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!!!

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.

Penny Stock Trading

   

What are Penny Stocks?

Penny stocks may have different definitions in different countries. This is because a Penny stock is kind of a relatively low value stock among the lot. Let's look at it in much clearer sense.  A Penny stock can be a stock priced lower than $1.00; this is the accepted definition is US (according to Wiki). But as I have mentioned above $1.00 could be a considerably larger amount in another country. So they may also define penny stocks as low valued stock compared to the prices of stocks in the respective country. (For example; In Sri Lanka a Penny stock is usually around Rs. 1.00 - Rs. 10.00). In UK it's below £1. 

Features..

However the definition varies from country to country the ground rule is that Penny stock is a stock that is of very low price/value compared to other stocks in the market. So it's generally understandable that these stocks are heavily traded. That is penny stocks can be seen traded in large quantities simply because of the fact that penny stocks give the investor a much more higher purchasing power. 

Also another feature is that these stocks are prone to constant 'manipulation'. We may often here this in the market. This is where large investors buy extremely large number of shares of penny stocks and use media to publicize it. This will lead to a sudden increase in demand for the stock leading to an unnatural rise in the price. Sometimes this rise may count up to 50% gain in one day or even less. The downturn is that this not a permanent increase. The price will fall drastically to it's original level when the big investors sell their portion with a huge gain (due to the rise in price). This is called 'Pump and Dump'. (This will be discussed further in coming articles). The plus side for the small investor is that if you're careful and observe when the big fish hunt for the stock, you can jump in too. That way you can ride the price wave and get out of it when the big fish gets out. This will need constant monitoring of the market, but it's worth a lot.      

However for a day trader Penny stocks could be a gold mine. Simply because Penny stocks tend to fluctuate more than any other stock. Also the negative side is that Penny stocks usually represent small, newly established or companies that are not financially sound. So the risk is there that a Penny stock company could go bankrupt overnight and make you suffer. 

So I think you have a basic idea of what penny stocks are and how they could help you in winning your Stock market game. 

References : Wikipedia

Dealing with today's distinctly dicey market - 15 Rules For Investing Success In Any Market

Keep the following 15 rules in mind that could help you hold your head high in times of sudden losses or for general investing purposes:

1) Think twice protecting against the downside (price downs), before daring to look up (price ups) when picking shares.

2) The norm is "Volatility does not represent risk, but creates opportunity". This is true. But go through the numbers (financial statements) and decide on your free will.

3) Investing when a share is neglected or out of focus is the best. The prices will be low and will produce you with enough gains in the long run.

4) Buy companies with excess cash flow.

5) Watch out for value, then make sure the basic figures tell you a clear story about the future of the company.

6) When digging further, use a Warren Buffet-like discounted cash-flow method to help determine underlying value.

7) Ask yourself if you're prepares to buy the whole company for yourself if you could. If the answer is 'NO', probably you should move on.

8) Don't fall for the reputation of the company or the centuries of years it has been in existence. The market has numerous examples for incidents where such companies have fell overnight. Always look at the current performance.

9) Don't listen to the directors if the reports show a complete over turn. If the numbers do stack up, take what the directors say with a healthy dose of salt. The same goes for brokers' forecasts.

10) If directors are buying shares, keep your eyes open.

11) No matter how hard you try and no matter the market condition, you will make losses. Accepting that will ease your pain. The general norm is that in stock trading you should always be prepared to take 20% loss anytime.

12) Make sure you understand how the company makes its profits and the essence of what it does.

13) Stick to your investment strategy. Pay less attention to market gossip and hush hush..

14) John Maynard Keynes said: "The market can stay irrational longer than you can stay solvent". But this is only true if you've overdone it. Don't invest more than you can truly afford to lose. (Margin trading is really not necessary)

15) Last but not the least... BE PATIENT.. You bought a stock, it's prices are not moving? Hold on. A price can never stay the same forever. If there's nothing interesting to buy. Just wait. Don't just go tie yourself in some good-for-nothing shares. Always be patient. 

Published in Investing Strategy

What is the Stock Market/Stock Exchange?

Stock Market

Stock Market or commonly mentioned as Stock Exchange is the market where stocks/shares of listed (Quoted Public Limited Companies) companies are being traded or bought or sold among buyers and sellers. It's as simple as that. But the process is much more complicated than that. 

Let's see how a company enters the Share Market. There are basically two ways, namely;

1) IPO - Initial Public Offering

2) SPO - Secondary Public Offering

IPO

An Initial Public Offering is where a company ENTERS the stock exchange with a share issue to the public. If the share issue is successful (meaning if all shares are bought by the public) it will be considered a valid share issue and the company name will be listed in the stock exchange and allowed to function as a PLC. However if the shares are not fully subscribed (bought) by the public, the IPO will be considered void or a failure and the Stock Exchange will not allow the company to proceed with it's business activities. 

Entering the market with an IPO involves some risk due to the above factor. If the public doesn't feel like the company is a safe and worthwhile investment, they will not buy the shares and the company will be forced to shut down. Why? Because a share issue is the main mode of capital generation for a company and when it comes to an IPO, it is the step which a company tries to generate capital to START a company, so if that fails there's simply no money to start the business. To avoid this companies use a method called "Under Writing". Under Writing means prior to an IPO, the company gets a bank to sign a deal with the company to purchase the shares of a company in the event the public refuses to buy the full amount of shares. This deal offers security for the company as-well-as some assurance for the public that if the bank trusts the company we should not worry too. So Under Writing works in those two ways and help IPOs get successful.

SPO

Secondary Public Offering is where a company ALREADY LISTED in the Stock Exchange issues shares to the public. A company could have many number of SPOs in it's life time. All the share issue except for the first and foremost share issue will be falling under the category of a SPO. SPOs generally do not involve very much risk so Under Writing agreements are not of necessity and even if a SPO fails, it will not threaten the existence of the company. Usually a company goes for a SPO to generate additional capital maybe for expansion activities, new researches and developments and activities like that. So that's about the two main methods a company gets enlisted in the stock exchange.