I think it has peaked out. Now I can lock in my gain, hold
it for 3 more months, and then get a long-term gain instead of a
short-term gain, saving me a bundle in taxes!"
Bzzt. The answer is absolutely NOT! Unfortunately, the IRS has already
thought of this idea and has set the rules up to prevent it. From IRS
Publication 550:
If you held property substantially identical to the property
sold short for one year or less on the date of short sale or
if you acquire property substantially identical to the
property sold short after the short sale and on or before the
date of closing the short sale, then:
* Rule 1. Your gain, if any, when you close the short sale
is a short-term capital gain; and
* Rule 2. The holding period of the substantially
identical property begins on the date of the closing of
the short sale or on the date of the sale of this
property, whichever comes first.
So if you have held a stock for 11 months and 25 days and sell short
against the box, not only will you not get to 12 months, but your
holding period in that stock is zeroed out and will not start again
until the short is closed. Note that your holding period is not
affected if you are already holding the stock long-term.
The 1997 revisions to the tax code define (or extend) the idea of
"constructive sales." A constructive sale is a set of transactions which
removes one's risk of loss in a security even if the security wasn't
actually disposed of. Shorting against the box as well as certain
options and futures transactions are defined as being constructive
sales. And any constructive sale is interpreted as being the same as a
real sale, which is why this strategy is no longer effective (don't you
hate it when the rules change in the middle of the game?).
For those who have read this far, there does appear to be a small
loophole in the 1997 revisions that permit shorting against the box to
delay a taxable event. If you have a short against the box position and
then buy in the short within 30 days of the start of the tax year and
leave the long position at risk for at least 60 days before ofsetting it
again, the constructive sales rules do not apply. So it appears that
you can continue shorting against the box to defer gains, but you have
to temporarily cover the short and be exposed for at least 60 days at
the beginning of each and every year.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Size of the Market
Last-Revised: 26 Apr 1997
Contributed-By: Timothy M. Steff (tim at navillus.com), Chris Lott (
contact me )
The "size of the market" refers to the number of shares that a
specialist or market maker is ready to buy or sell. This number is
quoted in round lots of 100 shares; i.e., the last two zeros are
dropped. The size of the market information is supplied with a quote on
professional data systems. For example, if you get a quote of "bid 10,
offer 10 1/4, size 10 X 10" this means that the person or company is
willing to buy 10 round lots (i.e., 1,000 shares) at 10, or sell you
1,000 shares at 10 1/4.
Specialists report size, they do not create it. It seems that different
specialists report the size in approximately three ways:
1. Some are very precise; if a quote is 10x10 and 100 trades the
offer, the size then becomes 10x9.
2. Some use what seems to be a convention number. That is if there
the size is 50x100 the specialist is reporting at least 5,000
shares bid but less than 10,000, and at least 10,000 shares offered
but less than 25,000.
3. Some seem to have no discernable method as the trading seems to be
unrelated to the reported size. Thousands of shares trade the bid,
the price and size remain the same, for example. The floor brokers
in front of the specialist may be more important than the specialist in
this regard; the specialist is not necessarily a party to the trade as
is an OTC market-maker; the brokers may or may not put their orders into
the specialists' limit order book, or may cancel their orders in the
book later. The floor brokers are able to change the size by bidding
and offering, and cancelling existing orders, thereby affecting how
others trade.
On the NASDAQ, which is not an auction market, size is usually reported
as 500 X 500.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Tick, Up Tick, and Down Tick
Last-Revised: 27 Aug 1999
Contributed-By: Chris Lott ( contact me )
The term "tick" refers to a change in a stock's price from one trade to
the next (but see below for more). Really what's going on is that a
comparison is made between trades reported on the ticker. If the later
trade is at a higher price than the earlier trade, that trade is known
as an "uptick" trade because the price went up. If the later trade is
at a lower price than the earlier trade, that trade is known as a
"downtick" trade because the price went down.
On a traditional stock exchange like the NYSE, there is a single
specialist for each stock, so this measure can be calculated based on
the trade data. On the NASDAQ, the tick measure is calculated based on
the trades reported (which might well be out of order, delayed, etc.)
Something called the "tick indicator" is a market indicator that tries
to gauge how many stocks are moving up or down in price. The tick
indicator is computed based on the last trade in each stock.
Note that certain transactions, namely shorting a stock, can only be
executed on an up tick, so this measure is used to regulate the markets
(it's not just of academic curiosity). Interestingly, on the NASDAQ,
the restriction on short sales is not done based on the tick but rather
based on the change in the BID on a stock; i.e., from the stream of bid
data. All Market Makers and ECN's who trade on NASDAQ have their change
in bids reported one at a time. For example, if a NASDAQ issue trades
at 100 then next trades at 101 but at the same time the bid goes from
101 to 100 15/16, that would cause a down tick for the purpose of
regulating short sales. The last trade was higher than the trade before
(so the traditional tick indicator is positive), but a drop in the bid
from 101 to 100 15/16 caused the would result in short sales being
prohibited.
The Wall Street Journal publishes a short tick indicator table daily
with the UP/DOWN cumulative ticks (tick-volume) for selected (i.e.,
leading) stocks.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Transferring an Account
Last-Revised: 9 Jan 1997
Contributed-By: anonymous; please contact Chris Lott ( contact me )
Transferring an account from one brokerage house to another is a simple,
painless process. The process is supported by the Automated Customer
Account Transfer (ACAT) system. To transfer your account, you fill out
an ACAT form in cooperation with your new broker. The new broker will
generally require a copy of your statements from the old brokerage
house, plus some additional proof of identity. The transfer will be
made within about 5-10 business days for regular accounts, and 10-15
business days for IRA and other types of qualified retirement accounts.
The paperwork starts the process, but thereafter it's all done
electronically.
There is one caveat. Some brokerage houses charge fees as high as $50
to close IRA accounts. Other houses (Quick & Reilly is one) will
reimburse you some fixed amount to cover those fees. Be sure to ask,
the answer may delight you.
--------------------Check http://invest-faq.com/ for updates------------------
Compilation Copyright (c) 2005 by Christopher Lott.
Christopher Lott
Version: $Id: part20,v 1.4 2005/01/05 12:40:47 lott Exp lott $
Compiler: Christopher Lott
The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance. This is a plain-text
version of The Investment FAQ, part 20 of 20. The web site
always has the latest version, including in-line links. Please browse
http://invest-faq.com/
Terms of Use
Disclaimers
Please send comments and new submissions to the compiler.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Can You Trust The Tape?
Last-Revised: 10 July 1999
Contributed-By: John Schott (jschott at voicenet.com), Chris Lott (
contact me )
Considering that there is big money involved in every trade, it is no
wonder that a great deal of effort is made to insure the accuracy and
completeness of each day's trading records. Yet despite this effort,
there are cases where the trading tape you see on your computer,
intraday charts, and in end-of-day data is not really telling a totally
accurate story.
To settle each day's trading obligations (shares and/or money), each
brokerage maintains a large "back office" function to ensure that each
trade is accurately recorded and reported. In fact, months after,
Standard and Poors publishes large reference volumes that list the
official day's prices (Open,-High,-Low,-Close) and volume for each
security traded on the NYSE, AMEX, and NASDAQ. Yet, the contemporaneous
data you get from your Internet or other data provider may not reflect
just what happened on any given day.
What can go wrong with the data? The answer is that a variety of
factors, some of them mistakes, can put bad or misleading data into the
stream. Consider the following cases.
1. After-hours trading
Transactions after hours (trades marked .T and "as of" trades) are
generally not included in the price and volume information that is
published daily. On the NASDAQ, volume data for after-hours
trading is integrated into the statistical record next day with a
24 hour cut-off. Price data for after-hours trading is not
integrated into the statistical record. Volume data reported
outside of 24 hours and price data are recorded for surveillance
purposes only.
2. Out of order reporting
On the NYSE and AMEX, there is only one specialist to report
orders. On the NASDAQ, the floor is spread electronically over the
world. So time stamped execution reports don't necessarily flow
into the reporting systems in order. Sometimes there is an
advantage for participants in delaying a report beyond the
exchange-mandated minimums - for example, when someone is urgently
trying to move a big block quietly. But most of the problems are
simply due to the chaos that is the exchange day.
Stocks trade everywhere - on multiple worldwide exchanges, on
electronic exchanges, at brokerage houses, and if two of us want,
behind the local hamburger joints just after the 2am close. Many
years ago, when this diffusing trend started, the NYSE made it a
rule that any trading by any member firm had to be reported on the
exchange even if the trade was executed elsewhere. And that rule
applies today. So the Merrill Lynch office in Tokyo, Rome or
London can handle a trade on one if the local markets in IBM, while
the traders in New York are still sound asleep - and report that in
hours (days) later.
Eventually those trades, and others crossed in local offices of
exchange members, filter onto the NYSE tape at some time during the
trading day. This would also be true of trades crossed by the
Merrill Lynch office in Dallas during NYSE hours. Those trades
make the tape sometime - but not always in order of trading or
nearly in real time. And these trades may appear potentially
outside the boundaries of the exchange-mandated maximum delay.
Trades in Nasdaq listed securities by foreign broker/dealers that
are not NASD members are outside NASD/Nasdaq jurisdiction and would
not be reported except if they involved some organization that had
a trade reporting requirement under U.S. securities regulations.
Some firms exist specifically to provide the large trader with
discrete private placements which largely go unreported.
If you are confused, consider the poor specialist who arrives early
only to find a variety of trade reports from Tokyo to London that
don't match yesterdays prices nor the orders on his book - where do
you open the stock? (See the article "Trading - Opening Price"
elsewhere in this FAQ for more discussion of that issue.)
3. Errors do happen
If you every get a chance to see a live exchange ticker you will
get to see the errors, too. Sometimes it is merely a misplaced
trade reported way out of order. Perhaps it is an incorrect price
or volume reported later as a correction. And then there are
trades that just didn't happen for one reason or another -
cancellations, repudiations, double fills, etc. They show up on
the ticker, but some information gathering systems have no way to
back them nicely out of the days activities. Some are not
discovered until days later in the back offices.
Simple data entry errors still happen. Looking at an interday
chart, one sometimes sees a single transaction far off the run of
contemporary trades. Quite often the offset is $3 or $30, which is
a clear signal that someone hit the wrong row of keys on a numeric
key pad. Those errors show up in the interday charts all the time
and often make the end-of-day quotes.
Even the floor traders get involved. When four or five people are
competing for a specialist's attention, it is not hard for several
people to hear the specialists "Done 500" as a fill of their order.
So two orders become one or one becomes two executions. Naturally
they all get corrected eventually - but does the tape ever show it?
4. Is volume really volume?
On the NYSE and AMEX when the specialist crosses an order and
reports 1000 shares traded, we all assume that this means 1000 sold
and 1000 bought (even if one party to the trade is the specialist
himself). But there are complaints that NASDAQ reported volume may
be far higher than the actual public trading. It is likely that
this is true given the multiple competing market makers, most of
whom actively trade for their own accounts. Sensing a trend, such
a market maker may sell stock not owned or scarf up offered stock
with the intention of laying off the stock on his competitors later
- something the NYSE/AMEX specialist really can't do. If you watch
intraday volume, you'll occasionally see such trading pairs pass
across the tape with a few minutes separation - some may represent
real trading, some merely various forms of market maker transfers.
5. Teasing the market
Technical analysts look for breakouts and other signals in their
data. And the wolves on Wall Street know that. Occasionally they
have a chance to push a few trades through to tip an indicator one
way or the other. Often this happens near the end of a quiet day.
Considering the spread, merely whether the last trade of the day is
on the buy or sell side is often enough to bias the day's technical
indicators. Recently I tried a $12 experiment on a NYSE stock that
had held one price for almost six hours of NYSE trading. I wanted
to see if the prevailing executions were on the buy or sell side.
My 100 share order 1/8th point off that price brought a quick
day-ending burst of trades - at successively different prices.
Someone with real malevolence could do even more to trigger a
technical move. A dramatic example of off-exchange trading
occurred on 26 Feb 97. After a 17-month battle, noted investor Carl
Ichan sold off his entire 19.9-million share holding of RJ Nabisco
Holdings (RN). He did this in an after-hours deal with Goldman Sachs at
$36.75, a $1 price concession from that day's close. It is unknown if
Goldman Sachs held the block for eventual distribution or acted for
another firm. Trading was 2.4M shares on 26 Feb and 4.6M and 3.3M on
the following two days, respectively, likely due to other arbitragers
moving out of the stock. Interestingly, the stock price held, closing
only 1/8th below the deal price. So this block never showed up on the
tape nor in your TA program's data base. Although this transaction
became public knowledge via a timely SEC filing and extensive press
coverage, other large block trades may be effectively masked from public
view.
Perhaps there is only one real lesson to be gained from understanding
these and other forms of data inaccuracies that can creep onto the tape.
It is that technical analysts should not regard all reports on the tape
as gospel.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trading - Selling Worthless Shares
Last-Revised: 26 May 1999
Contributed-By: Art Kamlet (artkamlet at aol.com), Chris Lott ( contact
me )
If you hold shares that have become worthless, maybe because the company
has ceased operations, you are probably interested in deducting the full
cost basis of that position when you do your taxes. And, since you're
already in the hole, you probably want to do this without throwing any
more money away. This article discusses ways you can prove to the IRS
that the shares really are worthless.
The simplest and best way to close out any position, of course, is to
sell it, even if you only get a dollar. But who is going to pay you
even a lousy buck for worthless shares?
If you hold the share certificates, you can probably convince one of
your friends or (deep breath) relatives to buy them from you for $1.
(You can give back the $1, buy the proud new owner a drink, etc.) Then
list the $1 as your selling price on your tax form. If your friend
really wants to take official possession of the shares, he or she must
send in the properly signed share certificates to the stock transfer
agent, but of course if the company really is gone, the transfer agent
is not going to do anything (no money, no work).
If your broker holds the shares (the shares are held "in street name"),
selling them to a friend isn't such a good deal because taking delivery
of the certificates will cost you about $25 (depending on the brokerage
house, of course). And you sure don't want to pay a brokerage
commission to get rid of your worthless shares. Many brokers have a
plan to let their good customers sell them worthless stock for $1 or 1c
for the lot. If you are a good customer, and stock is with the broker,
ask. You should be able to negotiate some solution that will be
satisfactory to both sides.
If for whatever reason you cannot sell the worthless shares, then you
will need to obtain documentation that will convince the IRS that the
stock really, truly had no value at some point in time, and close the
position at that same time. This will relieve you of the burden of
selling the shares. It's very important that you can demonstrate beyond
a doubt the year that the shares became worthless. When you do your
taxes, you would write "12/31" as the date of sale and "worthless" (or
0) as the sales price. For example, if the company has delisted the
shares or closed down completely, a letter from your broker or even a
letter from the company might be sufficient to establish the year in
which the shares became worthless.
Interestingly, if you had shares that became worthless, and you declared
them worthless, took the loss, yet hung on to the shares, you're OK if
they later regain value. The IRS now anticipates that a stock you kept
while declaring it to be worthless later rises from the dead. In that
case, no need to amend, but use the worthless date as the acquisition
date and 0 as the cost basis. So in this regard they are pretty
lenient.
Note that if a company's stock goes worthless, you should declare this
event in the year it becomes worthless. If you have to file an amended
return (1040X) later, you have 7 years to do so, unlike 3 years for most
other 1040X filings.
As you can see, it's far simpler to sell the shares for a pittance than
to demonstrate that they are worthless, so that's probably the way to go
if you can manage it. Although this does not establish the year in
which the shares became worthless, it does give you a clear sale at a
very low price, and that's always simple to explain.
One last caveat. Don't confuse a bankrupt company with a completely
defunct company. Many companies continue operating while in bankruptcy
proceedings, and their stock continues to trade. So the stock by
definition is not worthless. In the newspaper listings, the prefix 'vj'
is often used to indicate such companies. For example, when this
article was first drafted, vjRAYtc (Raytech) closed at 4/38. However, a
bankrupt company does not always have a low share price. About 25 years
ago John Manville Co. was hit with asbestos lawsuits, and filed for
bankruptcy to protect them against these suits. Except for the
potential liabilities of the law suits, they had an enormously healthy
balance sheet and their stock continued to trade high. More recently,
about 1991 Columbia Gas of Ohio filed for bankruptcy to get out of some
unfortunate long-term contracts they had written for natural gas
purchases. Their stock continued to trade, generally in the $30 range,
until they finally emerged with a favorable court ruling.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trivia - Bull and Bear Lore
Last-Revised: 29 Jul 1994
Contributed-By: David W. Olson, Jon Orwant, Chris Lott ( contact me )
This information is paraphrased from The Wall Street Journal Guide to
Understanding Money and Markets by Wurman, Siegel, and Morris, 1990.
One common myth is that the terms "bull market" and "bear market" are
derived from the way those animals attack a foe, because bears attack by
swiping their paws downward and bulls toss their horns upward. This is
a useful mnemonic, but is not the true origin of the terms.
Long ago, "bear skin jobbers" were known for selling bear skins that
they did not own; i.e., the bears had not yet been caught. This was the
original source of the term "bear." This term eventually was used to
describe short sellers, speculators who sold shares that they did not
own, bought after a price drop, and then delivered the shares.
Because bull and bear baiting were once popular sports, "bulls" was
understood as the opposite of "bears." I.e., the bulls were those people
who bought in the expectation that a stock price would rise, not fall.
In addition, the cartoonist Thomas Nast played a role in popularizing
the symbols 'Bull' and 'Bear'.
Finally, Don Luskin wrote a nice history of these terms for
TheStreet.com on 15 May 2001.
http://www.thestreet.com/comment/openbook/1428176.html
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trivia - Presidential Portraits on U.S. Notes
Last-Revised: 28 Apr 1994
Contributed-By: Paul A. Rydelek, Chris Lott ( contact me )
Just in case you were curious, here is a list of the presidential
portraits and other decoration on U.S. Currency and Treasury
instruments.
Den. Portrait Embellishment on back
$1 George Washington Great Seal of U.S.
$2 Thomas Jefferson Signers of the Declaration
$5 Abraham Lincoln Lincoln Memorial
$10 Alexander Hamilton U.S. Treasury
$20 Andrew Jackson White House
$50 Ulysses S. Grant U.S. Capitol
$100 Benjamin Franklin Independence Hall
$500 William McKinley Ornate denominational marking
$1,000 Grover Cleveland Ornate denominational marking
$5,000 James Madison Ornate denominational marking
$10,000 Salmon P. Chase Ornate denominational marking
$100,000 Woodrow Wilson Ornate denominational marking
U.S Treasury instruments:
Den. Savings Bond Treas. Bills Treas. Bonds Treas. Notes
$50 Washington Jefferson
$75 Adams
$100 Jefferson Jackson
$200 Madison
$500 Hamilton Washington
$1,000 Franklin H. McCulloch Lincoln Lincoln
$5,000 Revere J.G. Carlisie Monroe Monroe
$10,000 Wilson J. Sherman Cleveland Cleveland
$50,000 C. Glass
$100,000 A. Gallatin Grant Grant
$1,000,000 O. Wolcott T. Roosevelt T. Roosevelt
$100,000,000 McKinley
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trivia - Getting Rich Quickly
Last-Revised: 18 Jul 1993
Contributed-By: James B. Reed
Take this with a lot of :-) 's.
Legal methods:
1. Marry someone who is already rich.
2. Have a rich person die and will you their money.
3. Strike oil.
4. Discover gold.
5. Win the lottery.
Illegal methods:
1. Rob a bank.
2. Blackmail someone who is rich.
3. Kidnap someone who is rich and get a big ransom.
4. Become a drug dealer.
For the sake of completeness:
"If you really want to make a lot of money, start your own
religion."
- L. Ron Hubbard
Hubbard made that statement when he was just a science fiction writer in
either the 1930s or 1940s. He later founded the Church of Scientology.
I believe he also wrote Dianetics.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trivia - One-Letter Ticker Symbols on NYSE
Last-Revised: 13 Aug 2004
Contributed-By: Art Kamlet (artkamlet at aol.com), Doug Gerlach (gerlach
at investorama.com)
Some of the largest companies listed on the New York Stock Exchange have
1-letter ticker symbols, and some relatively unknowns do also. Not all
of the one-letter symbols are obvious, nor does a one-letter symbol mean
the stock is a blue chip, a US corporation, or even well known.
Originally when the symbol had to be written down on transaction slips,
it was faster to write down the real big companies, like T (Telephone),
F (Ford), K (Kellogg), G (Gillette), X (Steel), and Z (once Woolworth).
But later just anyone it seems was able to get 1-letter symbols. Yet
when Chrysler (C) was absorbed by Daimler to become DCX, note that
Citicorp (which had just merged Citibank with Travelers) jumped to claim
the C for themselves.
This page shows all of the one-letter ticker symbols listed on the NYSE.
Since the US exchanges avoid overlaps, this means that only the NYSE
uses one-letter ticker symbols. This list was current as of the
last-revised date (above), but due to changes it may be out of date by
the time you read it.
In the following list, the ticker links will take you to the appropriate
page at Yahoo! Finance with a current quote and price chart.
Ticker Company
A Agilent Technologies (split-off from H-P; previously Astra AB)
B Barnes Group
C Citigroup (previously, Chrysler had 'C')
D Dominion Resources
E Ente Nazionale Idrocarburi SpA (ADR)
F Ford Motor Company
G Gillette
H None - formerly Harcourt General
I None - formerly First Interstate Bancorp - ostensibly reserved (see
below)
J None - formerly Jackpot Enterprises
K Kellogg
L Liberty Media
M None - formerly M-Corp, ostensibly reserved (see below)
N Inco, Ltd.
O Realty Income Corp
P None - formerly Phillips Petroleum
Q Qwest Communications
R Ryder Systems
S Sears, Roebuck & Company
T AT&T Corp
U None - formerly US Airways
V Vivendi Universal
W None - formerly Westvaco
X US Steel
Y Alleghany Corp.
Z None - formerly Woolworth
The Chairman of the New York Stock Exchange has publicly said that he is
holding the symbols "M" and "I" for two companies he hopes to convince
to switch from Nasdaq to the NYSE -- Microsoft and Intel.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Trivia - Stock Prices in Sixteenths
Last-Revised: 22 Jan 1997
Contributed-By: DJS Highlander, infras at aol.com
The tradition of pricing stocks in fractions with 16 as the denominator
takes its roots from the fact that Spanish traders some 400 years ago
quoted prices in fractions of Spanish Gold Doubloons. A Doubloon could
be cut into 2, 4, or even 16 pieces. Presumably, it was too difficult
to split those 1/16 wedges any further, or prices today might be quoted
in 32'nds! Using fractions as a means of quoting prices was popular for
a couple of hundred years thereafter, and as the NYSE is more than 200
years old, there's the link!
If you really want to get specific, the Spaniards counted on their
fingers (as did everyone else, for the most part!) and did not include
the thumb in the 'low end' process because it was used to keep track of
the quarters. Two thumbs = doubloon. Both hands = doubloon, in eight
pieces (pieces of eight!). You could manage all sorts of good slave
deals from this mathematical base (other deals, too, of course).
Well, the Spaniards formulated all this as a simplification of the
decimal method used by the rest of Europe which was derived from the old
Roman way of doing things - which was taken from the Greeks - which was
taken from the Persians - who got it from the Chaldeans. That takes us
back to about 5000 BC and an interesting coin called the Dinar - which
was parsed into tenths.
According to the Hammarabi Code, the Dinar was worth today's equivalent
of about $325 (ie., an ounce of gold - only it weighed slightly more).
Within their agricultural economy, it was a piece of metal (more easily
transportable) equal in value to a bushel of wheat, which, according to
the Code, weighed 1 Stone (the Sumerian Standard), which, by our
standards, weighed about 60 pounds.
To Sumerize (pun), an ounce of gold was equal to about 60 pounds of
wheat in value. This was established since it was obviously easier to
carry a bag of gold to the other side of the empire to exchange for a
large quantity of, say, wool, than it was to caravan several tons of
wheat for the same purpose. And so on.
The whole process probably dates back even farther, but the Code of
Hammarabi is basically the oldest known documentation of such things.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Warning - Wade Cook
Last-Revised: 23 Feb 1998
Contributed-By: G. S. Reedy
Wade Cook runs seminars, priced around $3,500, that explain his
strategies for investing, with emphasis on writing covered calls. Much
of the same information is available in his book, The Wall Street Money
Machine .
Don't be fooled by Wade Cook's book. I read it, did some studies of
covered calls. Most cheap covered calls are written on stocks that are
in the process of declining in price. According to postings in
Dejanews, some people admit to having lost a bundle following Wade
Cook's trading programs. When I read his book, some of it seemed too
good to be true. And, as the old axiom says, "If it seems too good to
be true, it probably is."
I had a conversation with a commodity trader several years ago. He told
me that he was continually amazed at people who had demonstrated
expertise in their respective fields, and were somewhat successful at
their work. Then, they would read a book about commodity trading and
think that they could start making a living at it. Basically, the same
principle applies to trading stock options. Go slow, crawl before you
walk, walk before you run. To use a baseball analogy, go for base hits
first. The triples and home runs will come with practice.
You might also want to check the article elsewhere in this FAQ entitled
"Advice - Paying for Advice."
For more information, check out these sources:
* An article by Dan Colarusso of TheStreet.com that appeared on 16
August 2000.
http://www.thestreet.com/stocks/truthserum/1043588.html
* An article by James Surowiecki of the Motley Fool that appeared on
Slate on 18 September 1997.
http://slate.msn.com/id/2620/
* An article by Randy Befumo of the Motley Fool that appeared on 5
October 1997.
http://www.fool.com/Features/1997/sp971006WadeCook97002.htm
* An article that appeared in the Washington Times on 30 December
1997.
* At one time Gary Wall maintained a collection of information about
Wade Cook on his web site.
http://www.garywall.com
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Warning - Charles Givens
Last-Revised: 20 Jan 2003
Contributed-By: Jeff Mincy (mincy at rcn.com), Chris Hynes, Chris Lott (
contact me )
Charles J. Givens was a self-styled financial planner, investment
educator, and investment guru who once appeared in info-mercials on
late-night television to tell the world about the fortunes he had made
and lost, free seminars run by his associates, and the Charles J.
Givens Organization. He died in 1998, but one of his organizations,
International Administrative Services Inc. (IAS), lives on.
Givens' organization offers investment education and advice through
seminars and publications. He wrote several best-selling books:
* Wealth Without Risk (1988)
* Financial Self-Defense (1990)
* More Wealth Without Risk (1991)
As of this writing, a trial membership in his organization is offered
for about $50. The organization publishes a monthly newsletter.
Telephone advice is also offered to members. Their web site address is
given below.
Givens is regularly lauded by his fans for teaching people how to
navigate the world of personal finance and investments. However, his
critics point out that his advice is generally simplistic and sometimes
contradictory. All examples (below) are taken from Wealth Without Risk,
as cited in Reference (4).
Simplistic: number 210, don't buy bonds when interest rates are rising.
Contradictory: number 206, do not put your money in vacant land;
number 245, invest your IRA or Keogh money in vacant land.
Givens offers quite a bit of helpful advice but contrary to the titles
of his books, his ideas can be extremely risky. For example, some of
his suggestions about insurance, especially dropping uninsured motorist
coverage from one's automobile insurance, may leave people underinsured
and vulnerable in case of an accident unless they are very careful about
reading their policies and asking hard questions. On the other hand,
some people are arguably over-insured, which is why Givens makes these
recommendations. These people could certainly benefit from reading
their policies carefully and asking the insurance agent some hard
questions, but wholesale advice to drop coverage is risky.
He also makes aggressive interpretations of tax law, interpretations
which might get one in trouble with the IRS. Not that the IRS is
perfect, but not all people may be comfortable with Givens'
interpretations.
The Givens organization has lost several court cases. For example, in
December 1993, the Attorney General of Florida issued a complaint
against Charles J. Givens alleging that certain of his practices
violated Florida's Deceptive and Unfair Trade Practices Act. Among the
claims challenged by the Florida AG was that Givens misrepresented that
his programs provided purchasers with successful and legal financial
strategies that would enable them to make money. The case was resolved
in 1995 when Givens agreed to pay $377,000 to cover refunds and the cost
of the Florida investigation. Givens also agreed to stop making certain
claims about the value of his teachings and to make full refunds to
anyone who requests them within three days of receiving his materials.
In 1996, the Givens organization lost a class-action case in California
in which the Givens Organization was ordered to pay over $14 million to
the members of the class.
Prospective followers of Givens must, absolutely must, read about
successful lawsuits against Givens as well as his criminal convictions
and other disclosures about him and his organization. See below for
exact references.
In conclusion: his advice is simply not appropriate for everyone.
References:
1. Smart Money , August 1993.
2. The Wall Street Journal, ``Pitching Dreams,'' 08/05/91, Page A1.
3. The Wall Street Journal, ``Enterprise: Proliferating Get-Rich Shows
Scrutinized,'' 04/19/90, Page B1.
4. The Wall Street Journal, ``Double or Nothing,'' 02/15/90, Page A12.
5. Superior Court of the State of California, County of San Diego,
Case No. 667169: Cella Gutierrez, et al. vs. Charles J. Givens
Organization Inc., et al., Trial date 04/12/96.
6. The IAS Financial Education organization (successor to the Charles
J. Givens Organization).
http://www.iasfinancial.com
7. KYC News, short for 'Know Your Customer', publishes investigative
information on financial crime in its newsletters and web site.
They make available a facts and findings document from the clerk of
the U.S. Bankruptcy Court in Orlando, Florida about Givens and
others, dated April 2003.
http://www.kycnews.com/TedderFactFindings.pdf
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Warning - Dave Rhodes and Other Chain Letters
Last-Revised: 6 Sep 1994
Contributed-By: Mark Hall, George Wu, Steven Pearson, Chris Lott (
contact me )
Please do NOT post the "Dave Rhodes", "MAKE.MONEY.FAST", or any other
chain letter, pyramid scheme, or other scam to the misc.invest.* groups.
Pyramid schemes are fraud. It's simple mathematics. You can't
realistically base a business on an exponentially-growing cast of new
"employees." Sending money through the mails as part of a fraudulent
scheme is against US Postal regulations. Notice that it's not the
asking that is illegal, but rather the delivery of money through the US
mail that the USPS cares about. But fraud is illegal, no matter how the
money is delivered, and asking that delivery use the US Mail just makes
for a double whammy.
Note that when someone posts this nonsense with their name and home
address attached, it's fairly simple for a postal inspector to trace the
offender down.
Although the "Dave Rhodes" letter has been appearing almost weekly in
misc.invest as of this writing, and it's getting pretty old, it's mildly
interesting to see how this scam mutates as it passes through various
bulletin boards and newsgroups. Sometimes our friend Dave went broke in
1985, sometimes as recently as 1988. Sometimes he's now driving a
mercedes, sometimes a cadillac, etc., etc. The scam just keeps getting
updated to keep up with the times.
To close on a funny note, here's a quote from the "Ask Mr. Protocol"
column of the July 1994 (v. 5, n. 7) SunExpert magazine:
Rhodes (n) - unit of measure, the rate at which the same
annoying crud is recycled by newcomers to the net.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Warning - Ken Roberts
Last-Revised: 28 May 1999
Contributed-By: Conrad Bowers (cpbow at earthlink.net), J. Johnson
This article is a response to a message saying that the Ken Roberts
course is a good introduction to commodity trading (the message
originated on an AOL site but was quoted on the Motley Fool investment
site). According to one of the writers of that thread, Ken Roberts is
now advertising on radio with ads saying you can turn $5000 into lots of
money. Some of the comments below would apply to just about any
technique if you're starting with a small amount of money.
In my opinion, Roberts does not adequately warn of the risks about
trading commodities. Most of his first course is a pep talk about how
easy it is. In reality surveys have shown that some 90% of people stop
trading within about a year. Most stop because they have depleted more
of their capital than they can bear and keep on trading. Remember these
differences about commodities as compared to stocks:
1. Unlike the stock market, in commodities for every dollar won there
is a dollar lost in the markets. Most lose, a few are consistent
big winners. Remember you are competing against people that have
done this a long time, people that do it full-time, and
suppliers/users that use the commodity full-time. Unless you're
sure you going to beat these pros the first time, you better trade
with money you don't need.
While you dream of what the money you hope to generate will do for
you, don't lose sight of the initial odds against you. With time I
believe an individual can learn to trade successfully. But if you
don't survive the training period, you will have had a very
expensive education.
2. Highly leveraged; You can lose more than your entire investment if
you get in a position that's way too large for your account,
particularly if you get locked into it by 'limit moves'. These
happen occasionally in a number of commodities. (You can hedge
with options, though.) The more common problem is cumulative
losses. Someone who starts out with $5000 will have difficulty
placing stops that won't get hit by market 'noise' (short-term
fluctuations). If they place more reasonable stops, then it will
be a large percentage of their account. It's probably possible to
start with $5K, but you either have to be lucky enough to build the
account up before it gets wiped out, or you have to be disciplined
enough to trade very small positions and not the more lucrative
commodities. (Having seen my account dwindle 80%, I am trying to
rebuild it on this basis; some recovery with options, currently
pretty flat trading "small" commodities.)
The Ken Roberts course does teach how to calculate the dollar
differences a price move will profit/cost you. However, the is an
almost complete lack of discussion about the proper amount to risk. To
pitch a course to investors with only $5K with no discussion of risk
strategy is outrageous. His video repeatedly asks interviewees, would
you recommend this course for a struggling family/single parent, etc.
That is enough of a misrepresentation that I believe it should be
regulated.
I got interested in commodities through his course, TWMPMM I. I
actually didn't use his entry techniques so I won't fault those. I
fault him, the fax service I did use, and myself for my not
understanding risk control. I didn't risk a huge amount per trade
(never more than 10%, usually less) but I still overtraded enough that
my account bottomed out at less than 20% of the starting value. Of
course that's when the profitable trades came along but I couldn't take
them. Roberts' entry techniques (particularly one of the two) would
typically risk MORE than I did. If someone with a large account
followed his techniques with proper risk control in a diversified mix of
markets, it might work. There is no test of his entries so I don't know
if they are profitable or not. It's sending new people off into the
markets with small accounts and no risk management training that's
outrageous.
He does do a good job of stressing paper trading. However, three months
is good for introducing you to the daily process and stresses of
decision making. It is not a valid test of any strategy. Only by
testing a strategy over quite a long time of historical data, can you
tell if it works. He publishes no indication this is so. Often, people
hit a couple good trades in the paper trading stage, and they are sure
they're ready to make it. I think 6 months to 1 year of reading and
paper trading is necessary. Wish I had!! For the money you can get
several much better books, rather than one course that is literally more
than half hype.
The claim that the first course is complete is false. Want to know
about options? Buy the TWMPMM II course. Want to know about entering
already existing trends? Buy a bonus pack (or get it with a one year
renewal). In other words, if you're frustrated that you seem to be
losing your account just send in $95 or $195 more for the solution.
Want to learn how Ken really trades himself? Attend a $2000 seminar.
Not satisfied with a subscription? -sorry, prorated refund requests
refused (I tried).
Bottom line: If you don't know what you're doing you're gonna lose! If
you're looking for someone else to do the brain work, expect to lose!
Only you know how important your money is and how you want it to grow.
And, oh by the way, don't get greedy!
For other opinions, check out extensive discussions on the
misc.invest.futures news group; if the thread is not currently active
just type 'Ken' and 'Roberts' into a Dejanews search and you will get a
screenful.
--------------------Check http://invest-faq.com/ for updates------------------
Subject: Warning - Selling Unregistered Securities
Last-Revised: 29 Mar 1995
Contributed-By: Michael R. Mitchell (mitchel4 at ix.netcom.com)
Under the U.S. Securities Laws, specifically The Securities Act of
1933, the mere offer to sell a security -- unless there is an effective
registration statement on file with the SEC for the offer -- via the
Internet can be a felony subjecting the offeror to a 5 year federal
prison term. See the Securities Act of 1933, Section 5(c) Of course,
sales and deliveries after sale of unregistered securities is unlawful
(Section 5(a)) as is failure to deliver a prospectus (Section 5(b)).
Listen to an example from my own experience as a securities lawyer in
Los Angeles. Many years ago a young man came into my office and asked
my advice about whether he could advertise in the Hollywood Reporter for
investors in a movie he wanted to make.
I explained to him that such a course would be fraught with peril for
him because it would violate the federal securities laws. He said,
"Everybody does it; there are a bunch of ads soliciting people to invest
in movies there every day." He said, "Well, I'm going to do it."
About a week later, he phoned me up and said he had got a letter from
the SEC requiring him to refund any money he had collected and requiring
him to visit the LA office of the SEC. It appears that the SEC reads
the Hollywood Reporter. It also reviews the Internet newsgroups.
Certain transactions are exempted from the prohibition (See Section 4)
and certain securities are exempted from the prohibition (See Section
3). How a security is defined is set forth in Section 2(1) -- and
includes, among other things, any note, stock, bond, investment
contract, put call, straddle, option, etc.
You can determine whether a registration statement is or was in effect
as to a security by accessing the free SEC Edgar search machine at this
URL:
http://www.sec.gov/cgi-bin/srch-edgar
--------------------Check http://invest-faq.com/ for updates------------------
Compilation Copyright (c) 2005 by Christopher Lott.
stars news
1-Get real-time visibility
Track live and historical vehicle, trailer, and equipment locations on a single map.
Geofence yards to take real-time inventory
Send automatic customer ETAs to reduce check-in calls
Dispatch drivers faster with one-click HOS visibility
2-Reduce operational costs
Increase profits with actionable performance insights and cost-saving tools.
Prevent breakdowns with fault codes and maintenance reminders
Identify fuel-saving opportunities with MPG reporting
View expected dwell time before accepting a load
3- Streamline compliance
Spend up to 50% less time on compliance with the #1-rated ELD.
Easy-to-use driver app and bulletproof connectivity
Proactive violation detection and alerts
3x faster inspections reports and automated IFTA
4-Stay on the road
Protect your business and prevent accidents with intelligent video safety.
Exonerate drivers with the Smart Dashcam
Identify and correct risky behavior with an easy-to-use coaching workflow
Track trends and performance with AI analysis
👇👇👇
https://mbsy.co/3QtdhF