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    Stock Trading Basics

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    steam100deg8229
    This document discusses stock trading basics, including different types of stock orders, trading costs, margin trading, short selling, and regulation of short sales. It explains key order types like market orders, limit orders, and stop orders. Margin trading allows investing with borrowed money, while short selling allows profiting if a stock price declines. Trading involves both explicit costs like commissions and bid-ask spreads, as well as implicit costs from the market absorbing large orders, execution speed, and missed opportunities. Regulation aims to limit short selling during market stresses but there is debate around short sellers' impact on prices.

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    Stock Trading Basics

    Uploaded by

    steam100deg8229
    42 views6 pages
    This document discusses stock trading basics, including different types of stock orders, trading costs, margin trading, short selling, and regulation of short sales. It explains key order types like market orders, limit orders, and stop orders. Margin trading allows investing with borrowed money, while short selling allows profiting if a stock price declines. Trading involves both explicit costs like commissions and bid-ask spreads, as well as implicit costs from the market absorbing large orders, execution speed, and missed opportunities. Regulation aims to limit short selling during market stresses but there is debate around short sellers' impact on prices.

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    This document discusses stock trading basics, including different types of stock orders, trading costs, margin trading, short selling, and regulation of short sales. It explains key order types like market orders, limit orders, and stop orders. Margin trading allows investing with borrowed money, while short selling allows profiting if a stock price declines. Trading involves both explicit costs like commissions and bid-ask spreads, as well as implicit costs from the market absorbing large orders, execution speed, and missed opportunities. Regulation aims to limit short selling during market stresses but there is debate around short sellers' impact on prices.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    42 views6 pages

    Stock Trading Basics

    Uploaded by

    steam100deg8229
    This document discusses stock trading basics, including different types of stock orders, trading costs, margin trading, short selling, and regulation of short sales. It explains key order types like market orders, limit orders, and stop orders. Margin trading allows investing with borrowed money, while short selling allows profiting if a stock price declines. Trading involves both explicit costs like commissions and bid-ask spreads, as well as implicit costs from the market absorbing large orders, execution speed, and missed opportunities. Regulation aims to limit short selling during market stresses but there is debate around short sellers' impact on prices.

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    You are on page 1of 6

    5.

    Stock Trading Basics

    Before we move on to investment banking and stock markets to nish up


    the survey of nancial institutions, it is a good idea that we understand how
    stocks are traded rst.

    5.1 Stock Quote

    1. Bid, ask, and last prices


    Buyers and sellers look at dierent prices.
    a) Does a small bid-ask spread indicate an active market?
    b) The market can be seen as a gigantic order book for now.

    2. Volume
    Volume alone transmits very little information.
    3. Settlement
    An order executed must be settled within 3 working days (T+3 Rule).

    18

    5. Stock Trading Basics

    5.2 Order Types

    1. Market orders
    Market orders are buy or sell orders that are to be executed immediately
    at current market prices.
    2. Price-contingent orders
    Investors also may place orders specifying prices at which they are willing
    to buy or sell a security.
    a) Limit orders
    A limit buy order is to buy shares at or below a stipulated price.
    b) Stop orders (stop market orders)
    A stop order is similar to a limit order, but once the stipulated price
    is reached, the order will turn into a market order for immediate
    execution.

    5.3 Stock Trading Costs


    Trading stocks costs investors. Some of the costs are obvious and explicit,
    while others are not that straightforward.
    1. Explicit costs
    a) Brokers commission
    b) Bid-ask spread
    2. Implicit costs
    a) Impact costs
    It takes time and price concessions for the market to absorb large
    orders.
    b) Timing costs
    Execution speed makes or kills a trade. The speed depends on the
    privilege level and technology.
    c) Opportunity costs
    "Youll know that to lose your position is something nobody can
    aord; not even John D. Rockefeller."

    5.4 Leveraging Your Bets: Margin Trading

    19

    5.4 Leveraging Your Bets: Margin Trading


    There are many reasons why investors want to leverage their bets. For some,
    a strong belief in a certain stocks direction calls for doubling down bets. For
    others, leveraging is the price (or the benet, depending on the angle the
    investors look) of hedging. Leveraging through derivatives, such as options
    and futures, is not covered in this principles class. Buying stocks on margin
    means investing in stocks with borrowed money. We will use the balance
    sheet of an investors brokerage account to explain how margin trading is
    conducted.

    1. Before stock purchase:

    2. After stock purchase:

    20

    5. Stock Trading Basics

    3. Calculation of margin (Note that margin can be either the dollar amount
    or the percentage. Pay attention to the context.)
    Equity
    Margin = Value
    of Sto ck
    a) The initial margin
    Set by the Fed to be 50%.
    b) The maintenance margin
    Set by the broker. If the percentage margin falls below this level, the
    broker will issue a margin call.
    c) A margin call
    Additional assets (cash or other securities) are required to be added
    to the account. Otherwise, the broker will liquidate stocks in the
    account to restore the percentage margin.
    4. An example
    You purchased 100 shares of IBM stock on margin (50% initial margin).
    IBMs stock price is $100 per share at the time you purchase. Suppose
    your brokers maintenance margin is 30%. When will you receive a margin
    call from your broker?

    5.5 Short Selling


    Buying stocks on margin is a long bet, while short selling is a short bet, in
    which the investors wish the stock price to decline.
    The short-seller completes the following steps for a short sale.
    Step 1 Present margin (cash collateral) to broker
    Step 2 Broker lends the shares to you
    Step 3 Broker helps you sell the shares
    Step 4 You keep the proceeds but owe shares
    Step 5 You order to buy shares to pay back debts
    Step 6 Settle the transaction with your proceeds (possibly with money out
    of your pocket, if the stock is on the rise)

    5.6 Balance Sheet

    21

    5.6 Balance Sheet

    What happens to the share that is borrowed and sold?

    Street name securities: shares held electronically in the account of a stock


    broker. The real shareholder is referred to as the benecial owner.

    22

    5. Stock Trading Basics

    5.7 Short Sale Details


    1. Margin calculation
    Margin = Value ofEquity
    Sto ck

    Owed

    a) An example: You short sell 100 shares of IBM stock at $100 per
    share. Your broker required 50% margin. How much is required in
    your account for you to be able to short sell IBM? If IBMs shares
    drop to $80 per share and you immediately close your position, what
    is your prot?
    2. The short-seller owes dividends
    3. Proceeds must be kept in the account and are not generating any income.
    Large, institutional investors are exceptions.

    5.8 Short Squeeze and Regulation


    1. Unlimited losses for short sellers
    Short sellers are recommended to cover short positions with stop orders.
    2. Short ratio
    It is the percentage of oating shares being shorted.
    3. Short squeeze
    Stocks might be cornered if too many shares have already been shorted.
    At the rst sight of a potential price spike, the short sellers rush to re
    exit.
    4. Bans on short sales
    Many policy makers believe short sellers are to blame for stock plunges
    because they induce downward pressure on share prices. During market
    stresses, short sale bans are commonplace. The blame, however, is misplaced. There is no evidence that short sales exacerbate plunges. Short
    sellers bet with their own money, absorb the risk, and help discover the
    price faster.
    5. Un-American
    "Cheering for a short seller goes against the American spirit", said Rich
    Karlgaard, Publisher of Forbes.

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