Stock Option Definition

A stock option is a contract between the seller and the buyer of the option which gives the buyer the right to purchase or sell the stated amount of shares in the future at an agreed upon price.  The buyer of the option is not required to exercise his right to purchase or sell the actual shares from the seller of the contract.   If there is no advantage to exercising it the contract will normally expire worthless.

What does this look like in the real world?  All option contracts bought and sold through brokerages are for 100 share lots, and are sold at various price increments (known as strike prices) depending on the underlying symbol.  The contracts being sold expire at various time periods in the future, which are standardized and normally fall on the third Friday of the contract month.  A buyer may buy either put or call options, and the distinction is very important.  A trader can see the full list of options contracts available to trade on what is known as an options tree.

A call option gives the buyer the right to purchase shares of stock in the future at the designated price.  A buyer will purchase a call option contract when he believes the price of the stock will increase to more than the strike price plus the cost of the option.  If the price increases, the value of the contract is likely to go up with it.  If the stock at the end of the expiration date has a higher price than the option price, the owner can then purchase the stock for the option price and if he wishes immediately sell those shares in the open market at a higher value.

A put option gives the buyer of the option the right to sell a stock security at an agreed upon price in the future.  A buyer of a put option believes that the price of a stock will fall below the strike price of the option plus the cost paid.  If on the expiration date of the option the stock is trading at a lower price than the exercise price, the owner may purchase shares from the open market at the lower price and then sell them for the agreed upon option price to the seller of the contract, and will profit the difference (minus the original cost paid).

Option contracts give traders a way to increase their profits in a trade over simply buying or shorting shares on the open market.  How do options do this?

As an example let us say that a particular stock is trading at $48.  The trader believes that by the option expiration date, the stock will be trading at $52.  Currently $50 call options are being traded at .50 per share, or $50 for the contract.  If a trader buys the contract today for $50, and he is right and the stock goes to $52 at expiration, he has now made the $1.50 difference $52 market value – $50 strike price -.50 cost paid.  So the $1.50 multiplied by the 100 shares in the contract means the trader has profited $150 on his $50 investment, a return of 300%!

If the trader invested the same $50, well $48 dollars, to buy the stock on the open market, he could have bought 1 share, and his profit would have been $4, a return of 8.3%.  The same investment in an option in this example resulted in a profit of $146 more!

The caveat to this is that option contracts do not necessarily end up being worth any money.  If the price on the expiration date was $50 or less, the contract would be worthless and the trader would lose 100% of his investment in the option.

Because there is a potential to lose 100% of your investment (investment used loosely as options are used more for short term trading) brokerages typically will require the trader to be sophisticated enough to understand how the contracts work before they will give you privileges to actually trade them.  There are also varying degrees of option privileges as more sophisticated traders are also allowed to sell option contracts, which can expose the trader to enormous amounts of risk.

I should also mention that options are used by sophisticated investors as a way to hedge risk.  If they are long a position they may also purchase put options to provide protection should the price fall dramatically, as the put options will increase in value to offset the decline on the principal investment.  Call options can also similarly be used as hedges.

There are many options trading and hedging strategies, which can become very complex.  The most important factor for a trader new to options to understand is that they increase leverage, which magnifies gains and potentially losses.  It is crucial that the trader understands how the option he purchases will change in price in various scenarios, both upon expiration and before.

What is the Stock Market

The stock market is the term we use to refer to the collective marketplace where stock securities are exchanged for agreed upon prices.  The stock market as a whole is actually a collection of loosely tied together exchanges which facilitate the actual trading.  When most people in the United States think of the stock market, they think of the New York Stock Exchange with hundreds of brokers screaming to buy and sell securities rapidly throughout the day.  While this may have been how all the stock trading was facilitated in the past, today improvements in technology have vastly changed the landscape in which buyers and sellers interact.

Today most stock volume is transacted over electronic communication networks which are publicly viewable electronic exchanges, also called ECNs, as well as in dark pools, which are another form of electronic trading where the buyers and sellers are hidden until an agreed upon price is matched.  These various exchanges and dark pools are tied together through quoting systems to form the order book of a stock.  The highest bid (coming from any exchange) and the lowest offer (also coming from any exchange) make up the national best bid and offer.  It is now illegal for most transactions to occur away from the national best bid or offer (NBBO), so even though the market is fragmented amongst various exchanges, a retail trader is still guaranteed the best price possible at any given time.  There are some exceptions where institutions may trade with each other away from the NBBO but this isn’t of much concern to any day traders.

The true purpose of the stock market is to allow corporations to access private wealth in order to make investments to grow their companies.  The benefit to private wealth is that when they invest in a company that grows, they realize the appreciation in value of that company by holding securities that increase in value.  So fundamentally if a company makes more money, and has expectations to make more money in the future, the price of the companies shares should go up.  As any market participant knows the correlation between earnings and share price is less than perfect, especially in the short term.

Of course from the way the market is structured, and the ease with which buyers and sellers can interact, traders are able to take shorter term positions in hopes of profiting from near term volatility.  The value or detriment of trading volume as compared to purely investing volume in the stock market is always being debated, but of course as long as it is legal you can count on a significant amount of total orders to be for the purposes of taking trades.

Participants in the stock market range from small “mom and pop” long term investors to high frequency trading hedge funds whose trades are directed on microsecond time frames with super powerful computers and algorithms.  Today for better or worse most volume is transacted by high frequency operations.  Some of this is a necessity to navigate the fragmented markets with large orders, while other volume is very predatory on small inefficiencies in price.  There is also a substantial amount of volume transacted in dark pools, so it would behoove any prospective trader to really understand what these are, how they operate, and how they are used.

The stock market as it exists today may be unrecognizable to past generations given technological advances, but it is none the less thriving as volume continues to generally increase year over year.

 

What is a Stock Trade

A stock trade is actually a transfer of ownership in a publicly traded corporation. The trade refers to the exchange of money for ownership rights, which are denoted in shares of stock.  In common parlance, the term trade has come to mean a shortly held position taken with the intent of capitalizing on near term volatility.  Those who do this for a living are known as day traders, but many people will buy or sell stock in shortly held positions with the hopes of making a lot of money.

An example of how this is done:

A trader buys 1000 shares of stock ABC at $50.  The stock price moves up to $54 dollars after a positive earnings announcement creates buying interest. The trader sells his 1000 shares at $54 and makes $4 of gain per share on the position.  Total earnings are 1000 x $4 = $4000.  The trader made $4000 in a short time period, or an 8% gain on his investment of $50,000.  Traders will also use some tools such as margin buying power and options to create leverage, and magnify the extent of their gains.  Caution must always be taken by the trader however as losses are also magnified by leveraged positions.

Generally speaking short term trading is discouraged by the government, both for the safety of the trader’s capital as well for general healthy functioning of capital markets, since trading increases volatility.  Let’s not forget that the purpose of capital markets are for corporations to access public wealth so they may make investments in their businesses, and for the public to invest in corporations that they believe will make money for them, so that their personal wealth will grow.  This relationship is beneficial to both parties and it is why capital markets are such positive drivers of economic growth.  The value of having short term traders involved in these markets is always up for hot debate, especially with the explosion of high frequency algorithmic trading.

No matter which side of the issue you are on, you should always understand what you are doing when you place a trade.  Always understand what exactly you are trading, the maximum amount of money you can lose, and how you can be most effective in placing your orders.  This includes understanding how your broker works, how much you pay for commissions, the types of orders you are placing, and how you are determining that a particular moment is the best time to place the trade.

As always please contact us with any questions you may have!

How Do You Trade the Verizon Vodaphone Deal

At a time when Verizon’s stock price has slid over 12% from the 52 week high, today Verizon announced a deal to buy Vodaphone’s stake in Verizon Wireless, increasing earnings per share by 10 cents instantly.  Before you go assuming that this is a slam dunk for Verizon’s stock price, consider that as a result of the deal Moody’s Investor Service downgraded Verizon today.

If you are thinking about trading Verizon on Tuesday based on this news, consider that the stock has strong support in the $42 range.  If investors react negatively to the downgrade news and this $42 level is broken, watch out on the downside.  The big money could be in the short IF (and only if) we break this level.

An interesting options strategy might be a straddle play, possibly buying puts slightly out of the money and taking a swing on some puts further out closer to this $42 level, while at the same time buying call contracts at the 47.50 level.  The contradictory news of an accretive deal to earnings paired with the downgrade has made investor sentiment somewhat mixed and the price action may be difficult to decipher.  Read a full technical analysis here.

Remember, while this is a tempting play, when a deal gets this much press and attention, along with contradictory news, sometimes the best trade is not taking one.  This isn’t a play for the novice but if you have a good read we are definitely going to see good volume in the days ahead.

Do Day Traders Make Money Everyday

The reality is that no day trader in the world makes money every single day.  In fact, many day traders who make money over the long term actually lose money on more days than they profit.  Of course many prospective traders can not make money at all, and they rarely have profitable days.

The percentage of profitable days a trader has really depends upon the system being used by the trader.  Some systems are designed to make a small amount of money with a very high winning percentage, other systems are designed with the intent of losing small amounts of money many days, but occasionally having extremely profitable days which more than make up for the money lost.

An example of a system designed to take small profits a high percentage of the time would be a scalping system, either by hand or more commonly, using a high frequency algorithm.  Binary Options can also be used to leverage a scalping strategy.  Compare brokers here. While using high frequency trading systems was extremely profitable when it first became in vogue, fierce competition has quickly eliminated many of the inefficiencies in this niche.  Most of the profits are taken by large market making firms such as Getco and Citadel, as well as hedge funds that specialize in this arena.

A system that is designed to profit less often, but is also designed to take larger profits when correct may be an options trading strategy, or perhaps a tape reading strategy, or some combination of the two. If a trader can actually spot a large buyer or seller, or otherwise identify a time when a stock is likely to make a big move, they can take a large position with a tight stop loss, or take a position using options.  The trader can then capture a portion of the move with a leveraged position, and take a very large profit.  This recently seems to be where a high percentage of profitable hand traders are making money.

The lesson is that a trader can never believe a system that promises to make money 100% of the time, or on 100% of days.  Markets are always changing, and a system that was extremely effective yesterday could be worthless tomorrow.  The key is to always adapt, to use as many tools as you can at your disposal, and fiercely protect your account balance with a long term view in mind.  Many traders will make the bulk of their entire year’s profit in only a hand full of days, and the key is to be ready when the opportunity is present.  Find a system that works and exploit it as much as possible while it works, meanwhile always be testing new ideas and identifying future possibilities.

Risk Management in Trading

Risk management while trading is the practice of setting and maintaining tolerable loss levels given account size, trading technique, and personal thresh holds.   Effective risk management is put in place on every trade, and ideally is also monitored over longer time periods such as days, weeks and months.  It has been said that the biggest difference defining a professional trader from the rest is an ability to strictly follow predetermined risk guidelines.  Put simply a professional trader rarely will allow himself to lose more money on any one trade than he has decided is acceptable before entering into the trade.

Risk Management Techniques

A stop loss can be the most important risk management tool for a trader.  In its most basic form, a stop loss is simply a price at which the trader has decided to be the very largest loss he is willing to accept on a trade.  When a stop loss is reached, the position is liquidated or covered and the loss has been accepted.  A trader can accomplish this with either a stop market order or a stop limit order.  The difference is that when the stop price is reached either a market order to immediately exit the position is automatically placed, or if a stop limit has been chosen a limit order is placed and the limit order will execute if the security price reaches the limit price.  A stop limit order is not guaranteed to execute so it is best to be judicious when placing this stop order type.  The SEC gives a good description of stop limit and stop market orders as well.

A daily loss limit is another very effective risk management tool.  This sets a maximum loss level for a trader for any 1 day.  When this thresh hold is reached, the trader must either liquidate all positions immediately, or else be prevented from entering into new positions.

For profitable traders, it is also a good idea to systematically remove money from their trading account.  This can be a particular dollar amount every chosen period of time, or it can be a percentage of their account value, or it can even be anything above a particular thresh hold at which they decide that there is no benefit to holding a greater dollar amount in the account.  The point is that if money is systematically removed, the trader will never be bankrupt in a worse case scenario (think flash crash) and hopefully a declining percentage of total net worth is subject to risk in their trading account as they make money over time.

Why Manage Risk

The point of each of these techniques is limiting personal risk during a worst case downside scenario.  Every seasoned veteran knows that by nature, security price values are both unpredictable and volatile.  There are opportunities to make money consistently in the market, and there is no point in losing everything in one trade, day, or even month.  A professional will take the worst case scenario as a very real possibility, and plan accordingly so that they always live to make money another day.  A trader never knows if any one trade will make money, but if they are confident in their system they know they will make money in the long run.

A quantified loss limit also removes emotions from decisions, and for those who plan to be professional day traders it is a necessity.

 

What is Stock

In trading and investing, stock refers to a financial security that denotes ownership in an underlying corporation.  The stock is broken up into shares, which are easy to exchange over the stock market, or in private sale.  By owning shares of stock in a corporation, the holder is entitled to ownership rights of the corporation, which includes a right to participate in earnings and asset value growth of the company.  This is why investors buy stock, hoping the value and income of the underlying corporation increases.  Holders of common stock are also entitled to vote on company matters, either by attending annual and special meetings or by sending their vote by proxy, if they are a holder on the day of record.

The percentage of the corporation that one share of stock represents is different for every corporation, and depends on the total number of shares outstanding.  If there are 10 shares outstanding and a holder owns 1, he owns 10% of the corporation.  If there are 100,000,000 shares outstanding and the holder owns 1, he owns 1/100,000,000 (one one-hundred millionth) of the total corporation.

The shares that day traders exchange are in publicly traded corporations.  Day traders should be very happy that stock exists, as it makes it extremely easy to exchange small fractions of corporate ownership in thousands of corporations.  Publicly traded corporations are governed by the SEC, and holders have rights and limitations that may differ from privately held corporations.

While owners of stock are allowed to profit in the growth of a company, their liability for debts incurred by the corporation do not extend beyond their initial investment.  In the event of a bankruptcy, holders of the corporate stock are generally the last in security ownership line to receive any payment from the sale of all assets.  Some investors, and even some traders, will buy preferred stock in a corporation.  Preferred stock differs in that there are not typically voting rights associated with it, but in the event of a bankruptcy holders of preferred stock are ahead of the common stock owners in claiming a right to any value from the liquidation of the corporation.  Preferred stock may also receive a different yield in dividend payments, and are entitled to the rights to dividend payments before holders of common stock.

Traders should keep in mind that the stock they are trading represents real tangible value in the underlying corporations.  The nature of public stock and the public markets has made rapidly facilitating their exchange very easy, and without this day traders would not be able to function.

What is a Trade Blotter and How is it Used

A trade blotter is a record of each trade that transacted for a given period of time, normally one day. 

A blotter would include the time of the trade, the ECN or dark pool market the trade occurred over, the quantity, the exact price, and if it was marked as a buy, sell, or short order.  Sometimes a blotter will include orders that were entered but were cancelled before they transacted as well.

We made a list with the best Forex, Cryptocurrencies and CFD Brokers. Here are the best brokers.

A trader will use a blotter as a way to review his trading day.  The blotter allows the trader to see exactly what happened over the course of a day.  It is a good idea for day traders to review their blotters at the end of every trading day, and record their observations in a trading journal.

A trader will look for places where he could have had better timing with entries or exits, or could have entered orders more efficiently, for instance by using an ECN that has a lower cost or rebate.

If you are looking for a trading journal free excel spreadsheet, then take a look at this.

A trade blotter is a valuable tool for a trader when he reviews it daily to improve his trading technique.

Binary Options Trading is very popular at the moment. Become one of our successful traders, by trading stocks, indices, currencies and commodities.

What is a Day Trader

A day trader is someone who buys and sells securities, usually equities but possibly bonds, derivatives, futures, currencies or options, with the intent of taking advantage of short term price movements to create profits for their account.  Day traders may occasionally hold securities overnight, but normally close all positions by the end of the day, hence the term “day trader”.

A day trader works to establish a trading strategy that will result in the trader either only taking trades with a higher probability of being profitable than not, or with the probability of a winning trade creating profits such that over time the profits will be greater than the losses, even if there is a higher probability of the trade ending in a loss. Once developed a trader’s goal is to adhere to the strategy as strictly as possible, gradually using greater and greater trade sizes in order to increase their profits over time.

Strategies for equity traders may including reading a stock’s tape and order book to spot large buyers or sellers, going with price momentum during times of high volume or rapid price movement, or reacting to technical or algorithmic signals.  Some day traders work exclusively by writing algorithms, often times ones that operate on extremely short time frames, taking advantage of small inefficiencies in the market.  The trader will then let their algorithm work throughout the day, usually monitoring it constantly and adjusting it in response to changes in market conditions.  If you have the ideas but don’t have the computer skills to program your own algorithm, Cyborg Trading offers traders a fantastic resource by taking the need to know programming languages out of the equation for the trader.

Day traders may work for a proprietary trading firm, such as WTS, T3 Trading, or Bright Trading, or they may trade their own accounts with a retail brokerage such as TD Ameritrade or Interactive Brokers.  A trader will work with a proprietary trading firm to get increased leverage and more professional trading tools, or a retail brokerage in order to keep 100% of their profits.  A proprietary trading firm may have lower commission charges than a retail brokerage, but may require the trader to pay for some monthly costs such as software and ECN access, and will generally keep a percentage of the trader’s profits.  A proprietary firm will provide a trader with firm capital, however, and may increase a trader’s total profits significantly.  The right choice is an individual decision for each individual.

A day trader is a participant in the markets, always working on their strategy to predict short term price movements in order to create profits for their account.

The Importance of Keeping a Trading Journal

Day traders all go through a long learning curve as they transition from novice to professional abilities.  It is unavoidable that a new trader will make mistakes, and it is even an important part of the learning process.  The key to becoming consistently profitable, and reducing the time it takes to reach this level of success, is to minimize how often mistakes are repeated.  Repeating mistakes is the most common obstacle preventing traders from attaining their goals.  If you want to be a professional day trader, you must develop a strategy to avoid making the same mistakes over and over, and consistently develop your skills.

The best way to do this on a daily basis is to keep a trading journal.  What is a trading journal?  A trading journal is like a diary, it keeps a record of each trading day.  It details exactly what you did well and exactly what you did wrong.  Over time this will help you spot trends in your trading, trends in what you do well, and trends of common mistakes that you make.  A trading journal will also improve your efficiency, help you master your emotions, identify the trade setups that are most profitable for you, and give you a framework to improve your profitability.   How exactly do you develop this trading journal, and what is the best way to maximize its effectiveness?

A trading journal is not hard to develop, but you must be very honest with yourself, and you must be very consistent recording each day’s entry.  Start by bringing up your trade blotter at the end of each day.  Use this with a chart to review and remember each trade that you took throughout the day.  Start by writing what you saw that interested you in each trade in the first place.

Look at where you entered and where you exited the trade.  Could you reasonably have improved these points based upon the information you had at that time?  Be very honest here.  Sometimes the answer is no, but for new traders more often than not there was some aspect of the actual personal execution of the trade that could be improved upon.  Think back to your emotions at the time.  Did they help you?  Did they get in the way of you making a logical decision?  The vast majority of times you will find that emotions hinder your logical decision making processes.

It is very important to remember your emotions.  The most difficult part of becoming successful for most new day traders is not the learning or understanding of a strategy.  What stands in their way is allowing their emotions to influence how well they adhere to their planning and processing of information.  In your journal don’t just stop at remembering what your emotions were.  If all we know is that we were elated and it caused a decision to become more aggressive than was logical given the situation, it does very little to prevent feeling this kind of elation, and therefore mistake in the future.  Write down why you were so elated.  Did you previously have 3 profitable trades in a row, were you way up on your day, or was their some influence outside of trading such as family or personal matters affecting your emotions?

By writing down not just what your emotions were, but also the reasons underlying the emotion, it allows you to more effectively identify and short circuit potential emotional pitfalls in the future.  This is how a trader improves, and how a trader reaches consistent profitability.  Following a trading strategy is not an emotional decision.  The most successful traders think and act only based on probabilities. Be sure to include in your journal any emotions that prevented you from taking a good trade as well.  This is an opportunity cost the same way mishandling a trade is.

A trading journal is not just about emotions, however.  You also must detail the trade set ups that worked very well for you, and the trade set ups that did not.  Traders will commonly fall into a trap where they think that a trade set-up is consistently profitable for them, but in reality it is not.  Write down trade set ups that ended up being a waste of your time.  Be sure to include things in your writing such as hot key errors, technical glitches or equipment malfunction, and even reasons that you were away from your computer during profitable trading hours.  It is very easy to rationalize reasons for not making money while trading, but the reality is you are responsible for controlling and improving every variable that affects your trading.

At the end of each day right down the biggest takeaways from the day.  Remember that the journal is a record of your successes and failures.  What mistake do you most wish you could correct?  What did you do very well that you would like to continue to do?  Over time this will allow you to see common errors that you make, and it will help you identify the most probable trade set ups to deliver positive results.

A trading journal should also be reviewed each morning before trading starts.  Read the previous days entry and key points from past entries.  This will ensure that the information is fresh in your mind at all times as you trade.  Remember that you have one goal when you are trading, and that is to be as profitable as you possibly can be.  Having information at your fingertips but not utilizing it because it was not on your mind at the time it was needed most is a mistake for which a trader has no excuse to make.  The only way a journal is valuable is if you are actively making an effort to follow your own ideas for improving.

If you are bluntly honest and diligent in keeping your journal, you will never struggle to systematically develop strategies to improve your trading profitability.

 

 

Shorting a Stock

A short stock position is initiated by a trader in order to profit from a decline in the stock’s price.  A trader initiates a short by selling shares of a stock that he does not own.  If the stock’s price falls, the trader can then “cover his position” by buying the stock back from the open market and profiting from decline in price.

When a trader sells a stock that he does not own, his account is credited with the value of the sale.  At the same time, there is a debit in the account for the quantity of shares that he borrowed to sell.  If the stock does indeed fall in value and the trader wishes to realize his profit, the trader will purchase the shares from the open market and replace the borrowed shares.  This is known as covering the short.  The trader’s profit is then the difference between the amount of money he made from selling the borrowed shares, and the amount of money it costs to replace the borrowed shares.  Similarly, if the price increases in value, the trader will lose the difference between the proceeds of the sale and the cost of the purchase.

Besides expecting a decline in a securities price, a trader or firm may initiate a short position in order to hedge another position.  This will protect the trader or firm from future volatility in the hedged position.  If the hedged position performs as expected, the gains will be offset by the loss in the short position.  If the hedged position losses value, the loss should be offset by a gain in the short position.  This is a strategy used by many firms and traders to mitigate risk.

A trader can short a stock as long as he is able to borrow shares that he does not own. While this seems impossible, it is not, and in fact it is a very common practice.  Borrowing stock for shorting is facilitated by the brokerage, and in most instances the shares will be borrowed from the brokerages own inventory.  If the brokerage does not have the needed shares in their own inventory, they can borrow the shares from another brokerage or from another client’s margin account. There are firms that specialize in facilitating these transactions and they often find and borrow the shares from large institutions or pension funds.  This is known as a “stock locate” or “locating stock”.  A trader or firm must be able to locate the stock before the short is initiated, this requirement is known as Regulation SHO.  If the trader does not locate the stock and can not deliver the sold shares to the purchaser during the 3 day clearing deadline, it is known as a “naked short”.  The SEC has a great description of of the mechanics of short sales and the legal requirements here.

Traders should remember that brokerages will charge interest fees for the stock that is being borrowed, so there is a decaying value to holding a short position open over time.

Example of a Profitable Short Sale

A trader shorts 500 shares of stock ABC at $10.  The trader’s account will be credited with the proceeds of this transaction, $5,000.  The trader also has a debit to replace the 500 shares that he borrowed.  The stock falls in price to $9.00.  The trader decides to take his profit and cover his short position.  He buys 500 shares back at $9.00, for a total cost of $4,500.  The trader will make the difference between the proceeds of the sale $5,000, and the cost of the purchase $4,500 for a total profit of $500 (minus all commission and interest charges).

The ability to short a stock is important for a trader or firm to profit from declines in price.  It is important both as an opportunity to capitalize on a drop in price for profit, and to mitigate risk as part of a hedging strategy.

What is a Designated Market Maker

A designated market maker is a broker dealer firm that always maintains quotes on the bid and offer for a specific security in which they are designated as market maker.  The purpose of the market maker is to help facilitate smooth trading operations for a particular security.  A market maker will hold a certain quantity of a given security in their own inventory, and as their quotes are filled on one side they will balance their inventory by attempting to “take the spread” and re-balance their inventory on the other side of the bid-offer.  The market maker’s continuous quoting ensures that adequate liquidity is present on the books at all times for a smooth and efficient trading environment.  A designated market maker is also known as a “DMM”, and formerly was known as a “specialist”.

A market maker need not be “designated” to make a market in a given security, however.  Any person or institution adding liquidity to a stock’s books by quoting on the bid or offer is participating in market making activities.  If a person or institution adds liquidity to the books by quoting a new national best bid or offer, they are said to be “making the market”.

In today’s markets, arguably the most valuable time for a designated market maker to be present is during times of high volatility.  Ultra short term trading algorithms known as HFTs will perpetually quote liquidity during times of normal volatility.  When volatility increases based on news or other data affecting security prices, HFTs will often pull their quoted liquidity at nearly the speed of light, greatly diminishing the available liquidity in a security right at a moment when it is most needed.  The designated markets makers will step in during these times and provide much needed liquidity, and re-establish an orderly trading environment.

While in the past market makers were exclusively human, a significant amount of market making operations are now handled by computer algorithms.  Top electronic market makers for US securities include GETCO, Knight Capital, Virtu Financial, and Citadel Group.

Traders may not always be aware that market makers are present, but they should never forget that they help ensure the efficient and orderly markets they require.

Is Being a Day Trader for Everyone

A common question that should be on all prospective traders’ minds is, “is day trading the right career choice for me?”  While working, traders unequivocally will experience emotional highs and lows, many times in the course of 1 day, and certainly over time.  Trading can potentially be a very rewarding career, certainly monetarily, and for many it is very satisfying to reach some level of success in such a competitive field.  The questions on prospective traders’ minds though are, “can everyone reach this level of success” and “is the reward worth the emotional and potential financial tolls”?

The honest answer is that being a day trader is not for everyone.  Very few traders are immediately successful.  Many lose large sums of money before eventually becoming profitable, while some never reach a profitable level of success.    The reasons for this vary, from not putting in enough work, to not controlling emotions effectively, to simply not being intelligent enough to succeed in such a competitive environment.  Even successful traders must deal with the vagaries of the market, knowing that they must save money when times are good so they are able to survive during the leaner market cycles.

Some traders never develop the emotional tools to deal with the ups and downs.  While it is not surprising to most people to learn that no traders make money on 100% of their trades, it is surprising to some that many successful traders win on less than 50% of their trades.  Some traders only succeed on about 30% of trades they take.  While these traders may still be extremely profitable over time because their winning trades are much larger than their losing trades, they must deal with failure more often than success.  Some personality types are incapable of ever being able to accept that this is the reality of the career. And though they otherwise are capable of being successful as traders, they are unable to develop the needed stress coping mechanisms.

There is a large learning curve with trading.  No trader is immediately successful, and only maintains higher levels of success throughout their careers.  Learning a new strategy is a daunting task, and traders must be ready to dedicate themselves fully.  Successful traders stay humble, and realize they always have more to learn.

Aside from hard work, new traders must also accept the fact that it could be months before they actually realize any profits.  A question all new traders must ask themselves (unless they have another source of income) is “can I survive for 6 months without a pay check?”  It takes most traders at least this long to regularly become profitable, and even this is no guarantee that a trader will make money every month.

The good part of trading is that for those who have the personality type, dedication, and financial means to become a day trader, the income and satisfaction from becoming successful can be very high.  If a prospective trader is interested in pursuing a career they should not be deterred by the challenges, but it is wise to consider if they are willing to endure the more difficult aspects of the job.

If a trader decides that they are ready to pursue a career in day trading, the best they can do is to educate themselves as much as possible, find a good mentor or adviser who is successful, and be ready to commit fully to making themselves successful.

What is the Series 56

The Series 56 is a designation required by the SEC for any person who wishes to participate in proprietary trading activities.  The designation is obtained by passing a 100 question comprehensive exam administered by FINRA, and allows a trader to participate in proprietary trading over many exchanges such as the Chicago Board of Options Exchange (CBOE), (CBSX), the National Stock Exchange (NSX), and the International Stock Exchange (ISE).

The Series 56 was first required in 2011, and was created by the self-regulating organizations mentioned above.  The exam covers topics such as securities markets and how they operate, trading products, fraud prevention, investment strategies, and trading and reporting practices.  Designed specifically for proprietary traders, the exam ensures that traders are educated and relatively sophisticated market participants.  This is for the healthy operation of securities markets as well as for the trader’s personal protection, as market operations have become increasingly complex as technology advances.

The series 56 exam allows a testing time of 2 ½ hours, and requires a passing score of 70.  Initially pass rates for the exam were very low as high quality study material had yet to be developed.  The materials have quickly improved, and while official statistics are not available the exam is now relatively easy to pass for those who study.  If a prospective trader fails the test, he must wait 30 days to take the test again.  If the trader fails a second time, he must wait another 30 days.  If he fails a third time, he must wait 180 days to re-take the test.

A Series 7 license is considered to supersede the Series 56, and if a trader holds an active Series 7 a waiver may be granted by the CBOE and the trader will not have to pass the Series 56 exam.

While traders might not enjoy having to pass the Series 56 exam, ultimately the information that must be known to pass the exam is for the protection of the trader and for our securities markets.

HowWeTrade can help a trader pass the exam and recommend a sponsor if needed.  We can also recommend ways to trade without it such as binary options.  Compare brokers here.

What is A Share of a Stock?

A share of a stock represents ownership in the company that the share is issued for.  Share ownership entitles the investor to share in the profitability of the company (or lack thereof) as well as a say in company matters put to a vote of investors.  Stock investors purchase shares issued by corporations in hopes that the company will become more valuable through increased profits and business prospects.

One share of a corporation may represent different percentages of total company ownership based on the number of shares outstanding for each particular corporation.  For instance, if there are 10,000 shares outstanding for a given corporation, one share represents ownership of 1/10,000 of the company, and the shareholder has 1/10,000 of the total vote in shareholder votes on company matters.  If a shareholder owns 5,000 out of 10,000 total shares, they would own 50% of the company and have 50% voting rights.

Shares bought and sold on the stock market represent true ownership of a corporation, and entitles owners to the benefits and pitfalls of ownership.  A nice perk for investors of publicly traded corporations is that while they are entitled to share in the upside if company profits soar, an investor can not lose more than his or her investment if the company goes bankrupt.  In other words, owners of shares are not required to pay back company debts personally if the corporation can not meet its debt obligations.

Some people think of a share as something intangible that goes up and down in price almost randomly.  The reality is this is far from the truth. The price of shares is based on buying and selling, most of which is is performed by large institutions like hedge funds and mutual funds.  They decide to buy and sell based on exhaustive research and financial modeling of all available information on a corporation’s current profitability, current and project future asset values, and future profitability estimates and potential.  The price of a share, and the value represented by the share is no arbitrary matter.

The ability to break a corporation into many shares which can be sold to many investors has allowed owners of large companies to sell their companies, which would otherwise be too large to purchase for any single investor.  It has allowed average citizens to partake in the benefits of company ownership when they otherwise would not be able to, and this investment propagates economic growth, allowing companies to use investor money to expand operations and hire additional workers.  When a company first breaks itself into publicly traded shares, it is said to have an IPO or initial public offering.  When a company issues additional equity to the public after an IPO this is known as a secondary offering.

A trader should never lose sight of the fact that while their ownership may be short term, the instruments they are trading represent real tangible value, often in some of the world’s largest corporations.