Wednesday, March 10, 2010

Short Interest Ratio (Days to cover)

What is the short interest ratio?

We already talked about short interest, expressed as either the net number of shares sold short that are still outstanding (i.e. they have not yet been covered) or as a percentage of the company's float.

Short Interest

What is short interest?

The number of shares of a certain company that have been sold short and that are still outstanding (i.e. they haven't been covered yet). This can be expressed as the total number of shares sold short or as a percentage of the float (the float is the number of shares that are available to be traded by the public).

Tuesday, March 9, 2010

Short Squeeze

What is a short squeeze?

As we have seen, you can borrow shares that you don't have so that you can sell in the market and open a short position. While you have the short position open, you owe those shares to the entity that you borrowed them from (usually some sort of pension or mutual fund that does securities lending). Assuming there is no forced buy-in, you close out the position by eventually (when you decide) buying back to cover, thereby returning the shares to the original lender, netting you either a profit (if the shares declined) or a loss (if the shares rose).

Monday, March 8, 2010

Dividends on shares sold short

What happens to dividends and special distributions when a short position is open?

While a short position is open, there might be a scheduled dividend payment by the corporation to its shareholders or a special distribution of any kind (cash, stock, spin-offs, etc.). In this case, there are three participants, the original shareholder (who lent you their shares), the short seller (you), and the new shareholder (whoever bought the shares you sold short).

Voting rights on shares sold short

What happens to voting rights for shares that are sold short?

Normally, the shareholder lending out the shares will give up its voting rights to those shares while they are out on loan. This is done so that the voting power is not artificially increased just because there are shares that are borrowed to be sold short. The new shareholder (the one who bought the shares sold short) will have all the voting rights that said shares entitles him/her to. If the original shareholder needs to exercise their voting rights then they would have to call back their shares and finalize the loan so they can use those shares to exercise their voting rights. This is different than dividend rights since those usually go to both the original shareholder even while their shares are out on loan and also to the new shareholder (the one that just bought the shares that were sold short).

Capital gains on short positions

Is a profitable short position considered a capital gain?

Just like a long position any profits or losses you make (after you have closed out the position) are considered capital gains or losses and taxable as such. Furthermore, if you are in the US, short selling profits are always considered short term capital gains and taxed as such. Canada does not make this distinction between short and long term capital gains.

Uptick rule for short selling

What is the uptick rule?

In the past, you couldn't sell short when there was a down tick (i.e. the stock's last move in price was down in price). This was to prevent stocks that were already going down from going down even further because of short sellers. Starting in 2007 this rule was eliminated, although it might be reinstated either fully or in a modified version.

Short Selling Fees

What does my broker get when I sell short?

There is a commision per transaction that goes to your broker (when you open or "sell short" and when you close out or "buy to cover" the position). Your broker also gets additional compensation in the form of rebates by securities lending firms and also as margin interest if you use margin to open or maintain your short position. This is done as follows:

Your broker will have to get the shares for you to sell on the open market so they need to borrow them from a willing lender (this is called Securities lending and is a way for a long-term shareholder to generate income from shares that will remain in the account by lending them out).

Margin call on a short position

What is a margin call?

When you buy stock on margin (i.e. when your broker lends you money to buy stocks) you need to keep a percentage of the whole position in liquid assets (i.e. cash and marginable securities) to ensure that you will pay off the loan made to you. Since what you buy with the borrowed funds is actually a security that varies in price daily, there is a possibility that the money that was loaned to you was used to buy stocks that declined in price. When this happens, since the outstanding loan is for the same amount as originally and you have started to lose money, there might be a situation where your liquid assets (cash and marginable securities) become less than the minimum required. In this case your broker will issue a margin call, indicating to you that you should deposit additional cash and marginable securities to make up for the shortfall. If you fail to do so, your broker will close out your positions bought on margin at their convenience to recover the original loan made to you.

Sunday, March 7, 2010

Forced buy-in (short position)

What is a forced buy-in?

When you initiated your short transaction, there were shares that were borrowed for you to be able to sell in the open market. Sometimes the lender of the shares will need their shares back and will call their shares back. Your broker will try to return said shares from another pool of willing lenders or from its own inventory but sometimes it will be necessary for you to buy back the shares so that they can be returned to the original lender. This is called a "forced buy-in" and is a risk you take on when initiating a short position. It is possible that your whole position or a portion of it is forced to be closed out (regardless of the current profit or loss on it).

Closing out a short position

When do I have to close out a short position?

A short position is closed out with a "buy to cover" transaction in most cases when you decide to. The only exceptions are when you are issued a "forced buy-in call" or a margin call that you didn't deposit additional funds into.

Short Selling Mechanics

How do I actually short a stock?

Your broker's interface will include an optional similar to "Buy" or "Sell" which will be called something like "Short" or "Sell Short" (to open a short position) along with "Buy to cover" (to close out a short position). This can be done (broker-assisted) over the phone as well, usually for an extra fee.

Stocks that can be sold short

Can I short any stock I want to?

Your broker will indicate the restrictions that there are in terms of the stocks that you can short. For the most part, stocks with low stock prices will be difficult to short (or outright impossible to, depending on your broker). Also, there is a daily list of stocks that are "hard to borrow" and these ones might have additional restrictions (such as additional margin requirements).

Short Selling Account

What type of account do I need in order to sell a stock short?

There are most likely two types of accounts that your broker will offer you: a cash and a margin account. In order to be able to short stocks you will need to have a margin account. This means that your account will be able to use funds loaned to you (at interest) by your broker. This is necessary for your broker to keep your short position open because you are going to borrow a stock, sell it and receive the proceeds from it but will still need to eventually "cover" this position by buying back to cover.

Short Selling Risks

Why do people consider short selling to be riskier than buying ("going long") stocks?

As with most things in the financial markets, the answer is yes and no. Theoretically at least it is true that short selling is inherently riskier. A stock can go higher indefinitely (making your potential loss infinite at least in theory) while it can only go down to zero on the downside (limiting your potential profit to 100%). In reality though, things are a little bit different (and more short selling-friendly) because of the following factors:

Short Selling Questions

This article will attempt to answer questions that you may have once you do start selling stocks short. We have already talked about what short selling is conceptually and here we will try to tackle questions regarding the actual mechanics of short selling.

I assume that you have carried out sufficient fundamental and/or technical analysis (depending on your trading style) and that you have already decided to take a short position.

Thursday, March 4, 2010

An introduction to short selling

What is short selling? 

Most people when they hear about the stock market think of the old cliche "buy low, sell high" meaning that in order to make money in the stock market one should try to buy a stock at a certain price, then hold for some time and sell later for a higher price. Although that is a good way to net profits in the stock market, that is far from the only way to do so. If you do your research and find a stock that you think will go higher, then what you do is buy it, hold until it appreciates and then sell it at a higher price, pocketing the difference between the buying and selling price. Well what if based on your research (fundamentally or technically based) you have reasonable grounds to believe that a stock will go down? Is there a way to profit when a stock price goes down?

Wednesday, March 3, 2010

Trading Volume

What is trading volume and why is it important?

Technical analysts consider only two pieces of information relevant to determine the potential future price behaviour of a security (and therefore, potential trading strategies for it): the stock price itself and its trading volume both analysed over time. As you can see, trading volume is a very important technical tool and whether you base your strategies around fundamental or technical analysis it is imperative that you understand and interpret what it might reveal about a potential stock or any other financial instrument that you might be about to invest in or trade.

Monday, March 1, 2010

Bid-ask spread

What is the bid-ask spread?

You have done your analysis, have some money ready to be put to work and have decided to buy a stock because you have reasonable expectations that it will go up eventually netting you a profit.

So you go to your broker's interface and locate the stock that you intend to buy (by using its ticker symbol or looking it up) and decide to get a quote on it. Immediately you notice that there is a lot of information (last trade, change from last trading day's close, volume, etc) but most strikingly you notice that for the stock you are looking at you have three prices: the price that the stock last traded at, a bid and an ask.

Thursday, February 25, 2010

Enterprise Value

What is Enterprise Value?

A public corporation accesses the capital and debt markets to get funding to run its business but in the process their equity (stock) and liabilities (debt) now have several public owners. Let's assume that a group of investors wanted to take a company from public to private, how much money would they have to theoretically come up with to do so?

Wednesday, February 24, 2010

Levered and Inverse ETFs

How do you use levered and inverse ETFs on a day to day basis?

We have talked about the importance of using ETFs as diversification tools and also to gain quick exposure to an index, a market, a commodity and plenty other financial items. We also talked about the existence of levered ETFs (ETFs that use leverage to get a magnified exposure to the instrument they replicate) and also inverse ETFs (ETFs that move in a directly inverse way to the underlying instrument, which is basically the equivalent of getting short exposure).

Tuesday, February 23, 2010

Using ETFs

How can I use ETFs in my trading?
We already talked about what an ETF is and what it represents, now we'll talk about how to use them in your trading

ETFs are an excellent way to gain exposure to the price of something (an index, a sector, the price of a commodity, the list is endless) without going through the difficulties of acquiring the actual underlying securities. We talked about how just by buying SPDRs (ticker: SPY) you are actually buying the 500 components of the S&P 500 index. Now we will talk about more complex ETFs and how I use them in my actual real trading. Nowadays I buy ETFs on a regular basis mainly because:

Exchange Traded Funds (ETFs)

What are ETFs and how can I invest in or trade them?

You know what the S&P 500 index is. It is an index that tracks the performance of a basket of 500 of the largest US companies. It is a number that can be used to know whether the US stock market was mostly up, down or unchanged. The weight given to each company in the index is not even but rather determined based on the free float market capitalization so that large companies have a correspondingly large influence on the index.

Sunday, February 21, 2010


You have probably heard the phrase about something "paying dividends" meaning that something was succesful at what it set to achieve and is now generating tangible results but how is it applied when we are talking about stocks and the stock market? 

Dividends are payments from corporations to shareholders. When a company has a profit and generates cash there are basically two things it can do with that cash. It can pay it out to shareholders in the form of dividends or it can also invest it back into the business in the form of retained earnings, where it can use it to finance further growth or productivity. Most companies that pay out a dividend also have a portion of profits reinvested back into the business.

Saturday, February 20, 2010

Shares Outstanding and Float

When doing some research on a company whose stock I intend to buy I came across the number of Shares Outstanding and also another concept referred to as the “float”. What do these numbers represent?

Ownership of a public company comes in the form of shares of stock which determine the owners of the equity in a company and the size of their stake. The number of shares outstanding represents the total number of shares of stock that have been issued by a company and therefore this number includes 100% of the ownership of the company. If a company has 1000 shares outstanding and you own 40 shares, then you are the owner of 4% of the company.

Friday, February 19, 2010

Market Capitalization

I noticed that a company like Google (ticker: GOOG) is very expensive at $540 per share and a very well-known and large company such as Microsoft (ticker: MSFT) is trading at only $29. Does this mean that Google’s shares are expensive? Should I consider Microsoft’s shares to be a bargain?

When starting to trade the first thing that you will notice is that even if you have somewhat of a rough idea of what a company does and how successful it is their stock prices don’t necessarily reflect this at first glance. Even if you have two companies that you know are somewhat in the same ballpark in terms of size and success their stock prices can be completely different and this can be disconcerting, however there is a very simple explanation for this.

Thursday, February 18, 2010

Fundamental and Technical Analysis

What are the differences between Fundamental and Technical analysis?

So you’re all ready to start trading. You have decided that you have some money that you would like to put to use in the stock market. You have opened your brokerage account and your funds have already been transferred so you’re all ready to start buying and selling stocks and rake in all the profits that the stock market offers.

Now you ask yourself the big question. How am I going to know what to buy and what to sell? What strategy am I going to use to ensure that all (or realistically, most) of my trades or investments end up as winners and give me the profits that I am after?

Wednesday, February 17, 2010

What is investing?

What is investing?

Investing is the commitment of funds to assets with the objective of making profits either during the life of the investment (dividends in the case of stocks, coupon payments in the case of bonds, etc.) or at the end of it through its appreciation (capital gains).

From a financial standpoint, investments can be made in stocks, bonds, derivatives (such as futures or options), foreign currency and in the money market.

Tuesday, February 16, 2010

Dow vs S&P 500

What are the differences between the Dow Jones Industrial Average (DJIA) index and the S&P 500?

If you open the business section of your favorite newspaper (or go to any financial news website) you will find quotes for the Dow Jones Industrial Average index as well as the S&P 500. They both measure the performance of large cap american stocks. So, how do they differ?

The first and most obvious way in which they differ is the number of components. The DJIA contains 30 stocks while the S&P 500 is calculated based on, not surprisingly, 500 stocks. That mere fact should indicate that the S&P 500 would be a more accurate index (as it includes a greater number of large-cap stocks) but there is one other difference and it is in fact the most important one.

Monday, February 15, 2010

International Stock Indices

What are the main international stock indices and why are they important to my trading?

Just like the S&P 500 can be seen as a proxy for what is happening to the equity of US companies there are indices that act as a barometer for the health of stock markets worldwide.

There are several reasons that traders keep an eye on stock markets worldwide:

Market Up, Market Down

When I read in the news or hear people say that the market was up today or that it has been down lately, what exactly are they referring to?

When you hear "the market is up" or "the market is down" in all likelihood, what people are referring to is how the main stock indices have performed in the referenced period.

A stock index is a numeric value that consists of the weighted average of the prices of its components. It is a simple and practical way to see how stocks (also called equities) have performed. If you read that the market was "up" that does not necessarily mean that all stocks were up but merely that in general it is likely that a stock has performed somewhat closely paralleling what the index that contains it has done.

What is trading?

What is trading?

Trading is the buying and selling of financial instruments with the expectation of a profit.

The main financial instruments that are traded are: stocks, options, bonds, futures and forex (foreign exchange) and those are the ones we'll be talking about throughout the site.