What are Short Sales in the Financial markets?

A short sale is sale in which the seller does not actually own the security that is sold. This simple statement can help you comprehend how short selling works in finance and especially when trading stocks, shares or financial securities.

How Short selling works

Borrow shares from broker
Sell the shares
Buy shares from market
Return the shares

The way this works is simple. As an investor, you anticipate that the price of shares will go down and therefore, you borrow and sell at the current market price and when the share price eventually falls, you buy from the market and return the shares. Say for example. You borrow 1000 shares of Company X, sell the shares at $20 each earning a total of $20,000. A few days later, the market price of the shares of company X falls to $17 per share. You therefore go to the market, buy the 1000 shares at a total of $17,000 and return the shares to the broker. By so doing, you have made a total of $3,000 in profit. Only works if indeed the share price goes down.

Note that an investor who buys and owns shares of stock is said to be long in the stock or to have a long position. An investor with a long position benefits from price increases (Buys low and Sells High), whereas, an investor with a short position benefits from price decreases (Sells High – buys low.)

Short interest: The amount of common stock held in short positions

In practice, short selling is quite common and a substantial volume of stock sales are initiated by short sellers. Note that with a short position, you may lose more than your total investment, as there is no limit to how high the stock price may rise.

Types of Orders in Buying and Selling Shares in the stock market.

In the previous article, we looked at three types of orders, which were, market order, Limit order and Stop order. We will continue on to look at the remaining types of orders used in trading shares.

Stop limit order

An investor can avoid the risk of a stop order not guaranteeing a specific price by placing a stop-limit order. A stop-limit order is an order to buy or sell a stock that combines the features of a stop order and a limit order. Once the stop price is reached, the stop-limit order becomes a limit order to buy or to sell at a specified price. The benefit of a stop-limit order is that the investor can control the price at which the trade will get executed. But, as with all limit orders, a stop-limit order may never get filled if the stock’s price never reaches the specified limit price. This may happen especially in fast-moving markets where prices fluctuate wildly.

Day orders

Day orders are good only during that trading day. Unless you give your broker specific instructions to the contrary, orders to buy or sell a stock are day orders. Orders that have been placed but not executed during regular trading hours will not automatically carry over into the next regular trading day.

Good Till- Cancelled orders

A Good Till- Cancelled order is an order to buy or sell a security at a specific or limit price that lasts until the order is completed or cancelled. A Good Till- Cancelled order will not be executed until the limit price has been reached, regardless of how many days or weeks it might take. Investors often use GTC orders to set a limit price that is far away from the current market price.

There you have it, all the types of orders you can use in trading financial securities in order to maximize profits or say minimize losses on a bad trading day. As always, best of luck in your trading endeavours.

Types of Orders in Buying and Selling Financial Securities or stock

Looking at the types of Orders in Buying and Selling Financial Securities or stock, we note that investors have several options when it comes to placing an order to buy or sell securities.

Types of Orders

Market order
Limit order
Stop order
Stop limit order
Day orders
Good Till- Cancelled orders

Market order

A market order is an order to buy or sell a stock at the current market price. Unless you specify otherwise, your broker will enter your order as a market order. The advantage of a market order is you are almost always guaranteed your order will be executed (as long as there are willing buyers and sellers). A market order may also be less expensive than a limit order. The disadvantage is the price you pay when your order is executed may not always be the price you obtained from a real-time quote service or were quoted by your broker. This may be especially true in fast-moving markets where stock prices are more volatile.

A limit order

A limit order is an order to buy or sell a security at a specific price. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. Limit orders may never be executed because the market price may quickly surpass your limit before your order can be filled. Some firms may charge you more for executing a limit order than a market order. But by using a limit order you also protect yourself from buying the stock at too high a price.

Must Read: What Are Short Sales In The Financial Markets?

A stop order

A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the specified price is reached, your stop order becomes a market order. Buy Stop Order — Investors typically use a stop order when buying stock to limit a loss or protect a profit on short sale. The order is entered at a stop price that is always above the current market price. Sell Stop Order — A sell stop order helps investors to avoid further losses or to protect a profit that exists if a stock price continues to drop. A stop order to sell is always placed below the current market price. The advantage of a stop order is you don’t have to monitor how a stock is performing on a daily basis. The disadvantage is that the stop price could be activated by a short-term fluctuation in a stock’s price. Also, once your stop price is reached, your stop order becomes a market order and the price you receive may be much different from the stop price

The rest of the types of orders used in trading shares, that is, Stop limit order, day orders and good till- cancelled orders in the next article.

Other Possible Types of brokerage accounts

Successful trading of financial instruments requires one to be fully equipped with enough information before diving deep into investing. We covered two main types of brokerage accounts and here comes the other Types of brokerage accounts.

Hypothecation

Pledging securities as a collateral against a loan, so that the securities can be sold by the broker if the customer is unwilling or unable to meet a margin call.

Street name registration

An arrangement under which a broker is the registered owner of a security.

The account holder is the “beneficial owner.”

Trading accounts can also be differentiated by the ways they are managed.

Advisory account – This is where an investor pays someone else to make buy and sell decisions on your behalf. The investor is not directly involved.
Wrap account – All the expenses associated with your account are “wrapped” into a single fee. it is therefore expensed as one in a single transaction
Discretionary account – You simply authorize your broker to trade for you. Almost similar to the advisory account but in this case, the broker is in charge of it all.
Asset management account – Provide for complete money management, including check-writing privileges, credit cards, and margin loans.

You may be asking yourself, is it a must to have a brokerage account for one to invest in financial securities? the simple answer is No. The long answer is that you do not need a brokerage account to invest in financial securities because a brokerage account is not a necessity. One can buy securities directly from the issuer or another alternative is to invest in mutual funds.

Margin Accounts Calculations and Solutions

We have discussed before what a margin account is. In a margin purchase, the portion of the value of an investment that is not borrowed is called the margin. The portion that is borrowed incurs an interest that is based on the broker’s call money rate, which is the rate brokers pay to borrow bank funds for lending to customer margin accounts. Here are a few case scenarios of margin accounts calculations:

Example 1: The Account Balance Sheet

You want to buy 1000 TechnologySage shares at $24 per share. You put up $18,000 and borrow the rest.

Solution

Amount borrowed = $24,000 – $18,000 = $6,000

Margin = $18,000 / $24,000 = 75%

ASSETS LIABILITIES AND ACCOUNT EQUITY

1000 WM shares $24,000 Margin loan $ 6,000

Account equity 18,000

Total $24,000 Total $24,000

In a margin purchase, the minimum margin that must be supplied is called the initial margin. The maintenance margin is the minimum margin that must be present at all times in a margin account. When the margin drops below the maintenance margin, the broker may demand for more funds. This is known as a margin call.

Example: Margin Requirements

Your account requires an initial margin of 50% and a maintenance margin of 30%. Stock A is selling at $50 per share. You have $20,000, and you want to buy as much of stock A as you possibly can.

Solution:

You may buy up to $20,000 / 0.5 = $40,000 worth of shares.

ASSETS LIABILITIES AND ACCOUNT EQUITY

800 A shares $40,000 Margin loan $20,000

Account equity 20,000

Total $40,000 Total $40,000

Example: Margin Requirements

After your purchase, the share price of stock A falls to $35 per share.

ASSETS LIABILITIES AND ACCOUNT EQUITY

800 A shares $28,000 Margin loan $20,000

Account equity 8,000

Total $28,000 Total $28,000

New margin = $8,000 / $28,000 = 28.6% which is less than maintenance margin of 30% Therefore, you are subject to a margin call.

In conclusion, Margin is a form of financial leverage. It is important to bear in mind that when you borrow money to make an investment, the impact is to magnify both your gains and your losses. You should therefore deal with margin accounts with caution.

Types of Brokerage Accounts in securities market.

What is a brokerage account, you may ask. Well, a brokerage account refers to a formal arrangement between an individual investor or firm and a licensed brokerage firm which allows the investor to deposit funds with the firm and place investment orders (buy and sell orders) through the brokerage firm. The firm then carries out the transactions on the investor(s)’ behalf. We are aware on what to consider in choosing a broker and its only fare we to it up with the types of Brokerage Accounts to open with those brokers.

We will discuss two main types brokerage accounts that you can consider opening as an investor. Check out the other types of brokerage accounts to be well equiped.

Cash account

A brokerage account in which all transactions are made on a strictly cash basis. In other words, a cash account refers to a regular brokerage account where the customer or the investor is required by law to pay for all securities’ purchases in full within two days of when a purchase is made.

Margin account

This is a brokerage account in which, subject to limits, securities can be bought and sold on credit. To expound further, a margin account is one offered by brokerages which permit investors to borrow money for use in buying securities. An investor may put down a given percentage, say 60% of the total value of a purchase and borrow the remaining amount from the broker. The broker then charges the investor interest for the right to borrow money using the securities as collateral. Take a look at the margin accounts calculations to better understand these type of account.

Given the information above on the Types of Brokerage Accounts together with the fact that you a rational investor that you are, I believe you are well placed to make the best possible account depending on your financial position.

Choosing a Broker and the Broker Customer Relationships

Who is a broker? Well, a broker is an individual or firm which charges a fee or commission for implementing a buy and sell order or orders submitted by an investor. Before diving into this, check out the basics of buying and selling shares. What is the best practice in choosing a Broker? Brokers are traditionally divided into three groups which are:

full-service brokers; A full–service broker is a licensed financial broker-dealer firm which offers extensive services to its clients, including research and advice, retirement planning, tax tips, and much more.
discount brokers; A discount broker is a stockbroker that charges its clients significantly lower fees compared to traditional brokerage firms but without providing financial advice.
deep-discount brokers: An agent that performs sales and exchanges between securities buyers and sellers at even lower commission rates than those offered by a regular discount broker. They do not offer investment advice.

These three groups can be distinguished by the level of service provided, as well as the resulting commissions charged. However, as the brokerage industry becomes more competitive, the differences among the broker types seem to be blurring. Another important change is the rapid growth of online brokers, also known as e-brokers or cyber brokers. Online investing has fundamentally changed the discount and deep-discount brokerage industry by slashing costs dramatically. The choice is therefore easy to make depending on the level of discount you prefer as an investor and the kind of investment advice you would wish to have.

Broker-Customer Relations

There are several important things to keep in mind when dealing with a broker. Note the following:

Any advice you receive is not guaranteed.
Your broker works as your agent and has a legal duty to act in your best interest. On the other hand, brokerage firms are in the business of generating brokerage commissions.
Your account agreement will probably specify that any disputes will be settled by arbitration and that the arbitration is final and binding.

Introduction to Buying and selling financial Securities

This article covers the Buying and selling financial Securities which are among basics of the investing process. We already know what an investment is as discussed earlier including the steps in the investment process. We begin by describing how you go about buying and selling securities such as stocks and bonds. Then we outline some important considerations and constraints to keep in mind as you get more involved in the investing process.

Getting Started Buying and selling financial Securities

I will try to break the process down and make it as simple as possible to help you understand what happens in the investment environment. This can be made simple by the diagram below. Buying and selling financial Securities

Open a brokerage or Trading Account; The first step is to make sure you have a trading account in which all the trading transactions will be taking place. Check out guidelines on chosing a broker so that you dont make a mistake in this initial step. Be keen on the type of brokerage account you open.
Deposit money into the account: Once in possession of a trading account, the next step is to avail funds into the account to offset the trading activities.
Buy Securities; The next obvious step is to buy stock. the best basic practice is to buy securities that are underpriced in relation to the market value at that time and off coz other factors come into play.
Sell Securities: In trading securities, assuming you made the best decision in buying the securities, you are required to sell the securities in possession once the prices go up. “First you buy a stock. If it goes up, sell it. If it doesn’t go up, don’t buy it.”~ Will Rogers.
Withdraw money; When you are satisfied with the profits from trading and wish not to continue with trading, you can withdraw your funds from the trading account. You can as well do withdrawals in between trading sessions without necessarily clossing the account. This solely depends on the respective broker you are dealing with.
Close account: This is obviously the last of the steps if you wish to discontinue Buying and selling financial Securities. Do close your account after withdrawing your gains.

Objectives and Constraints of Institutional Investors

Tha various Objectives and Constraints of Institutional Investors. Who are institutional investors? It is worth mentioning that the institutional investors include mutual funds, pension funds, endowment funds, insurance companies and banks.

Mutual Funds

The role of mutual funds is to pool together funds of investors who share a common investment goal or interest and invests them in financial assets as per its investment objective.

2. Pension Funds

Pension funds receive contributions from the firm, its employees, or both and invests those funds for the respective contributing parties.

Defined Benefit – promise to pay retirees a specific income stream after retirement. Risk resides with the employer
Defined Contribution – Employees contribute to a pension scheme while employed. No guarantee from the employer regarding the size of retirement income stream. Risk resides with the employee.

3. Endowment Funds:

Endowment funds represent contributions made to charitable or educational institutions. it is an investment fund set up by a foundation which periodically makes withdrawals from the invested capital.

4. Insurance Companies

An insurance company is that which pools together clients’ risks to make payments more affordable for the insured in the event of losses due to the insured peril. the types of insurance cover include:

Life Insurance Companies

–Earn rate in excess of actuarial rate

–Growing surplus if the spread is positive

–Fiduciary principles limit the risk tolerance

–Liquidity needs have increased

Nonlife Insurance Companies

–Cash flows less predictable

–Fiduciary responsibility to claimants

–Risk exposure low to moderate

–Liquidity concerns due to uncertain claim patterns

–Regulation more permissive

Read On: How Interest Rates affect Investment Decisions

Banks

A bank can be defined as a financial institution licensed to accept customer deposits and advance loans too. Banks can also offer financial services which include wealth management, safe deposit boxes and currency exchange. They;

Must attract funds in a competitive interest rate environment
Try to maintain a positive spread between their cost of funds and their return on assets
Need substantial liquidity to meet withdrawals and loan demands
Face regulatory constraints

Role of Short Term Investment Vehicles, advantages and disadvantages

The Role of Short Term Investment Vehicles can be well understood if the terms are broken down. The term “investment vehicle” refers to any method by which individuals or businesses can invest and, ideally, grow their money. A short-term investment, also called a temporary investment or marketable security. It is a debt or equity security that is expected to be sold or converted into cash in a period less than one year.

Role of Short Term Investment Vehicles

Short term investment vehicle therefore refers to kind of investments that are generally liquid and mature quickly. What therefore is liquidity? Liquidity is the ability of an investment to be converted into cash quickly and with little or no loss in value. It can be deduced that the role of the short term investment vehicle is to make the investments liquid. The primary reason for the need for liquidity is for emergency cash reserve or to save for a specific short-term financial goal.

Advantages of Short-Term Vehicles

High liquidity; This makes it easy for investors to convert assets to cash. The most liquid asset, and what everything else is compared to, is cash. This is because it can always be used easily and immediately.
Low risks of default; this lowers the chance of default by companies or individuals on the required payments on their debt obligations. Lenders and investors are exposed to default risk in virtually all forms of credit extensions and hence the need for short term vehicles.

Advantages of Short-Term Vehicles

Low levels of return; A return on an investment is the gain or loss on a security in a particular period. Short term investments tend to have low levels of return because of the relatively low risks involved. The term to maturity also impacts on the levels of return. The lesser the period the lower the returns.
Loss of potential purchasing power from inflation; Purchasing power refers to the number of goods or services that a unit of currency can be purchase. Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. The returns from a short term investment may not have the same purchasing power they had due to inflation over the investment period.