Short Selling - Dealing with Downturn markets..

The world economy is trekking down a rough road. Production is plummeting, agriculture is highly uncertain and services are rising rapidly. So this has affected the Stock markets around the world, obviously. Many markets are experiencing Bearish trends. Keep aside the Bearish markets; are your stocks going down? have you made the wrong decision? Then Short Selling is probably the answer you're looking for. Now that I have your attention, let's dig in deep.

What is Short Selling?

As investors we know how to scrape profits out of the Stock markets. Buy a share at a low/er price hold it till the price rises and sell at a predetermined profit. This is the foundation of stock trading. But what can we do in a down turned market? Well, Short Selling says we can still make profits in a down turned market. 

Short Selling is exactly the opposite of what we discussed above. In simple it's a trading strategy to make profits when a specific stock is decreasing in it's value or going down. 

Long or Short?

When an investor invests in a share expecting the prices to increase in the future, it's known as investing for Long. On the other hand when an investor invests in a share expecting the prices to decrease in the future, it's known as investing for Short. Hence the word play Short Selling is derived. 

The Process... How to Short Sell?

When an investor needs to Short Sell, his broker will lend the specific stocks to him. The stocks may be owned by the broker or another investor of the broker. It doesn;t matter since it's only lending. Then the investor can sell the stocks at the prevailing price. The amount will be credited to his account as usual. However the investor must buy the Shorted stocks again, that's only when the Shorting will be complete. So after some time, when the stock prices have gone further down, the investor can bu back the stocks he sold previously. 

Even though the prices of the stock is going down, the investor sold the lent stocks at a higher price than the price he bought again. Thus the difference being the profit from the overall transaction. Look at the following image for a better understanding.

Risks associated with Short Selling..

Share price movements

Short Selling can only be done if the prices of the share is dropping. If by chance, the share prices increase from the point where you lent them, you'll only end up making losses. Because you have to buy them back at a higher price than what you sold them for.

Margin Trading

Stock Shorting is done on borrowed money. That means money lent from your broker. This has significant risks as we have discussed in previous articles. 

Timing is everything..

This is not particularly a risk related to Short Selling only. However the investor will have to be extra vigilant about the movement of the prices to buy them back at the lowest price possible to maximize the profits. 

Conclusion:

Short Selling is a process that could help an investor in uncertain or Bearish markets. Use the knowledge with care and you'll be able to squeeze profits out of almost all the market conditions.

Happy Trading!!!

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. 

Averaging

What is Averaging?

We used to 'average' in our mathematics lessons when we were small. Remember? Well this is basically the same thing. You take two prices, add them together and divide by two (since we took only two prices). That's what averaging is.

What's the big deal?

Well, averaging may seem easy. And yes, it is. But it's implications are what that counts. As we may understand averaging is used to bring the 'average cost' of a stock down. This is called 'Averaging Down'. (there's nothing called averaging up OK?). Say we buy 100 shares at $10, the total cost would be $1000 right? So the average cost per share would be again $10 (1000/100). Say now the prices of this particular stock is going down. Alas! So we see this as an opportunity to bring our average cost down. This is how it's done. Say the price goes down to $8, we buy another 100 shares at a total cost of $800. So we add up both the investments; that would total up to $1800 ($1000+$800).  So if we calculate the average cost per share it would come to $9 (1800/200). Seems pretty good huh? Well that depends. Read further and find out why.

Good Move or BAD Move?

This is a very controversial part of the investment process. In a quick glance, reducing the average cost of a share seems the wisest thing to do. But most experts absolutely PROHIBIT to do this. Of course there are reasonable reasons. The main argument against averaging down is that you're continuously investing or blocking money on a failing stock. The more the price goes down the longer it will take to recover, so actually you'd be stuck with a bunch of loss shares till it bounces back. Positive side is that when the stock price starts to climb again, averaged down stock would have a lower break-even point. That is a lower point from where anything above that point is profits. That has a magnifying effect on profits. And on the downside, if the prices continue to dip further, that too tends to have a magnifying effect of losses. 

Should you do it?

This is not really a question I could answer for you. You should be the overlord of your investment portfolio. However for Investors, averaging down doesn't make any sense at all. Investors look at the long term and a sudden dip in the price wouldn't affect their decisions. For a trader, who looks at the short term, this could be vital. At the end of the day it all comes down to risk management. The higher the rick higher the gain. But that doesn't mean you should burn your fingers in hot water either.

Swing Trading

What is 'Swing Trading'?

Swing Trading is yet another type of stock trading where a trader will attempt to make several trades within 'one to four' days following the price fluctuations of a stock within the period. Unlike Day Traders who hold the stock for a maximum of one day, Swing traders may actually hold a stock for a small period of time, generally one to four or five days. This is a breed of traders between Day Traders and Investors. :)

That being said, we'll look what kind of technique Swing Trading involves. 

Generally, Swing Traders watch the market closely to determine the absolute perfect entry and exit prices. This is very vital for a Swing Trader since he does not wish to hold the stock more than a few days, so he has to know the profit maximizing in and out prices. Yes! This is relevant for all types of trading. But investing, which is long term, does not necessarily require an absolute perfect entry price. An investor will anyway be holding the stock for a minimum of say one year, that is an absolutely enough time period for a stock to improve despite market conditions, demand and supply etc. So it is pretty clear that Swing Traders require pin-point knowledge on market behavior. 

Another feature of a Swing Trader is that he is a more of a technical analyzer than a fundamental analyzer. Technical analyzing is about examining and reading the stock market charts, trend lines, price symbols, graphs etc. Fundamental analysis looks at the performance related information of the company. For a stock to reflect the performance of it's company, it might take some time, a resource Swing Traders don't have. Technical analysis is more real-time. We can literally watch the price lines move up and down every minute. These information provide enough knowledge for a Swing Trader to act. This requires some real guts. Fundamental analysis is a promising road, but takes time. Technical analysis is risky and equally rewarding. After-all it's all about high risk-high reward for a Swing Trader.

The right stock

A Swing Trader will have to pick a 'good' stock to do the swing trading. It is the accepted norm that the relevant company should have a large market-capitalization. Also it is very important that the price fluctuates constantly. The range of fluctuation doesn't really matter, but more-the-better. Because that will allow the Swing Trader to enter at the minimum price and exit at the highest price. 

Examine the above picture. This is an intra-day price chart of a stock. For an experienced Swing Trader this stock would've earned him a fortune. The BLUE arrows show the price increases. The ORANGE arrows show the price drops. The BLUE lines show the minimum price level and BLACK lines show the maximum price levels. This is a price chart, that's why swing traders use technical analysis rather than fundamental analysis. Within one day this stock has gone up and down 5 times. These are the kind of stocks a Day Trader would be eyeing too.

The right market

To be boldly honest either kind of market is not perfectly ideal for Swing Trading. Whether it's a sleeping bear market or raging bull market, it really doesn't matter for a Swing Trader. All that matters for him is the price fluctuations of a said stock. Any market that goes up and down would be ideal for a Swing Trader.   

So;

We have come to the end of the article. It is often said that Swing Trading is the best approach for a novice or a new trader. That might be actually true if you learn to identify the price movements, only limitation with Swing Trading is that a trader has to actually keep staring at the screen for subtle price movements. That is pretty insignificant compared to the gain you are about to receive through Swing Trading. 

Sources : Wiki

                   Investopedia