Forced Selling

What is Forced Selling?

Forced Selling is simply; where your broker, on his own will, sell stocks that belong to you. Yes, that's the process. But there's a story behind it. 

Forced Selling can only occur if you, the investor, buys stocks on broker credit. That means you decide to invest in stocks worth more than what you have actually invested in the stock market by yourself. The broker will usually provide a credit limit up to 50% of your total investment, but this can hugely vary form stock market to another. The next part is settlement of the credit. It's a very short term loan, so it must be paid back. Usually the brokers provide the investor around 3 days (T+3) to settle the credit, but some stock markets may extend this date up to T+5 (5 days). 

So when the settlement date arrives, the investor should have enough money or liquid cash in his portfolio to pay back the broker. The investor could either willingly sell all or portion of his portfolio sufficient to cover the credit or settle the credit with cash directly. But settling with cash seems unlikely since you're already trading on credit. We could opt. to sell our stocks and settle the credit, if the stocks had made us our intended profits. But if the stocks have crumbled, we wouldn't want to sell them. This is where Forced Selling comes. 

If the available credit isn't settled as of the time limit allowed, your broker will have all the powers to sell any portion of your portfolio up to an amount sufficient to cover the credit. This is called Forced Selling, as you are forced to sell your investments to settle the credit. This is a fully legal process and the investor cannot do anything to stop it or take any legal action against it. 

We can understand that this will mostly affect the traders rather than investors. Investors concentrate on the long term and the broker credit facilitates credit up to maximum 5 days only. So traders are the ones who usually get the worst out of this.

This is just another reason why most investment advisers ask the investors not to trade on credit. Unless you are 200% sure of what you're doing, my advice is, don't go for broker credits.    

Insider Trading

Legal or Illegal?

It's both. There are two forms of Insider Trading. One legal and the other not. In general Insider Trading is the dealings (buying and selling) of stocks/shares of a company by people relating to the company, for an example, directors, officers, employees and large share holders. However if this is done in full disclosure it is considered legal. On the other hand it is illegal to engage in trading of a share for the above mentioned parties based on material and undisclosed/non-public information. This is considered unfair or unethical to those traders who  doesn't have possession of such information.

Who is an 'Insider'?

An Insider is identified as a person/party who has access to important information about the company that could affect the share prices of the company directly or indirectly or that might affect investor decisions at large. These kind of information is known as 'Material Information'.

So in general, the CEO, the Managing Director/s, the members of the Board of Directors, employees, other officers, brokers and even family members of related people can be found guilty of Insider Trading. Any 'tipping off' of any information by and to such parties could be found guilty. 

If found guilty;

If found guilty of Insider trading, the Insider will have to return all the profits he/she made from the Insider trade or this may extend up to three times the profit earned form the trade. Beyond this Laws are being strengthened to increase the penalties for Insider Trading. As of now stock defrauding can extend to a penalty up to 10 years of imprisonment. 

For more information :

US Securities and Exchange Commission

Wikipedia

Management

Fundamental Analysis

What is Fundamental Analysis?

In the simplest form 'Fundamental Analysis' is the process of analyzing the financial reports of  an economy, industry or a company. Since this is the Stock Market, it's always about the companies. As always the aim of Fundamental analysis is to forecast the future price movements of the company and also a long term investor may look at features such as stability, growth etc.

Unlike Technical Analysis which determines price fluctuations based on the real-time information like price trends, charts etc., Fundamental analysis is concerned on more solid grounds. Those include, company profitability, company performance (quarters, annually, semi-annually), goodwill, stability, management etc.

Criteria for Fundamental Analysis

As the above picture shows, there are three main parts of Fundamental analysis. 

1. Economy Analysis
2. Industry Analysis
3. Company Analysis

Economy Analysis -  this is the analysis of the annual reports published by the Central Bank of a country and other relevant incidents, events and transactions that might affect the economy.

Industry Analysis - this is the analysis of the industry a specific company is in. For an example a hospital belongs to the healthcare industry and almost all the events that occur within the industry will have an impact on the said company.

Company Analysis - this is the analysis of the company you have or hoping to invest in. This might look as if the most relevant analysis for an investment, but the other two are as equally important. 

Company Analysis

Analysis a specific company can be done in many ways. The more analyse the better chances you have in making a sound decision. Company analysis can be discussed in following topics.

Financial Analysis.

This is the most common for of Fundamental analysis. In-fact most people think this is the only form of Fundamental analysis. But this is just a small part of a bigger chain. Financial analysis includes the analysis of financial statements, reports, past financial data and so on. This is purely of financial nature. This makes more sense since at the end of the day the financial situation of a company is what really decides the price of the share tomorrow. In financial analysis we will mostly look for information like 'debtors, creditors, acid ratios, current ratios, price earning ratio, total revenue, total current and non current expenditure, total debt capital, total equity capital, gearing ratio, liquidity, price, taxes, dividends, cash flows, working capital management etc, and the list goes on. However these information will directly relate to the price of a share of the company.

Management

Another important aspect of the company analysis would be the 'management' or the board of directors of the company who actually makes the decisions on behalf of the company. A 'good' management will give a more positive outlook for the company and vice versa. 

Business Plan

This is the document that provides all stakeholders the information relating to the company as to what it does, what are it's objectives, what are the growth prospects and so forth. A sound business plan with sound goals and objectives and a good management to support that will give the investor confidence to believe the company would perform well in the future.

All these put together, Fundamental Analysis will become a much stronger tool for your decision making process. 

Portfolio

What is 'Portfolio'?

A Portfolio in general means a collection. A group of something and such. In the Stock Market, your collection of the total investment can be referred to as the Portfolio. But more commonly the collection or the group of invested stocks by you is called as your 'Portfolio'. Your portfolio could consist of a single stock up to a maximum decided by you.

How to manage your 'Portfolio'?

Portfolio management simply refers to the process of making decisions as to the appropriate investment mix, the potential performance of the investments, managing risks and meeting your investment objectives. 

Diversification

The main problem with any type of investment is the certain degree of 'risk' associated with it. Risk could be either favorable or unfavorable outcomes that were not foreseen. There's NO term called 'ZERO RISK', because that is practically unavoidable not to face a risk. But there is a term called 'minimizing risk' or 'managing risk', because that is practically possible. So how to minimize the risk of your overall investment? One word answer. 'Diversification'. Diversification in simple means investing in more than one or two stocks. A more advanced explanation would be, a risk management technique that utilizes a mix of investments in your portfolio. 

Let's see how Diversification reduces the risk of the investment. This could be quoted with a popular proverb, "don't put all your eggs in one basket". If you drop the basket by mistake all the eggs are gone. But if you had the eggs in two baskets and if one basket falls and breaks all the eggs, there's still the other basket with a bunch of saved eggs. If you understand this story, you've understood what diversification is really about. It' that simple. But most of us tend to neglect the small facts and go for big calculations, predictions, equations and stuff. But sticking to the basics will not fail you at all.

So it is said that you should diversify your portfolio in order to minimize your risk. Say you have 10 stocks and if five of them go down, there's still hope with the rest five stocks. With diversified portfolio it's very hard to loose the whole game. But if you have just merely a stock or two your chances of failing are pretty high. Investing is a lesser number of stocks is called as 'Under Diversification'.

Over Diversification

This is the other extreme of diversification. Fearing the risk, the investor tends to diversify his portfolio as much as possible. But this is not good at all. Yes, over diversification could bring your risk to a very low level, but the chances of making profits out of these stocks reduce to a great extent. Because of monetary constraints a single stock in an over diversified portfolio will only have a small quantity of shares. Thus it will be very hard to gain a proper profit when all the stock market fees, brokerage fees and other taxes add up to the cost of buying and selling. So it is not advisable to have a HUGE collection of stocks either. The generally accepted number of stocks that should be present in a good portfolio would be 20. But this will vary immensely based on the value of your total investment. But it is advisable that you don't exceed 20 stocks when buying shares. 

(this is not buy/sell/hold recommendation.)

Why the Stock Market?

Savings Account?

Savings account is the normal account any person can open with a bank to safely deposit their hard earned money. This is probably the safest mode to invest money. The banks are regulated by monetary authorities and hence the risk of loosing your money is near zero. They provide you a interest on the balance you have in the account. The interest rate provided is the main tool for attracting customers to deposit their money in banks. This is mostly calculated daily on the account balance and added to the balance monthly. So it's basically earning money with no effort at all. That doesn't sound right, right? Well it doesn't. 

Even the best banks in the world will provide you an interest rate not more than 7%-8% per annum. i you have a balance of $1000 at the beginning of the year, you'd have $1080 at the end. (1000*8%) Of course this is zero-effort money, but is it really enough? The answer is NO. This is because the real value of money is decreasing at a faster rate. Real Value of money is the value of actual goods and services that you can purchase with a given amount of money. The Real Value of money is constantly decreasing, thus creating 'Inflation'. Inflation Rate is the rate at which the prices of commodities increase during a given period of time. In a normal economy the Inflation Rate is almost always above the Bank Interest Rate. This would eventually result in a higher decrease of the 'real value' of the money in your bank, than what the 'interest rate' adds to your bank account. Say we live in an economy with a 10% inflation. So in the above example the bank balance grew by $80 during the year. But due to the inflation, the real value of the balance will decrease by $100 (1000*10%). So eventually resulting in a much less value of money than the amount you had in the beginning. (Real Value of the bank balance at the end of the year = Inflation effect - Interest component = -100+80 = -20). So we can see why it's not financially feasible to lock up your money in a bank account. 

Fixed Deposits?

Sure, FDs give a higher interest rate than a normal savings account. And for a moment let's assume that even the FD interest rate is higher than the Inflation rate which would result in an actual increase in real value of money, but still there's a problem. That is 'Liquidity'. Liquidity is the ability of an asset to be converted to cash with minimum economic and financial loss. In the liquidity department, the FDs do not look nice at all. Because when opening a FD, you sign an agreement with the bank saying that you deposit the money for a specific period of time, it could vary from 3  months to even 10-20 years. Let's assume that a sudden financial requirement pops out and you cancel the FD and withdraw your money before the maturity of the FD, you will only get a normal savings interest rate for your FD. So now it doesn't look that attractive either.

Stock Market?

This is the big YES! The Stock Market is a gold mine to the person who's ready to harvest the gold. Being 'ready' means knowing actually what you are doing in the market. This Blog is a humble attempt to help you get there. So read carefully the articles and try to grasp the psychology behind the market movement. You don't need to remember all these stuff, but let this be a guide to you. All the best!