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Introductory Notes on Financial Markets
Last Updated: 5 March 2012
Site Maintained By:
http://www.econ.iastate.edu/tesfatsi/Professor Leigh Tesfatsion
mailto:email@example.com AT iastate.edu
Econ 308 Web Site:
Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets, Seventh Edition, Addison-Wesley, Boston, MA, latest edition.
Throughout his text, Mishkin stresses that the evolution of financial markets, both in the U.S. and throughout the world, has resulted from an intricate interplay of three factors: chance, necessity, and design. In short, history matters, and it matters a lot.
In addition, throughout his text Mishkin consistently stresses the importance of information. He argues that it is impossible to understand the special nature of financial markets relative to markets for real goods and services unless one understands the peculiar types of "asymmetric information problems" intrinsically associated with financial assets. He argues that these asymmetric information problems have largely shaped the structure of financial markets in the past, and that the recent surge of innovations in information technology (IT) -- in particular, Internet-related IT -- is leading to a dramatic restucturing of financial markets today.
The notes, below, provide basic background information on financial markets as covered in Mishkin in Chapters 2 and 4. For a more extensive set of notes relating to these and other Mishkin chapters, visit the home page for
http://www.econ.iastate.edu/classes/econ353/tesfatsion/Econ 353 (Money, Banking, and Financial Institutions)
http://www2.econ.iastate.edu/tesfatsi/finintro.htmIntroduction to Financial Markets and Institutions
http://www2.econ.iastate.edu/tesfatsi/finintro.htmAdditional Distinctions Among Securities Markets
http://www2.econ.iastate.edu/tesfatsi/finintro.htmAsymmetric Information Problems Arising in Financial Markets
http://www2.econ.iastate.edu/tesfatsi/finintro.htmThe Concept of Present Value
http://www2.econ.iastate.edu/tesfatsi/finintro.htmMeasuring Interest Rates by Yield to Maturity
http://www2.econ.iastate.edu/tesfatsi/finintro.htmInterest Rates vs. Return Rates
http://www2.econ.iastate.edu/tesfatsi/finintro.htmReal vs. Nominal Interest Rates
An asset is anything of durable value, that is, anything that acts as a means to store value over time. Real assets are assets in physical form (e.g., land, equipment, houses,...), including "human capital" assets embodied in people (natural abilities, learned skills, knowledge,..). Financial assets are claims against real assets, either directly (e.g., stock share equity claims) or indirectly (e.g., money holdings, or claims to future income streams that originate ultimately from real assets). Securities are financial assets exchanged in auction and over-the-counter markets (see below) whose distribution is subject to legal requirements and restrictions (e.g., information disclosure requirements).
Lenders are people who have available funds in excess of their desired expenditures that they are attempting to loan out, and borrowers are people who have a shortage of funds relative to their desired expenditures who are seeking to obtain loans. Borrowers attempt to obtain funds from lenders by selling to lenders newly issued claims against the borrowers' real assets, i.e., by selling the lenders newly issued financial assets.
A financial market is a market in which financial assets are traded. In addition to enabling exchange of previously issued financial assets, financial markets facilitate borrowing and lending by facilitating the sale by newly issued financial assets. Examples of financial markets include the New York Stock Exchange (resale of previously issued stock shares), the U.S. government bond market (resale of previously issued bonds), and the U.S. Treasury bills auction (sales of newly issued T-bills). A financial institution is an institution whose primary source of profits is through financial asset transactions. Examples of such financial institutions include discount brokers (e.g., Charles Schwab and Associates), banks, insurance companies, and complex multi-function financial institutions such as Merrill Lynch.
Introduction to Financial Markets and Institutions:
Financial markets serve six basic functions. These functions are briefly listed below:
Borrowing and Lending: Financial markets permit the transfer of funds (purchasing power) from one agent to another for either investment or consumption purposes.
Price Determination: Financial markets provide vehicles by which prices are set both for newly issued financial assets and for the existing stock of financial assets.
Information Aggregation and Coordination: Financial markets act as collectors and aggregators of information about financial asset values and the flow of funds from lenders to borrowers.
Risk Sharing: Financial markets allow a transfer of risk from those who undertake investments to those who provide funds for those investments.
Liquidity: Financial markets provide the holders of financial assets with a chance to resell or liquidate these assets.
Efficiency: Financial markets reduce transaction costs and information costs.
In attempting to characterize the way financial markets operate, one must consider both the various types of financial institutions that participate in such markets and the various ways in which these markets are structured.
Who are the Major Players in Financial Markets?
By definition, financial institutions are institutions that participate in financial markets, i.e., in the creation and/or exchange of financial assets. At present in the United States, financial institutions can be roughly classified into the following four categories: "brokers;" "dealers;" "investment bankers;" and "financial intermediaries."
A broker is a commissioned agent of a buyer (or seller) who facilitates trade by locating a seller (or buyer) to complete the desired transaction. A broker does not take a position in the assets he or she trades -- that is, the broker does not maintain inventories in these assets. The profits of brokers are determined by the commissions they charge to the users of their services (either the buyers, the sellers, or both). Examples of brokers include real estate brokers and stock brokers.
Diagrammatic Illustration of a Stock Broker:
Payment ----------------- Payment
Stock | | Stock
Buyer| Stock Broker | Seller
Stock| (Passed Thru) | Stock
Shares ----------------- Shares
Like brokers, dealers facilitate trade by matching buyers with sellers of assets; they do not engage in asset transformation. Unlike brokers, however, a dealer can and does "take positions" (i.e., maintain inventories) in the assets he or she trades that permit the dealer to sell out of inventory rather than always having to locate sellers to match every offer to buy. Also, unlike brokers, dealers do not receive sales commissions. Rather, dealers make profits by buying assets at relatively low prices and reselling them at relatively high prices (buy low - sell high). The price at which a dealer offers to sell an asset (the "asked price") minus the price at which a dealer offers to buy an asset (the "bid price") is called the bid-ask spread and represents the dealer's profit margin on the asset exchange. Real-world examples of dealers include car dealers, dealers in U.S. government bonds, and Nasdaq stock dealers.
Diagrammatic Illustration of a Bond Dealer:
Bond | Dealer | Bond
Buyer | | Seller
<-------------| Bond Inventory |<-------------
Bonds | | Bonds
An investment bank assists in the initial sale of newly issued securities (i.e., in IPOs = Initial Public Offerings) by engaging in a number of different activities:
Advice: Advising corporations on whether they should issue bonds or stock, and, for bond issues, on the particular types of payment schedules these securities should offer;
Underwriting: Guaranteeing corporations a price on the securities they offer, either individually or by having several different investment banks form a syndicate to underwrite the issue jointly;
Sales Assistance: Assisting in the sale of these securities to the public.
Some of the best-known U.S. investment banking firms are Morgan Stanley, Merrill Lynch, Salomon Brothers, First Boston Corporation, and Goldman Sachs.
Unlike brokers, dealers, and investment banks, financial intermediaries are financial institutions that engage in financial asset transformation. That is, financial intermediaries purchase one kind of financial asset from borrowers -- generally some kind of long-term loan contract whose terms are adapted to the specific circumstances of the borrower (e.g., a mortgage) -- and sell a different kind of financial asset to savers, generally some kind of relatively liquid claim against the financial intermediary (e.g., a deposit account). In addition, unlike brokers and dealers, financial intermediaries typically hold financial assets as part of an investment portfolio rather than as an inventory for resale. In addition to making profits on their investment portfolios, financial intermediaries make profits by charging relatively high interest rates to borrowers and paying relatively low interest rates to savers.
Types of financial intermediaries include: Depository Institutions (commercial banks, savings and loan associations, mutual savings banks, credit unions); Contractual Savings Institutions (life insurance companies, fire and casualty insurance companies, pension funds, government retirement funds); and Investment Intermediaries (finance companies, stock and bond mutual funds, money market mutual funds).
Diagrammatic Example of a Financial Intermediary: A Commercial Bank
Lending by B Borrowing by B
-------funds ------- funds -------
| |<............. | | <............. | |
| F |.............> | B | ..............> | H |
-------loan ------- deposit -------
Loan contracts Deposit accounts
issued by F to B issued by B to H
are liabilities of F are liabilities of B
and assets of B and assets of H
NOTE: F=Firms, B=Commercial Bank, and H=Households
Important Caution: These four types of financial institutions are simplified idealized classifications, and many actual financial institutions in the fast-changing financial landscape today engage in activities that overlap two or more of these classifications, or even to some extent fall outside these classifications. A prime example is Merrill Lynch, which simultaneously acts as a broker, a dealer (taking positions in certain stocks and bonds it sells), a financial intermediary (e.g., through its provision of mutual funds and CMA checkable deposit accounts), and an investment banker.
What Types of Financial Market Structures Exist?
The costs of collecting and aggregating information determine, to a large extent, the types of financial market structures that emerge. These structures take four basic forms:
Auction markets conducted through brokers;
Over-the-counter (OTC) markets conducted through dealers;
Organized Exchanges, such as the New York Stock Exchange, which combine auction and OTC market features. Specifically, organized exchanges permit buyers and sellers to trade with each other in a centralized location, like an auction. However, securities are traded on the floor of the exchange with the help of specialist traders who combine broker and dealer functions. The specialists broker trades but also stand ready to buy and sell stocks from personal inventories if buy and sell orders do not match up.
Intermediation financial markets conducted through financial intermediaries;
Financial markets taking the first three forms are generally referred to as securities markets. Some financial markets combine features from more than one of these categories, so the categories constitute only rough guidelines.
An auction market is some form of centralized facility (or clearing house) by which buyers and sellers, through their commissioned agents (brokers), execute trades in an open and competitive bidding process. The "centralized facility" is not necessarily a place where buyers and sellers physically meet. Rather, it is any institution that provides buyers and sellers with a centralized access to the bidding process. All of the needed information about offers to buy (bid prices) and offers to sell (asked prices) is centralized in one location which is readily accessible to all would-be buyers and sellers, e.g., through a computer network. No private exchanges between individual buyers and sellers are made outside of the centralized facility.
An auction market is typically a public market in the sense that it open to all agents who wish to participate. Auction markets can either be call markets -- such as art auctions -- for which bid and asked prices are all posted at one time, or continuous markets -- such as stock exchanges and real estate markets -- for which bid and asked prices can be posted at any time the market is open and exchanges take place on a continual basis. Experimental economists have devoted a tremendous amount of attention in recent years to auction markets.
Many auction markets trade in relatively homogeneous assets (e.g.,
http://www.ny.frb.org/pihome/fedpoint/fed41.htmlTreasury bills, notes, and bonds) to cut down on information costs. Alternatively, some auction markets (e.g., in second-hand jewelry, furniture, paintings etc.) allow would-be buyers to inspect the goods to be sold prior to the opening of the actual bidding process. This inspection can take the form of a warehouse tour, a catalog issued with pictures and descriptions of items to be sold, or (in televised auctions) a time during which assets are simply displayed one by one to viewers prior to bidding.
Auction markets depend on participation for any one type of asset not being too "thin." The costs of collecting information about any one type of asset are sunk costs independent of the volume of trading in that asset. Consequently, auction markets depend on volume to spread these costs over a wide number of participants.
An over-the-counter market has no centralized mechanism or facility for trading. Instead, the market is a public market consisting of a number of dealers spread across a region, a country, or indeed the world, who make the market in some type of asset. That is, the dealers themselves post bid and asked prices for this asset and then stand ready to buy or sell units of this asset with anyone who chooses to trade at these posted prices. The dealers provide customers more flexibility in trading than brokers, because dealers can offset imbalances in the demand and supply of assets by trading out of their own accounts. Many well-known common stocks are traded over-the-counter in the United States through
http://www.nasdaq.com/NASDAQ (National Association of Securies Dealers' Automated Quotation System).
Intermediation Financial Markets:
An intermediation financial market is a financial market in which financial intermediaries help transfer funds from savers to borrowers by issuing certain types of financial assets to savers and receiving other types of financial assets from borrowers. The financial assets issued to savers are claims against the financial intermediaries, hence liabilities of the financial intermediaries, whereas the financial assets received from borrowers are claims against the borrowers, hence assets of the financial intermediaries. (See the diagrammatic illustration of a financial intermediary presented earlier in these notes.)
Additional Distinctions Among Securities Markets
Primary versus Secondary Markets:
Primary markets are securities markets in which newly issued securities are offered for sale to buyers. Secondary markets are securities markets in which existing securities that have previously been issued are resold. The initial issuer raises funds only through the primary market.
Debt Versus Equity Markets:
Debt instruments are particular types of securities that require the issuer (the borrower) to pay the holder (the lender) certain fixed dollar amounts at regularly scheduled intervals until a specified time (the maturity date) is reached, regardless of the success or failure of any investment projects for which the borrowed funds are used. A debt instrument holder only participates in the management of the debt instrument issuer if the issuer goes bankrupt. An example of a debt instrument is a 30-year mortgage.
In contrast, an equity is a security that confers on the holder an ownership interest in the issuer.
There are two general categories of equities: "preferred stock" and "common stock."
Common stock shares issued by a corporation are claims to a share of the assets of a corporation as well as to a share of the corporation's net income -- i.e., the corporation's income after subtraction of taxes and other expenses, including the payment of any debt obligations. This implies that the return that holders of common stock receive depends on the economic performance of the issuing corporation.
Holders of a corporation's common stock typically participate in any upside performance of the corporation in two ways: by receiving a share of net income in the form of dividends; and by enjoying an appreciation in the price of their stock shares. However, the payment of dividends is not a contractual or legal requirement. Even if net earnings are positive, a corporation is not obliged to distribute dividends to shareholders. For example, a corporation might instead choose to keep its profits as retained earnings to be used for new capital investment (self-financing of investment rather than debt or equity financing).
On the other hand, corporations cannot charge losses to their common stock shareholders. Consequently, these shareholders at most risk losing the purchase price of their shares, a situation which arises if the market price of their shares declines to zero for any reason. An example of a common stock share is a share of IBM.
In contrast, preferred stock shares are usually issued with a par value (e.g., $100) and pay a fixed dividend expressed as a percentage of par value. Preferred stock is a claim against a corporation's cash flow that is prior to the claims of its common stock holders but is generally subordinate to the claims of its debt holders. In addition, like debt holders but unlike common stock holders, preferred stock holders generally do not participate in the management of issuers through voting or other means unless the issuer is in extreme financial distress (e.g., insolvency). Consequently, preferred stock combines some of the basic attributes of both debt and common stock and is often referred to as a hybrid security.
Money versus Capital Markets:
The money market is the market for shorter-term securities, generally those with one year or less remaining to maturity.
Examples: U.S. Treasury bills; negotiable bank certificates of deposit (CDs); commercial paper, Federal funds; Eurodollars.
Remark: Although the maturity on certificates of deposit (CDs) -- i.e., on large time deposits at depository institutions -- can run anywhere from 30 days to over 5 years, most CDs have a maturity of less than one year. Those with a maturity of more than one year are referred to as term CDs. A CD that can be resold without penalty in a secondary market prior to maturity is known as a negotiable CD.
The capital market is the market for longer-term securities, generally those with more than one year to maturity.
Examples: Corporate stocks; residential mortgages; U.S. government securities (marketable long-term); state and local government bonds; bank commercial loans; consumer loans; commercial and farm mortgages.
Remark: Corporate stocks are conventionally considered to be long-term securities because they have no maturity date.
Domestic Versus Global Financial Markets:
Eurocurrencies are currencies deposited in banks outside the country of issue. For example, eurodollars, a major form of eurocurrency, are U.S. dollars deposited in foreign banks outside the U.S. or in foreign branches of U.S. banks. That is, eurodollars are dollar-denominated bank deposits held in banks outside the U.S.
An international bond is a bond available for sale outside the country of its issuer.
Example of an International Bond: a bond issued by a U.S. firm that is available for sale both in the U.S. and abroad.
A foreign bond is an international bond issued by a country that is denominated in a foreign currency and that is for sale exclusively in the country of that foreign currency.
Example of a Foreign Bond: a bond issued by a U.S. firm that is denominated in Japanese yen and that is for sale exclusively in Japan.
A Eurobond is an international bond denominated in a currency other than that of the country in which it is sold. More precisely, it is issued by a borrower in one country, denominated in the borrower's currency, and sold outside the borrower's country.
Example of a Eurobond: Bonds sold by the U.S. government to Japan that are denominated in U.S. dollars.
Asymmetric Information in Financial Markets
Asymmetric information in a market for goods, services, or assets refers to differences ("asymmetries") between the information available to buyers and the information available to sellers. For example, in markets for financial assets, asymmetric information may arise between lenders (buyers of financial assets) and borrowers (sellers of financial assets).
Problems arising in markets due to asymmetric information are typically divided into two basic types: "adverse selection;" and "moral hazard." This section explains these two types of problems, using financial markets for concrete illustration.
1. Adverse Selection
Adverse selection is a problem that arises for a buyer of goods, services, or assets when the buyer has difficulty assessing the quality of these items in advance of purchase.
Consequently, adverse selection is a problem that arises because of different ("asymmetric") information between a buyer and a seller before any purchase agreement takes place.
An Illustration of Adverse Selection in Loan Markets:
In the context of a loan market, an adverse selection problem arises if the contractual terms that a lender sets in advance in an attempt to protect himself against the consequences of inadvertently lending to high risk borrowers have the perverse effect of encouraging high risk borrowers to self-select into the lender's loan applicant pool while at the same time encouraging low risk borrowers to self-select out of this pool. In this case, the lender's pool of loan applicants is adversely affected in the sense that the average quality of borrowers in the pool decreases.
2. Moral Hazard
Moral hazard is said to exist in a market if, after the signing of a purchase agreement between the buyer and seller of a good, service, or asset:
the seller changes his or her behavior in such a way that the probabilites (risk calculations) used by the buyer to determine the terms of the purchase agreement are no longer accurate;
the buyer is only imperfectly able to monitor (observe) this change in the seller's behavior.
For example, a moral hazard problem arises if, after a lender purchases a loan contract from a borrower, the borrower increases the risks originally associated with the loan contract by investing his borrowed funds in more risky projects than he originally reported to the lender.
The Concept of Present Value
Suppose someone promises to pay you $100 in some future period T. This amount of money actually has two different values: a nominal value of $100, which is simply a measure of the number of dollars that you will receive in period T; and a present value (sometimes referred to as a present discounted value), roughly defined to be the minimum number of dollars that you would have to give up today in return for receiving $100 in period T.
Stated somewhat differently, the present value of the future $100 payment is the value of this future $100 payment measured in terms of current (or present) dollars.
The concept of present value permits financial assets with different associated payment streams to be compared with each other by calculating the value of these payment streams in terms of a single common unit: namely, current dollars.
A specific procedure for the calculation of present value for future payments will now be developed.
Present Value of Payments One Period Into the Future:
If you save $1 today for a period of one year at an annual interest rate i, the nominal value of your savings after one year will be
(1)V(1) = (1+i)*$1 ,
where the asterisk "*" denotes multiplication.
On the other hand, proceeding in the reverse direction from the future to the present, the present value of the future dollar amount V(1) = (1+i)*$1 is equal to $1. That is, the amount you would have to save today in order to receive back V(1)=(1+i)*$1 in one year's time is $1.
Notice that this calculation of $1 as the present value of V(1)=(1+i)*$1 satisfies the following formula:
(2) Present Value = -------- .
of V(1) (1+i)
Indeed, given any fixed annual interest rate i, and any payment V(1) to be received one year from today, the present value of V(1) is given by formula (2). In effect, then, the payment V(1) to be received one year from now has been discounted back to the present using the annual interest rate i, so that the value of V(1) is now expressed in current dollars.
Present Value of Payments Multiple Periods Into the Future:
If you save $1 today at a fixed annual interest rate i, what will be the value of your savings in one year's time? In two year's time? In n year's time?
If you save $1 at a fixed annual interest rate i, the nominal value of your savings in one year's time will be V(1)=(1+i)*$1. If you then put aside V(1) as savings for an additional year rather than spend it, the nominal value of your savings at the end of the second year will be
V(2) = (1+i)*V(1) = (1+i)*(1+i)*$1 = (1+i)2*$1 .
And so forth for any number of years n.
(4) START --------------------------------/\/\/\-------->YEAR
| 1 2 n
Nominal 2 n
Value of $1 (1+i)*$1 (1+i) *$1 (1+i) * $1
Now consider the present value of V(n) = (1+i)n*$1 for any year n. By construction, V(n) is the nominal value obtained after n years when a single dollar is saved for n successive years at the fixed annual interest rate i. Consequently, the present value of V(n) is simply equal to $1, regardless of the value of n.
Notice, however, that the present value of V(n) -- namely, $1 -- can be obtained from the following formula:
(5) Present Value = ------------ .
of V(n) n
Indeed, given any fixed annual interest rate i, and any nominal amount V(n) to be received n years from today, the present value of V(n) can be calculated by using formula (5).
Present Value of Any Arbitrary Payment Stream:
Now suppose you will be receiving a sequence of three payments over the next three years. The nominal value of the first payment is $100, to be received at the end of the first year; the nominal value of the second payment is $150, to be received at the end of the second year; and the nominal value of the third payment is $200, to be received at the end of the third year.
Given a fixed annual interest rate i, what is the present value of the payment stream ($100,$150,$200) consisting of the three separate payments $100, $150, and $200 to be received over the next three years?
To calculate the present value of the payment stream ($100,$150,$200), use the following two steps:
Step 1: Use formula (5) to separately calculate the present value of each of the individual payments in the payment stream, taking care to note how many years into the future each payment is going to be received.
Step 2: Sum the separate present value calculations obtained in Step 1 to obtain the present value of the payment stream as a whole.
Carrying out Step 1, it follows from formula (5) that the present value of the $100 payment to be received at the end of the first year is $100/(1+i). Similarly, it follows from formula (5) that the present value of the $150 payment to be received at the end of the second year is
Finally, it follows from formula (3) that the present value of the $200 payment to be received at the end of the third year is
Consequently, adding together these three separate present value calculations in accordance with Step 2, the present value PV(i) of the payment stream ($100,$150,$200) is given by
(1 + i)1
(1 + i)2
(1 + i)3
More generally, given any fixed annual interest rate i, and given any payment stream (V1,V2,V3,...,VN) consisting of individual payments to be received over the next N years, the present value of this payment stream can be found by following the two steps outlined above.
In particular, then, given any fixed annual interest rate, and given any payment stream paid out on a yearly basis to the owner of some financial asset, the present (current dollar) value of this payment stream can be found by following Steps 1 and 2 outlined above. Consequently, regardless how different the payment streams associated with different financial assets might be, one can calculate the present values for these payment streams in current dollar terms and hence have a way to compare them.
Measuring Interest Rates by Yield to Maturity
By definition, the current annual yield to maturity for a financial asset is the particular fixed annual interest rate i which, when used to calculate the present value of the financial asset's future stream of payments to the financial asset's owner, yields a present value equal to the current market value of the financial asset.
Below we illustrate this calculation for coupon bonds.
Yield to Maturity for Coupon Bonds:
The basic contractual terms of a coupon bond are as follows:
Receives: Price Pb
START |_______________________ /\/\/\ _____ DATE
| | |
CouponCoupon ... Coupon
Buyer Payment C Payment C Payment C
Receives: + Face Value F
Consider a coupon bond whose purchase price is Pb=$94, whose face value is F = $100, whose annual coupon payment is C = $10, and whose maturity is 10 years.
The payment stream to the buyer (new owner) generated by this coupon bond is given by
( $10, $10, $10, $10, $10, $10, $10, $10, $10, [$10 + $100] ).
For any given fixed annual interest rate i, the present value PV(i) of the payment stream (9) is given by the sum of the separate present value calculations for each of the annual payments in this payment stream as determined by formula (5). That is,
PV(i) = $10/(1+i) + $10/(1+i)2 + ... + $10/(1+i)10 + $100/(1+i)10 .
The current value of the coupon bond is its current purchase price Pb = $94. It then follows by definition that the yield to maturity for this coupon bond is found by solving the following equation for i:
Pb = PV(i) .
The calculation of the yield to maturity i from formula (11) can be difficult, but tables have been published that permit one to read off the yield to maturity i for a coupon bond once the purchase price, the face value, the coupon rate, and the maturity are known.
More generally, given any coupon bond with purchase price Pb, face value F, coupon payment C, and maturity N, the yield to maturity i is found by means of the following formula:
Pb = PV(i) ,
where the present value PV(i) of the coupon bond is given by
PV(i) = C/(1+i) + C/(1+i)2 + ... + C/(1+i)N + F/(1+i)N .
Interest Rates vs. Return Rates
Given any asset A held over any given time period T, the return to A over the holding period T is, by definition:
the sum of all payments (rents, coupon payments, dividends, etc.) generated by A during period T, assumed paid out at the end of the period,
PLUS the capital gain (+) or loss (-) in the market value of A over period T, measured as the market value of A at the end of period T minus the market value of A at the beginning of period T.
The return rate on asset A over the holding period T is then defined to be the return on A over period T divided by the market value of A at the beginning of period T.
More precisely, suppose that an asset A is held over a time period that starts at some time t and ends at time t+1. Let the market value of A at time t be denoted by P(t) and the market value of A at time t+1 be denoted by P(t+1). Finally, let V(t,t+1) denote the sum of all payments accruing to the holder of asset A from t to t+1, assumed to be paid out at time t+1.
Then, by definition, the return rate on asset A from t to t+1 is given by the following formula:
(13) Return Rate onV(t,t+1) + P(t+1) - P(t)
Asset A From= ---------------------------
time t to t+1 P(t)
V(t,t+1) P(t+1) - P(t)
= --------- + -------------
= payments + Capital Gain (if +)
received as or Loss (if -) as
percentage percentage of P(t)
Formula (13) holds for any asset A, whether physical or financial. The question then arises: For financial assets, what is the connection between the return rate defined by formula (13) and the interest rate on the financial asset defined by the yield to maturity?
The return rate on a financial asset is not necessarily equal to the yield to maturity on the financial asset. Starting at any current time t, the return rate is calculated for some specified holding period from t to t', whether or not this holding period coincides with the maturity of the financial asset. Moreover, the return rate takes into account any capital gains or losses that occur during this holding period, in addition to any payments received from the financial asset during this holding period. In contrast, starting at any current time t, the yield to maturity takes into account the payment stream generated by the financial asset over its entire remaining maturity, plus the overall anticipated capital gain or loss that will be incurred when the financial asset is held to maturity.
Real vs. Nominal Interest Rates
The yield to maturity measure of an interest rate, as examined to date, has been "nominal" in the sense that it has not been adjusted for expected changes in prices. What actually concerns a "rational" saver considering the purchase of a financial asset is not the nominal payment stream he or she expects to earn in future periods but rather the command over purchasing power that this nominal payment stream is expected to entail. This purchasing power depends on the behavior of prices.
Let infe(t) denote the expected inflation rate at time t, and let i(t) denote the (nominal) yield to maturity for some financial asset at time t. Then the real interest rate associated with i(t) is defined by the following "Fisher equation:"
ir(t) = i(t) - infe(t) .
That is, the real interest rate is the nominal interest rate minus the expected inflation rate.
Note:The real interest rate defined by (14) is more precisely called the ex ante real interest rate because it adjusts for expected changes in the price level. If the expected inflation rate in (14) is replaced by the actual inflation rate, one obtains the ex post real interest rate.
Real interest rates provide a more accurate measure of the true costs of borrowing and the true gains from lending than nominal interest rates, and hence provide a better indicator of the incentives to borrow and lend. In particular, for any given nominal interest rate i on a debt instrument D, the incentive to borrow (issue D) will be higher if the real interest rate associated with i is lower (i.e., the expected inflation rate is higher). This is so since a higher expected inflation rate means the borrower (issuer of D) can expect to pay off his future nominal debt obligations using cheaper dollars than he borrowed. For this same reason, the incentive to lend (purchase D) will be lower if the real interest rate associated with i is lower.
A similar distinction is made between the (nominal) return rate defined by (13), which has not been adjusted for expected changes in prices, and the "real return rate" which is subject to such adjustment. More precisely, the real return rate on any asset A over any holding period from t to t+1 is defined to be the (nominal) return rate (13) minus the expected inflation rate infe(t).
Copyright © 2012 Leigh Tesfatsion. All Rights Reserved.
How Professional Day Traders Make Money In The Stock Market
http://wanderingtrader.com/day-trading-blog/Day Trading Blog
How professional day traders really make money in the stock market is a question that I get quite frequently. I even announced a Q&A session recently via the
http://www.facebook.com/wanderingtraderWanderingTrader Facebook page and most questions were actually about
http://wanderingtrader.com/day-tradingday trading rather than travel.
There is an aura around Wall Street and the stock market that involves a lot of money. Most people are vaguely acquainted with the stock market and only understand that there’s a lot of money involved.
Some of us in recent years have even begun to dislike everyone associated with the stock market because they have all the money that we are supposed to have. If you can beat them join them right?
As I continue to get more and more questions about day trading I plan on explaining a bit more on what day trading is and how I make a living doing it.
What Day Traders Really Do….
Basics of How Professional Day Traders Make Money in the Stock Market
The financial system is significantly more complex than it used to be even 10 or 20 years ago. The basic premise behind why the stock market exists is because companies need money to grow. After a company gets to a certain point they need more money to grow. A private company turns into a public company and that is when a company first appears in the stock market.
The stock market can be compared to eBay. EBay is the 21st century version of a garage sale, we have things we don’t need that still have value and we want money for them.
The stock market is essentially the same thing but with companies that need capital (money) to continue growing. Eventually a company gets so large that they stop lending money from their friends, local banks, and family. They go public to receive a cash infusion they need to keep growing and compete in their industry. Once a person initially invests in a company via stock market we become part owners of the company.
Stock markets deal in shares of stock. If there are 100 shares of Google and I buy one share I therefore own 1% of Google.
This is relative because there are actually millions of shares of stock for certain companies.
Every company is placed in a group of stocks called stock indexes much like categories on eBay. If we want to purchase a camera or laptop we will look in the electronics section. When one wants to purchase a new bed we look in the furniture section. Categories on eBay vary a bit to stock indexes but to the untrained eye we can look at it the same way. The NASDAQ composite index for example is mostly known for having technology stocks. The S&P 500 index is an index of the 500 largest public companies in the United States.
So once a company goes from private to public we begin to invest in it. The left over shares have value and the general public decides what that value is based on the stock market. With anything that has value one can determine a future value. This is the reason why the stock market exists and the fundamental way that professional day traders really make money in the stock market.
They buy and sell stocks based on their future value.
What our day trading charts look like
Fundamental vs Technical Analysis
In order to determine the value of a stock or company traders and investors used two typical models, fundamental analysis and technical analysis. It is important to note that these two types of analysis are the main forms of investing/
http://wanderingtrader.com/day-trading-blogtrading in the stock market.
Fundamental analysis involves someone understanding concepts like the health of a company via its competition, revenue and profit, it’s management, and potential for future growth (think Warren Buffet). The concept here is to understand a company is in a good position to grow and increase value.
Once a company increases its value it pleases investors and professional traders.
A trader or investor would have purchased the stock at a lower price and since the company has a higher value (higher priced stock) it makes a person money.
Technical analysis does not include any of the above. Technical analysis strictly involves looking at a chart with a set of indicators and recognizing patterns. One random example would be if a certain company goes up during a certain time of year.
If we assume that Apple will make more sales during the holiday season then we may be able to assume that its stock price will go up during that time of year. A professional trader that is looking at Apple stock might look for patterns in changes in price during a specific date or time of year.
Technical analysis does not involve analyzing the company’s financials or management. It simply involves looking at a chart and making decisions.
An example of two reversal patterns which is part of technical analysis
Professional day traders have advantages and disadvantages with both types of analysis but it also depends on what kind of trader a person is.
If one is looking to invest in a company long-term we may look more at fundamental analysis. I prefer strictly a technical analysis approach due to the uncertain economic times we are in. I simply prefer to not have my money in the markets when something erratic or volatile can happen.
It also takes a lot of work to look at news and connect the dots with all of the different opinions and news sources online. Instead I turn on my computer and begin looking at a chart, do a few minute pre market analysis, and begin trading.
Most people that we call day traders look at the market which strictly technical analysis. They are normally classified into three different types of traders; scalpers, intraday traders, and swing traders. All three types of professional day traders are looking to do the same thing, make a profit based on a different in value. The only difference between the three is the amount of time they are involved in positions.
Professional day traders that make money in the stock market with high frequency and lower profit are called scalpers. The goal is to take advantage of small inconsistencies in the market in addition to quick movements (changes in value in a matter of seconds or minutes).
A scalper may only be in a position for five or 10 seconds or possibly a minute. A scalper also tends to place a higher frequency of trades and as their profit is normally lower per trade. A higher frequency of positions (entering and exiting trades) is needed in order to make higher profits.
Types of day traders
Professional day traders that make money in the stock market on a daily basis are considered intraday traders. An intraday trader never holds a position overnight hence the term “intra-day”. Intraday traders are typically in positions from within a few minutes to possibly a few hours. Intraday traders are typically not as high frequency as scalpers but due trade more often than swing traders.
I would consider myself an intraday trader as I normally trade between an hour or two a day with TheDay
http://thedaytradingacademy.com/TradingAcademy.com. Most of our traders make their money within an hour or two a day. Our live classes are normally a few hours as well since the best activity in the markets come within the first few hours.
Professional day traders that make their money swing trading involves a much longer period of time. A swing trader uses fundamental or technical analysis but stays in trades over a few days or even weeks. To compare the differences between a scalper or intraday trader, a swing trader may be in a position for a few days or weeks whereas an intraday trader never holds a position overnight.
This swing trader term infers that someone plays the swings in the stock market rather than the quicker movements.
There are also much longer term day traders called position traders which hold trades for several weeks or even months. We won’t highlight these kinds of traders on today’s post.
The whole basis of a professional trade day trader making money in the stock market involves accurately gauging the value of a stock. A stock of a company is in essence the price at which the general public says it’s worth.
Since the financial system has changed it has become more complex and there are more investment vehicles than just stocks to invest in. These can be stocks, futures, options, and even forex (currency fluctuations). The basic premise of making money in the stock market is simple, gauging the value of something and making a profit when your estimation was correct. (Check out the
http://youtube.com/daytradingacademyDay Trading Academy YouTube to see how we actually trade)
One of the most important things to understand is that a day trader can make money when the market goes up or down. If we are estimating the value on something we can also estimate that the value is going down and make a profit on it.
Day traders can actually make more money when the market is going down, when the economy is in a recession, or when there is a crisis. One of the reasons I love to make a living day trading is because we actually make more money and an economic downturn and a crisis than we do when things are going well. I do still hope the best for you!
So there you have it! A bit of novice background of how I make a living day trading &
http://wanderingtrader.com/travel-blogtraveling around the world.
- See more at:
FREE REPORT - INTRODUCTION
http://www.chartadvisor.com/freereport/free_report_pg2.aspxSymetrical Triangle 2
http://www.chartadvisor.com/freereport/free_report_pg3.aspxAscending/Descending Triangle 3
http://www.chartadvisor.com/freereport/free_report_pg4.aspxHead & Shoulders 4
http://www.chartadvisor.com/freereport/free_report_pg5.aspxDouble/Triple - Bottom/Top 5
http://www.chartadvisor.com/freereport/free_report_pg6.aspxMinimizing Risk 6
http://www.chartadvisor.com/freereport/free_report_pg7.aspxMaximizing Profit 7
So you’re a believer.
You believe there are profits to be made in stocks. You believe you don’t have to pay a high-profile Wall Street banker to make money. You believe the average Joe can earn a healthy fortune using the right system. And you are dead-set on figuring that system out.We agree with you. We believe that with the right tools, anyone can make consistent money in stocks. And we are going to give you those tools.
A Simple Toolkit for Reliable Returns
In this simple-to-follow, eight-page guide, ChartAdvisor introduces you to five of the most powerful, profitable
http://www.investopedia.com/terms/p/pattern.asppatterns in stocks.
These stock patterns pave the way 10%, 15%, even 20% gains for each winning trade. True, not the 2000% some people are touting. But it’s darn good money, made using an established strategy, and attainable at relatively low risk. It’s realistic money. And you don’t have to trust your hard-earned cash to some broker’s favorite fad.
In the next few pages, you’ll learn all the skills you need to recognize proven money-making stock patterns, and you’ll get to see these patterns in action.
"I've used a variety of ... systems, and lost 25% of my portfolio over a 2-3 year period crazily trading hundreds of stocks. When I began using ChartAdvisor and sticking to the rules it made all the difference. The stress of watching stocks is gone, I can do my job without constantly worrying, and I've made a 26% return on my portfolio just in the last three months on just a few trades!" ~ B. Hiebert, Canada
We’ll also introduce you to our ChartAdvisor system – Three Simple Steps to Stock Profits. Whether you decide to continue with ChartAdvisor or not, after reading this guide, you’ll …
Discover How To:
1. Identify profitable stock patterns 2. Minimize your risk 3. Maximize your return in up and down markets
Make money on the stock market
You’ll learn how to make big money on stocks using a technical analysis toolkit that has been wielded successfully for hundreds of years. That’s no exaggeration.
That makes these patterns some of the most time-tested strategies in finance. You can feel secure that you are trusting your investments to a highly refined system – not a new craze or an analyst’s hunch.
There are hundreds of patterns in stock charts that traders can look for, but at ChartAdvisor, we focus only on the most trusted.
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Profitable Pattern Number One
The Symmetrical Triangle: A Reliable Workhorse
You’ll recognize the
http://www.investopedia.com/terms/s/symmetricaltriangle.aspsymmetrical triangle pattern when you see a stock’s price vacillating up and down and converging towards a single point. Its back and forth oscillations will become smaller and smaller until the stock reaches a critical price, breaks out of the pattern, and moves drastically up or down.
The symmetrical triangle pattern is formed when investors are unsure of a stock’s value. Once the pattern is broken, investors jump on the bandwagon, shooting the stock price north or south.
Symmetrical Triangle Pattern To form your symmetrical triangle pattern, draw two converging trendlines that bound the high and low prices. Your trendlines should form (you guessed it) a symmetrical triangle, lying on its side.
How to Profit from Symmetrical Triangles
Symmetrical triangles are very reliable. You can profit from upwards or downwards breakouts. You’ll learn more about how to earn from downtrends when we talk about
If you see a symmetrical triangle forming, watch it closely. The sooner you catch the breakout, the more money you stand to make.
Sideways movement, a period of rest, before the breakout.
Price of the asset traveling between two converging trendlines.
Breakout ¾ of the way to the apex.
Set Your Target Price:
As with all patterns, knowing when to get out is as important as knowing when to get in. Your target price is the safest time to sell, even if it looks like the trend may be continuing.
For symmetrical triangles, sell your stock at a target price of:
Entry price plus the pattern’s height for an upward breakout.
Entry price minus the pattern’s height for a downward breakout.
ChartAdvisor Symmetrical Triangles in Action
ChartAdvisor has a long history of identifying symmetrical triangle patterns. Over the last two and one-half years, ChartAdvisor has brought to its readers over 20 symmetrical triangle patterns. That’s an average of one every month and a half.
Our readers earned an amazing 40% profit on our Nortel Networks Inc (
http://www.investopedia.com/markets/stocks/NTNT) pick. Those who followed our call on Rochester Medical Corp (
http://www.investopedia.com/markets/stocks/ROCMROCM) in September of 2004 earned 15% in 33 days. And in October of 2004, our members earn 11% in 19 days when ChartAdvisor noticed Pan American Silver Corp (
Our members earned 11% in 19 days on the PAAS symmetrical triangle pattern.
If you’re not sure you can recognize a symmetrical triangle on your own, be sure to visit
http://www.chartadvisor.com/ChartAdvisor.com daily for out Charts of the Day.
http://www.chartadvisor.com/freereport/free_report_pg3.aspxLearn How to Profit from our Next Set of Profitable Patterns: The Ascending and Descending Triangles >
Pattern Number Two
Ascending and Descending Triangles: The Traditional Bull and Bear
When you notice a stock has a series of increasing troughs and the price is unable to break through a price barrier, chances are you are witnessing the birth of an
http://www.investopedia.com/terms/a/ascendingtriangle.aspascending triangle pattern.
Ascending Triangle Pattern Confirm your ascending triangle pattern by drawing a horizontal line tracing the upper price barrier and a diagonal line tracing the series of ascending troughs.
http://www.investopedia.com/terms/d/descendingtriangle.aspdescending triangle is the bearish counterpart to the ascending triangle.
Descending Triangle Pattern Confirm your descending triangle by drawing a horizontal line tracing the lower price barrier and a diagonal line tracing the series of descending troughs.
The ascending and descending patterns indicate a stock is increasing or decreasing in demand. The stock meets a level of
http://www.investopedia.com/terms/r/resistance.aspresistance (the horizontal trendline) several times before breaking out and continuing in the direction of the developing up or down pattern.
How to Profit from Ascending and Descending Triangles
Ascending and descending triangles are short-term investor favorites, because the trends allow short-term traders to earn from the same sharp price increase that long-term investors have been waiting for. Rather than holding on to a stock for months or years before you finally see a big payday, you can buy and hold for only a period of days and reap in the same monster returns as the long-time stock owners.
As with many of our favorite patterns, when you learn to identify ascending and descending triangles, you can
http://www.chartadvisor.com/freereport/free_report_pg7.aspxprofit from upwards or downwards breakouts. That way, you’ll earn a healthy profit regardless of where the market is going.
An ascending or descending pattern forming over three to four weeks.
For ascending and descending triangles, sell your stock at a target price of:
ChartAdvisor Ascending and Descending Triangles in Action
Ascending and descending triangles are some of our most popular patterns, because their features are so clear and the breakouts are almost always fast and furious.
Flanders Corp (
http://www.investopedia.com/markets/stocks/FLDRFLDR) earned our readers 28% in 18 days. Dominos Pizza (
http://www.investopedia.com/markets/stocks/FLDRDPZ) jumped 12% in 20 days after we pinpointed the breakout point on June 13, 2005.
Another of our winning picks in 2005, Dril-Quip Inc (
http://www.investopedia.com/markets/stocks/DRQDRQ) jumped 12% in just 6 days. On Boyd Gaming (
http://community.investopedia.com/q.aspx?s=BYDBYD), investors following our pick earned a whopping 29% in 35 days.
Our readers earned 29% in 35 days on the BYD ascending triangle pattern.
http://www.chartadvisor.com/ChartAdvisor regular you would have reaped incredible profits on the 60 ascending and descending triangle picks we’ve made since our program’s beginning.
We features an average of two of these cash cows per month, making them one of the most prevalent and predictable patterns in your toolbox.
http://www.chartadvisor.com/freereport/free_report_pg4.aspxLearn How to Profit from our Next Profitable Pattern: The Head and Shoulders >
Profitable Pattern Number Three
Head and Shoulders: A ChartAdvisor Staple
The head and shoulders pattern is a prevailing pattern among
http://www.investopedia.com/terms/s/shortselling.aspshort sellers, investors who profit from downtrends. After three peaks, the stock plummets, offering a textbook, high-return opportunity to traders who catch the trend early.
Head and Shoulders Pattern Head and shoulder patterns are characterized by a large peak bordered on either side by two smaller peaks. Draw one trendline, called the neckline, connecting the bottom of the two troughs.
The first trough is a signal that buying demand is starting to weaken. Investors who believe the stock is undervalued respond with a buying frenzy, followed by a flood of selling when traders fear the stock has run too high. This decline is followed by another buying streak which fizzles out early. Finally, the stock declines to its true worth below the original price.
How to Profit from the Head and Shoulders Pattern
Short sell as soon as the price moves below the neckline after the descent from the right shoulder.
For the head and shoulders pattern, buy shares at a target price of:
Entry price minus the pattern’s height (distance from the top of the head to the neckline).
ChartAdvisor Head and Shoulders Pattern in Action
Profiting from a downtrend can seem counterintuitive at first, but
http://www.chartadvisor.com/ChartAdvisor.com readers soon learn the benefits of being able to profit in up OR down markets.
This head and shoulders pattern on PAWC shot up an astonishing 27% in just 33 days.
http://www.chartadvisor.com/freereport/free_report_pg5.aspxLearn How to Profit from our Next Set of Profitable Patterns: Double and Triple Bottoms and Tops >
Profitable Patterns Number Four and Five
Triple and Double Bottoms and Tops: Reversals upon reversals
When you see a W or M pattern forming, you may have just discovered a money-making
http://www.investopedia.com/terms/d/doublebottom.aspdouble bottom or
http://www.investopedia.com/terms/d/doubletop.aspdouble top pattern. These patterns are common reversal patterns used to suggest the current stock trend may be likely to shift.
But don’t panic if your double bottom or double top patterns do not develop as you had originally thought. You haven’t lost your chance for cash. If your W or M pattern reverses for a fourth time, you could now be working with the profitable triple bottom or triple top.
Double Bottom Pattern
Double Bottom Pattern A small peak is surrounded by two equal troughs.
The price exceeds the middle-peak price.
A price increase of 10% to 20% from the first trough to the middle peak.
Two equal lows, not to differ by more than 3% or 4%.
For the double bottom pattern, sell your stock at a target price of:
Entry price plus the pattern’s height (distance from the peak to the bottom of the lowest trough).
Double Top Pattern
Double Top Pattern A small trough is surrounded by two equal peaks.
Short Sell When:
The price drops below the middle-trough price.
A price decrease of 10% to 20% from the first peak to the middle trough.
Two equal highs, not to differ by more than 3% or 4%.
For the double top pattern, buy shares at a target price of:
Entry price minus the pattern’s height (distance from the trough to the top of the highest peak).
Triple Bottom Pattern
Triple Bottom Pattern Three equal troughs amid a series of peaks.
The price exceeds the resistance established by the prior peaks.
A series of three identical troughs at the end of a prolonged downtrend.
For triple bottom patterns, sell your stock at a target price of:
Entry price plus the pattern’s height (distance from the resistance to the bottom of the lowest trough).
Triple Top Pattern
Triple Top Pattern Three equal peaks amid a series of troughs.
The price falls below the support that formed from the prior troughs.
A series of three peaks at relatively the same level.
For triple top patterns, buy shares at a target price of:
Entry price minus the pattern’s height (distance from the support to the top of the highest peak).
Now You Know
The five most profitable stock patterns:
ascending and descending triangles
head and shoulders
double top and double bottom
triple top and triple bottom
You’re halfway through your ChartAdvisor toolbox. But you still need a couple more nuts and bolts to ensure high-dollar profits in the market. Before you’re ready to invest, you’ll want to learn how best to cut your losses and maximize your returns.
http://www.chartadvisor.com/freereport/free_report_pg6.aspxLearn How to Minimize Your Stock Market Losses >
How to Minimize Your Risk
No investment advisor likes to admit it, but no stock picking system is perfect. Sometimes, the stocks we think will explode, don’t. Sometimes, the stocks we feature lose money.
There may not be a foolproof system to predicting the stock market, but we do have a foolproof system for managing risk.
http://www.chartadvisor.com/ChartAdvisor follows one of the safest risk reduction systems available.
Using these three simple steps, you can reduce the risk in your stock picking plan:
Three Ways to Take Risk Out of the Stock Market
Screen Your Picks. This might seem obvious, but patterns that look like they are developing into predictable trends do not always follow through. After combing over thousands of stock charts a day, ChartAdvisor will often not fetures a single stock.
Get In. Get Out. ChartAdvisor preaches setting realistic target exit prices for all stocks. We lock in high returns while the stock is high, and we get out before the market has a chance to change its mind.
http://www.investopedia.com/terms/s/stop-lossorder.aspStop Losses. This step is absolutely critical to minimizing your risk in the stock market. If a sure-fire winner turns out to be a fizzled-out dud, your system needs to have a built-in, abandon-ship trigger. That is, you need to know when to cut your losses and move on to brighter prospects.
ChartAdvisor sets its stop-loss trigger around 3%. So if a trade starts to go sour, you will almost never lose more than 3% of your investment.
“I am glad I took a second look at
http://www.chartadvisor.com/ChartAdvisor. I keyed in your data from the 2nd of Feb 04 into a spread sheet with 20% of capital allocated to each symbol and came up with the 38% annualized return which is better than a poke-in-the-eye-with-a-sharp-stick, considering "the market" has been a sideways affair since the starting date.
What I must mention is how inspired and relaxed I am after an in-depth study of your real trading account making that amount of return... I can more fully appreciate the much-lectured "cut your losses short now", seeing just how early it pays to get out when the trade goes against you, rather than the "give-it-room" systems I have tried."
-P. Cameron, New Zealand
http://www.chartadvisor.com/freereport/free_report_pg7.aspxLearn the Final Key To the ChartAdvisor System: Maximizing Your Profit in Up or Down Markets>
FREE REPORT - MAXIMIZING PROFIT
How to Maximize Your Return In Up or Down Markets
Remember at the beginning of this report when we said we’d show you the Three Simple Steps to Stock Profits?
We already learned about step one: picking profitable stock patterns. We’ve also covered step two: minimizing your risk. Now we’ve come to the final step that makes the
http://www.chartadvisor.com/ChartAdvior system so unique: how to profit from stocks, even when the stock goes down.
It’s a common misconception that traders can only make money when the price of a stock rises.
Investors can make money anytime they can predict a stock’s future movement – up or down.
It’s time to learn about short selling.
Short selling is the secret to making cash in a down market. Here’s how it works:
Identify a stock pattern that suggests a stock is headed down. Example: The Cleveland Cliffs descending triangle pattern in April of 2005 was perfect for short selling.
Borrow shares of the soon-to-decline stock from your brokerage. Example: Let’s say, right before the Cleveland Cliffs pattern (above) breaks out and moves downwards, you borrow 100 shares of the stock.
Immediately sell these borrowed shares. Example: You immediately sell these borrowed shares of Cleveland Cliffs at the price just below the support line: $70 per share, 100 shares = $7,000. You are now sitting on $7,000. But, of course, you still owe the brokerage 100 shares, which you don’t currently have anymore.
Wait for the stock to drop to your target price. Example: You wait for the stock to reach the target price, which in this example, is $63 per share.
Buy the shares at the target price. Example: You use the $7,000 you made earlier to purchase 100 shares at $63 per share. That costs you $6,300 dollars and leaves you with an extra $700 in your account.
You return the shares to your brokerage. Example: Return the 100 shares of Cleveland Cliffs to your brokerage.
Enjoy your profits. Example: You earned $700, a 10% profit on $7,000. And even better, you made $700 when the price of
http://www.investopedia.com/markets/stocks/CLFCLF declined and all other investors were losing money!
http://www.chartadvisor.com/freereport/free_report_pg8.aspxLearn The Top 5 Reasons To Try ChartAdvisor >
http://www.chartadvisor.com/freereport/free_report_pg6.aspx< previous |
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Chart Advisor for August 28, 2015
http://www.investopedia.com/contributors/68/Justin Kuepper | August 28, 2015 AAA |
The U.S. markets were mixed over the past week, with the Nasdaq posting a 1.69% gain and the
http://www.investopedia.com/terms/r/russell2000.aspRussell 2000 Index, a benchmark of small-cap stocks, losing 1.12% as of Thursday’s close. After suffering from a six-day losing streak, the market recovered sharply to end the week on a much higher note than on which it started. The economy seems to have grown much faster than expected between April and June, with the government raising growth estimates from 2.5% to 3.7%, citing higher consumer, business and government spending.
http://www.investopedia.com/terms/n/nikkei.aspNikkei 225 Stock Average fell 2.93%, Germany’s
http://www.investopedia.com/terms/d/dax.aspDAX 30 rose 1.89% and Britain’s
http://www.investopedia.com/terms/f/ftse.aspFTSE 100 fell 0.09%. In the Eurozone, manufacturing and services purchasing managers' indices (
http://www.investopedia.com/terms/p/pmi.aspPMIs), indicators of the health of the manufacturing sector, both expanded. The exception was France, which continues to lag behind the rest of the region. In Asia, China’s stock market continued to experience extreme volatility that has left investors guessing just how severe the country’s economic downturn could be beneath the central government’s headline figures.
The SPDR S&P 500 ETF (ARCA:
http://www.investopedia.com/markets/etfs/spy/SPY) rose 0.73% over the past week as of Thursday’s close. After breaking down sharply lower, the ETF, which is based on the S&P 500 Index, briefly traded as low as $182.50 before rebounding to its S2 support at around $200.19. Traders should watch for a breakout above these levels back to its former support and S1 support at $205.35. Traders could also watch for a breakdown to test its lows. Looking at technical indicators, the relative strength index (
http://www.investopedia.com/terms/r/rsi.aspRSI) recovered to neutral levels, while the moving average convergence divergence (
http://www.investopedia.com/terms/m/macd.aspMACD) experienced a bearish crossover.
The SPDR Dow Jones Industrial Average ETF (ARCA:
http://www.investopedia.com/markets/etfs/dia/DIA) rose 0.01% over the past week as of Thursday’s close. After breaking down sharply lower, the ETF briefly traded below $152.50 before rebounding sharply higher. Traders should watch for a breakout higher to its S2 support at $169.32 or a breakdown lower to retest its lows of around $152.50. Looking at technical indicators, the relative strength index appears neutral at 42.14, while the MACD experienced a bearish crossover.
The PowerShares QQQ Trust (NASDAQ:
http://www.investopedia.com/markets/etfs/qqqQQQ), an ETF based on the
http://www.investopedia.com/terms/n/nasdaq100.aspNasdaq 100 Index (the 100 largest and most actively traded companies on Nasdaq), rose 1.69% over the past week as of Thursday’s close. After breaking sharply lower, the ETF briefly touched $85.00 before rebounding back above $100.00 and towards its key support levels. Traders should watch for a rebound above its S1 support and 200-day moving average at around $106.50 or a move back down to its S2 support at $102.16. Looking at technical indicators, the relative strength index appears neutral, while the MACD looks bearish.
The iShares Russell 2000 ETF (ARCA:
http://www.investopedia.com/markets/etfs/iwm/IWM), which offers exposure to 2000 small-cap U.S. companies, fell 1.12% over the past week as of Thursday’s close. After breaking down sharply lower, the index briefly touched the $110.00 levels before recovering a bit by the end of the week. Traders should watch for a breakout from its S2 support at $115.61 or a move lower to retest its lows at around $110.00. Looking at technical indicators, the relative strength index appears a bit oversold at 38.55, but the MACD remains in a bearish downtrend.
The Bottom Line
The major U.S. indexes were mixed over the past week amid extreme volatility, as of Thursday’s close. Next week, traders will be closely watching a number of domestic economic indicators, including the
http://www.investopedia.com/terms/i/ism-mfg.aspISM Manufacturing Index data on September 1, jobless claims on September 3 and employment data on September 4. Of course, traders will be also closely watching the central bank for any hints on interest rates.
All charts courtesy of StockCharts.com
http://www.investopedia.com/stock-analysis/cotd/082815/chart-advisor-august-28-2015-spy-dia-iwm-qqq.aspxChart Advisor for August 28, 2015 (SPY,DIA,IWM,QQQ)
http://www.investopedia.com/stock-analysis/cotd/082815/chart-advisor-august-28-2015-spy-dia-iwm-qqq.aspxhttp://www.investopedia.com/stock-analysis/cotd/082815/chart-advisor-august-28-2015-spy-dia-iwm-qqq.aspx#ixzz3kDPECR6b Follow us:
http://ec.tynt.com/b/rf?id=arwjQmCEqr4l6Cadbi-bnq&u=InvestopediaInvestopedia on Facebookcom/terms/f/ftse.aspFTSE 100 fell 0.09%. In the Eurozone, manufacturing and services purchasing managers' indices (
http://www.investopedia.com/terms/p/pmi.aspPMIs), indicators of the health of the manufacturing sector, both expanded. The exception was France, which continues to lag behind the re