Naked short selling is not only considered to be bad practice, but has also been deemed illegal by the SEC as of 2008. While not all types of naked short selling is illegal, the SEC have devised very strict regulations, as this practice is very often abused in order to drive prices of certain stocks down more than they should.

A nice metaphore to naked short selling is a person who wants to take a loan in order to buy something.  Websites like logbookloancentre.co.uk offer loans to people with bad credit. However they take collateral for their loans, in the form for example of a loan against car. If the customer was for example to borrow this money without making any collateral security, this would be the same as if they were performing a naked borrow, as they are taking the money from the loaner and immediately using it for something else. If the loaner was to come back to them after a month and ask for the money back, there would be no guarantee that the borrower would be able to pay.

Normal short selling, as discussed previously, is a tool that allows a trader to take a negative position on a stock which he or she predicts will reduce in price in the future. The proper course of action would be that the trader borrows the stock from either another trader or from the broker, and immediately sells it. If the price of the stock goes down, the trader can then cover the short by buying the stock at a lower price and returning it to whom he or she borrowed it from, at the original price. The profit would then be the difference between the short price and the cover price.

If however the price increases, after the trader shorts, a loss would be incurred, since the trader would then need to buy back the stock at a higher price than borrowed in order to cover the trade. The risk involved in short selling is theoretically unlimited, as there is theoretically no limit to how high the stock can rise, while when buying a stock the lowest price it can reach is $0.

This is also why short trading is considered riskier than regular “going long”. It is actually considered similar to margin trading, since if the stock makes an unexpected surge in price you stand to lose more than you initially invested, and in fact perhaps more than you have in your entire stock trading portfolio, resulting in your broker to require you to deposit more funds in order to cover a negative balance.

There are plenty of reasons why traders and investors may turn to stock loans. For example, some people may need to free some cash for the time being, but they do not want to sell the stock they own just yet, so they turn to a loan instead. This is usually the case for those who own a company that has been recently listed, or for executives who receive stocks as part of their revenue plan, and so on. In such cases, it’s important to continue to own the shares, in order to maintain the control over the company, or the number of votes on the board. However, that also means that a lot of cash is tied up in a stock that may not be very profitable for the time being, so a loan is the best solution to diversify the portfolio without losing control.

Stock loans can be very important sources of financing for corporations that have a low share value. Usually, it’s very difficult for such companies to obtain a loan against their stock from traditional lenders, who do not want to deal with shares that value less than 4 or 5 dollars each. But there are stock loan programs that cover all types of shares, even those priced at one cent, so business owners may use that as an option to access quick funds when they need to.

The reason why stock loans are so popular is a type of speculative trading called short sale. Basically, traders borrow shares (using cash as collateral) and sell them. Then they wait until the prices of those shares decrease, and they buy them back. They return them to the original owner, cover the associated fees and interest rates of the transaction, and keep the remaining profit. Needless to say, this requires a lot of careful planning and a perfect understanding of the market, not to mention that a bit of luck every now and then doesn’t hurt, either.

Short selling is very common these days, but not everybody is happy with it, and its critics argue that it should be banned completely, because it drives some companies’ stock down artificially. Every now and then, governments ban short selling for a period of time – though a definitive interdiction is unlikely. If that happens, the stock loans tend to freeze as well for a while, because there is little interest on the market to speculate on the short term, so nobody wants to take any chances.

Stock loans extend over very short periods of time, to prevent the accumulation of interest, which would cut even more into an already uncertain profit margin. They are also quite severely regulated by various financial authorities, in order to prevent fraud – though there are still many shady businesses that advertise this type of loan, so it’s always important to check and double check before joining any such program.

The Basics of Margin Trading

When you buy on margin, you take a loan to pay for the stock. Usually, this loan comes from your broker, though there are other sources of financing available as well. Most brokers will require an initial investment from your side, which is usually 50% of the total value of the account, though it may be more or less, depending on their own internal regulations. For the entire duration while the account remains active, you will be required to maintain a minimum amount – so at some point you may have to add more cash, especially if things don’t go as planned.

You can keep the purchased stock for as long as you want, but, once you sell it, the money will first go towards repaying the loan, and you can only collect any profit left after that. In addition, as with every other type of loan, there will be interest rates to cover, and, needless to say, the longer it takes you to repay your debt, the more interest it will accumulate.

The Risks of Margin Trading

Stock trading is typically a bit risky; taking a loan is never one hundred percent safe, something may still go wrong at any point before you can repay it in full. The combination of the two is, of course, very risky. As a matter of fact, margin trading has often been compared to gambling, and the traders have been likened to professional poker players: you need nerves of steel in order to make a profit and pay up all your debts on time.

Using a loan for trade stocks makes sense only on the short term. The longer you wait, the more expensive the loan will become, and the chances of covering it from the trading profit are slim. That is why the system of lending from the broker was implemented in the first place: otherwise, it’s nearly impossible to get a decent loan with a good interest rate on such as short term, so the options are quite limited.

The importance of researching ever aspect of margin trading cannot be stressed enough. This is a type of deal recommended only for experienced traders, who have already obtained profits from other ventures, and who have the necessary resources to cover any potential failures. The area is heavily regulated by the Securities and Exchange Commission (SEC) and by other financial authorities especially in order to protect new traders, who might feel tempted to bury themselves deep in debt, dreaming on a day when the profits pile up by magic. You must understand these rules and comply with them; failure to do so (for example, by using alternative sources of financing, such as other types of loans, there weren’t meant for stock trading in the first place) can only lead to debts, not profits.

To get a better understanding of an ETF it’s important to explore what is an index.  An index is a method used to measure the value of a section of the stock market.  Think of this as a tool to describe the performance of a sector or the stock market as a whole.  Listening to a business news channel such as CNBC you will hear phrases such as “The Dow is up 4% today” or “The S&P 500 is down 1%”.

It is impossible to invest in an index directly since they are mathematically constructed by financial information companies such as Dow Jones Index and as such only exist on paper.  One of the most widely used indexes, The Dow Jones Industrial Average tracks the performance of a weighted average allocation of 30 of the largest American companies.  Another large index, the S&P 500 tracks the performance of the 500 largest American companies that trade on major exchanges.  This is where ETFs come in!  An ETF is an investment fund that is composed of the exact same stocks in the exact same proportion as an index.  If an index rises by 1.5%, then the ETF will rise by the same amount because the ETF is a real life trading instrument that is identical to the index.  ETFs trade on stock exchanges such as NYSE and Nasdaq and can be bought and sold just like a regular stock.  ETFs are managed by investment management firms such as BlackRock who manages some of the largest and most popular ETFs.

The largest and most known ETF is the S&P500 index which trades under the ticker “SPY” and is operated by the second largest investment management firm in the world, State Street Global Advisors.  The stated objective of the ETF is to be “a fund that, before expenses, generally corresponds to the price and yield performance of the S&P 500® Index”.  An investor would want to invest in ETF such as SPY if they believe that the US companies that compose the index will experience growth.  Investing in the ETF directly gives the investor access to a diversified portfolio as buying SPY represents holdings in all 500 companies.  ETFs are similar and often compared to mutual funds in that respect with the key difference being that ETFs trade on stock exchanges while mutual funds do not.

Looking at the chart below we see that the ETF has fulfilled it’s objective of providing a return approximately equal to that of the index. SSGA charges a small annual fee for investors that hold the ETF of around 0.2% of the asset value.

Source: https://www.spdrs.com/product/fund.seam?ticker=spy

 Some of the other widely known and used indexes and their corresponding ETFs are:

Conclusion

ETFs provide investors with the ability to easily hold a diversified portfolio of companies.  Investors can also gain international exposure through the use of ETFs as many foreign indexes have corresponding ETFs that trade on American exchanges.  For example the MSCI Brazil Index Fund trades on NYSE under the ticker EWZ.  The MSCI Tawain index fund trades on the NYSE under the ticker EWT.  Exposure to international ETFs can be specific to an industry such as the India Infrastructure ETF that tracks 30 Indian based companies that compose the Indxx India Infrastructure Index.  The ETF trades on NYSE under the ticker INXX.

ETFs are far more complex and the table above includes some of the most common ETFs that are straightforward and easy to understand.  In recent years ETFs have grown complex in nature for example there exists ETFs that are designed to yield returns that are triple (300%) the inverse of an index.  These types of ETFs are not intended for novice investors as they are considered to be risky.  By following the ETFs in the table above an investor can find suitable investment choices that are used already by millions of investors in regular brokerage accounts, retirement accounts and pension plans.

About the author: Jayson Derrick is the director of trading at PromptTrader, an international proprietary trading firm that trades in US equities and options. 

What are Binary Options?
Binary options allow money to be made by simply choosing whether the price of an underlying asset will be higher or lower than the current ‘strike’ price after a chosen amount of time. Similar to traditional options, the expiry time will determine whether the binary option has closed in or out of the money. This is the reason why they are also known as “all-or-nothing” options and this simplicity is also one of the reasons that they are attractive to trade. The expiry time, as well as the amount of money that a trader wants to invest in each option is highly flexible. Binary options can be purchased with anything from as little as 60 second’s expiry to one month.

What makes them Different from Forex?
Binary options are different from other forms of trading for several reasons. First, the profit and losses are predetermined before each investment. This means that binary options traders know exactly how much they are set to win or lose before entering a position. Winnings tend to be around 80% of the initial investment and losses can be between 85-100% of the investment depending on the broker. Secondly, because the losses are pre-determined, binary options traders don’t require stop-loss or take profit levels in their trading. The binary options will simply move “in the money” or “out of the money” depending on whether they are “call options” (long) or “put options” (short) as they move above or below the strike price. Binary options therefore do not rely on the degree to which they go beyond the entry price but can close fully in profit just one pip above or below the entry, of “strike”, price.

Choosing an Expiry Time
Binary options expire either “in the money” or “out of the money”, and in a few cases at the precise price that they were entered. The expiry time is essential to the options being profitable as a movement “out of the money” a few seconds before expiry will result in the a loss even if they have been “in the money” for almost all of the time before this. Binary options traders have a wide range of times to purchase options and use similar techniques to forex and stock traders to predict if price will be higher of lower at any one time. Although many brokers allow options to be closed prior to their expiry for a lower profit, the full profit can only be realised using the original expiry, or using a “rollover” feature offered by some brokers to extend the binary options’ life.
To further understand binary options and the different trading methods, I suggest you try the binary options school available on Banc De Binary

While the S&P 500 futures contract represents a portfolio of stocks the final delivery is actually a cash settlement of the difference between the original transaction price and the final price of the index when the contract terminates.  This means that a buyer of the contract will not receive an allocation of stocks of 500 different companies but instead will receive a cash profit from the seller or have to pay for the losses to the seller.  This contrasts with physical commodities such as gold, silver or oil that is physically delivered to the buyer when the contract is terminated.  Futures expire on the third Friday of the last month of each quarter (March, June, September, December).

The S&P 500 has two contracts that trade on the CME, the most popular being the E-mini.  The contract size of the E-mini is $50 times the current price of the index, while the “big” S&P 500 is $250 times the index.  The trading volume in the S&P 500 is far greater than the combined traded dollar volume of the underlying 500 stocks.  Futures are much more active than equities as they trade 23 hours a day five days a week with a daily trading session occurring in an open outcry within the trading pits at the CME.

By following the S&P 500 futures traders and investors will notice that stock sectors and individual stocks will tend to follow or mimic the movement of the futures.  Many high frequency traders will listen to a squawk box in which an announcer is physically located in the trading pits who gives a “play by play” of the floor activity.  Many traders find that this gives them an edge as the announcer will often yell out key activity such as “Goldman’s coming in to buy”.  For the most part when Goldman Sachs is buying you want to be buying also.  Investors and traders can monitor the S&P 500 futures as well as other stock index futures by going to http://www.bloomberg.com/markets/stocks/futures/

About the author: Jayson Derrick is the director of trading at PromptTrader, an international proprietary trading firm that deals  in US equities and options. 

 4:00AM- 9:30AM.  Many investors are surprised to learn that the ARCA exchange begins executing orders as early as 4:00AM.  The pre-market trading session is very illiquid meaning the amount of shares being traded is very small, which can result in wild price fluctuations.  Investors and day traders take this time to read up on any news that has happened overnight and to check in on international markets and commodities.

 9:30 –  Market order auction.  This will be explained in further detail later

 9:30AM –9:45AM.   Market open.  At the NYSE a VIP guest (such as business leader or foreign dignitary) will ring a symbolic bell to indicate the beginning of the trading day at exactly 9:30.  The first 15 minutes of trading is the time when volatility is high as many day traders and automated trading machines begin entering large positions.  It is recommended that longer term investors not initiate a new position at this time.

 9:45AM-11:00AM – Morning session.  During this time the market has calmed down a bit and trading activity is at normal levels.

 11:00AM-2:00PM.  Lunch time.  During this time the market trades at a pretty slow level when compared to the previous few hours.  Many high frequency traders have either finished trading for the day or will not be taking a long break as volatility and volume is not as lucrative and profitable.

 2:00PM-3:30PM.  Afternoon session.  During this time volume picks up slightly.  At this point day traders start to plan out their strategy for the rest of the trading day including when to sell remaining positions.

3:40PM: Closing imbalances will be released to the public.  This will be explored in further detail later.

3:40PM-4:00PM.  Closing session.  Volume and volatility will pick up at this time as many traders are executing their end of day strategy.  Portfolio managers and ETF owners can also be active in large volume if they have to rebalance their holdings by either adding or removing a stock in large numbers.

4:00PM-7:00PM.  Post-market.  Like the pre market trading session volume and liquidity are much smaller and anyone trading in this atmosphere puts themselves at tremendous risk.  ARCA will accept orders until 7:00PM.

Investors need to educate themselves on the different characteristics of the trading day.  More importantly an investor needs to understand that high frequency trading accounts for a significantly large percentage of trading activity and that it can be very dangerous to trade during certain times of the day.  Long term investors can still earn large returns in the market. However, “going up” against professional traders can result in minor setbacks such as a higher buying price or lower selling price.

About the author: Jayson Derrick is the director of trading at PromptTrader, an international proprietary trading firm that deals  in US equities and options. 

The SEC
The SEC was established in 1934 with the objective of promoting full public disclosure to protect the public against malpractice in the stock market.  By doing so the SEC maintains the integrity of the stock market.  The SEC has authority from the U.S Congress to bring civil enforcement actions against individuals and companies that are alleged to have committed accounting fraud, provided false information, or engaged in insider trading and many other violations.  The SEC has used this power many times against well known companies, CEOs, hedge funds, and even against the NYSE itself.  In September 2012 the SEC charged the NYSE with violating regulation that prohibits the practice of sending market data to proprietary customers before the general public.  The NYSE agreed to a $5 million penalty and undertakings to settle the SEC charges.

The FINRA
The Financial Industry Regulatory Authority (FINRA) is responsible for regulatory oversight of all securities firms that do business with the public.  FINRA is a private corporation and often mistaken for a government agency.  FINRA also oversees firms that offer professional training, testing, and licensing of registered persons, arbitration and mediation, market regulation by contract for the major exchanges.  FINRA oversees about 4,400 brokerage firms, about 162,930 branch offices and approximately 630,020 registered securities representatives.  FINRA’s most well known product is BrockerCheck, a free tool to help investors research the professional backgrounds of brokerage firms, individual brokers and financial advisors.

Without financial regulatory bodies there would be no confidence in the market, and the entire financial system would be full of corruption  and would not have any legitimacy.  Every country has their own regulatory system which is required to attract international investors with rules and regulations that promote fairness in local markets.

About the author: Jayson Derrick is the director of trading at PromptTrader, an international proprietary trading firm that deals  in US equities and options. 

Short selling is the act of borrowing a stock and simultaneously selling it in the market with the intent of buying back the shares at a later date.  The stock is borrowed automatically from another client within the broker’s system.  There is often a small fee involved which is paid to both the broker and the other investor that agreed to ‘loan’ out the shares to someone else.  In order to short a stock, an investor will place a short sell order on their brokerage platform.  The process of buying back the shares is referred to as “short covering”.  If the stock drops in price, the investor makes a profit, but if the stock rises then the investor will lose money.  A simple example will help explain this.

Suppose Rebecca shorts 100 shares of Amazon.com which trades on the Nasdaq exchange at a price of $250 a share.  If in 2 months the stock has dropped to $200 a share, Rebecca makes a profit of around $50 a share as the broker charges additional commission and other fees.

Short sell revenue: $250*100 = $25000

Short covering cost: $200*100 = $20000

Profit: $25000-$20000=$5000

Suppose the price of Amazon.com has appreciated and in 2 months the stock is now trading at $300 a share.  Rebecca is now losing $50 a share and following a strict risk management system she has decided to cut her losses.

Short sell revenue: $250*100 = $25000

Short covering cost: $300*100=$30000

Loss: $25000-$30000= ($5000)

Short selling is considered to be risky as the losses involved are in theory limitless.  If Amazon.com were to skyrocket to $500 or more a share, Rebecca would face huge liabilities and would be forced to cover her losses.  This is why many brokers require investors to be more informed and investment savvy before being allowed to short sell stocks on their account.  In addition, brokers can also stipulate their own risk management guidelines and reserve the right to cover a client’s short position if they deem the losses are becoming too large.

About the author: Jayson Derrick is the director of trading at PromptTrader, an international proprietary trading firm that deals  in US equities and options.