All individual stocks are traded on stock exchanges. Whether you own individual stocks, index funds, etfs or mutual funds – these articles are important to read.

• What is a stock market exchange?
• What is a stock market index?
• Different types of stock market indexes
• More information on stock market indexes

Short selling stocks is a method of betting against a stock. You borrow stocks from your broker and sell them a view to buying them back at a lower price. Short sellers hope to profit from market declines, or when a stock is hit with unexpected bad news leading to a tanking of the share price.

The mechanics are rather simple. You borrow the shares from your broker, for which you pay a financing fee, and return them when you them back at a lower price. For example, if you get news that stock XX is suffering from sharply lower customer orders and is currently trading at $50, you can sell 200 shares at $10,000. Two months later, you buy them back at $25.00 and pocket a gross profit of $$5,000, for a hefty 50% return.

Short selling is a short-term strategy that works best when the broader market is in decline. In 2008, any investor who shorted the banks would have done very well. However, this strategy requires monitoring prices closely so as not to be caught out by a reversal of trend. In an improving market, the headwinds are against short selling.

Your profits are limited to what you receive from the short sale, but the prospect for losses are pretty steep as a stock can fall to zero.

The SEC has in July 2009 permanently banned “naked” short selling where the investor looks to cover the stock only after the sale, to stop wild swings and market turbulence. Now the transaction broker has to promptly buy or borrow the stock. Stopping the abuse of short selling is a an announced SEC priority, and it is considering other rules including more public disclosure of short trades.

One of these is the Depression-era uptick rule which prevents short selling until the stock ticks at least 1 cent above the previous trading price.

In a previous post, the “market” order was discussed – if you haven’t done so, please read that post first.

If you want to buy an ETF (exchange traded fund) or a stock online,  it is important to learn about market orders and limit orders.  One of the potential problems with a “market” order is that you don’t have any control of the price.  If the ETF or stock you are trading is thinly traded, then you might get a poor price.

Limit order

A “limit order” takes care of this problem – basically you enter the trade like you would a “market” order but you also enter a “limit” which is the maximum price you are willing to accept.

Buy order limit example

If you want to buy a stock and the last trade was for $50, you might enter an order for 100 shares with a limit of $51.  This ensures that the highest price you will pay for the shares will be $51.  This doesn’t mean you are bidding $51 – the order is still considered a ‘market’ order with a limit so you will get the current price which will hopefully be less than $51.

Sell order limit example

If you want to sell an ETF and the last trade was for $60, you might enter an order for 50 shares with a limit of $59.  The sell limit is the opposite of the buy limit – you are instructing the brokerage to get the best price possible for the shares but don’t accept a price below $59.

No guarantee order will be filled

If you enter a buy “market” order then it is very likely that the order will get filled as long as there is someone else selling the same shares at that time.  If you use a limit – then it is possible the order will never get filled.

Photo by Noodlz55

Stock splits occur when a company decides that their stock price has risen to a level where it is getting harder for investors to buy it in small quantities.  Normally a company will replace 1 of its shares with 2 or more new ones (ie 2 for 1 split).  For example if the stock price of ABC Incorporated is $300 and the company wants to do a 2 for 1 split then each current share will turn into 2 new shares worth half as much or $150.

The important thing to note is that while the number of shares you own goes up, the value of each share goes down so your total investment will remain the same.  Jason Zweig who wrote “Your Money or Your Brain” said very aptly that a stock split is like trading in a dime for two nickels.

Berkshire Hathaway (stock symbol BRK-A) run by Warren Buffet, is a very famous example of a company that has never split its stock.  It currently trades for about $95,000 which makes it next to impossible for most investors to buy even 1 share!  Fortunately there is a cheaper version of Berkshire Hathaway (called the baby Berk) (stock symbol BRK-B) which trades for a mere $3200.

Reverse stock split

The opposite of a stock split is called a reverse stock split.  This is when a company decreases the number of shares and increases the value of each share.  This usually happens when a stock has gone down in price.  If the shares of a company trades at $0.50 then they might do a 10 to 1 reverse split which means that 10 old shares become 1 new share worth $5.00.

Can mutual funds split too?

In theory, mutual funds can split their unit prices, however since investors can buy partial units of mutual funds, there isn’t really any point in doing so.

An exchange traded fund or ETF is an investment that contains the same stocks of a stock market index, in the same proportion as the stock index. If you are thinking this sounds a lot like index funds, you would be correct!

How ETFs are priced

The price of an ETF is determined by the value of the stocks contained in the ETF.  For example Vanguard VTI is an ETF that covers most of the stocks available in the US.  As the price of the underlying stocks change value, the ETF price will also change because investors will bid the ETF shares higher or lower.  Keep in mind that ETFs can hold investment that are not stocks as well, such as bonds.

Differences between ETFs and index funds

One of the key differences between index funds and ETFs is that index funds are priced once a day.  It doesn’t matter what time you put your order in, the price you get will be set at the end of the trading day.  ETFs on the other hand are priced throughout the day in a similar fashion to stocks.  Every time some shares of an ETF are bought and sold, the price might be adjusted.

Another way that ETFs are different from index funds is the costs.  In theory, ETFs have a cheaper management fee than index funds but since you have to buy and sell them like stocks, there will be a trading fee every time you buy or sell an ETF.  Usually with index funds, there are no fees for purchasing or selling them.  Both ETFs and index funds are generally much cheaper than a managed mutual fund.

More information

Should I Buy ETFs Or Index Funds?

If you follow the news regularly then you have probably heard of the “Dow Jones” index and maybe the “S&P 500” index.  Let’s take a look at what a stock market index is and why you should know about them.

An stock market index (or just “index) is a number that measures the relative value of a group of stocks. As the stocks in this group change value, the index also changes value. If an index goes up by 1% then that means the total value of the securities which make up the index have gone up by 1% in value.

The most common indices such as the Dow Jones Industrial Average, are made up of stocks but there are indices of bonds, real estate and others.  Usually the index value is termed “points” – as in “the Dow Jones dropped 500 points today”.  This means that the index went from a value of perhaps 4000 points to a value of 3500 points.  The points don’t mean anything – the best way to look at an index number is to compare it with a previous value such as the previous day’s number.

Example of stock market index

The ABC index is made up of four companies.  As of the end of yesterday’s trading day the ABC index was set at 4,123 points.  Today, two of the companies went up in value, one company dropped in price and the fourth company stayed the same – the total value of those stocks went up by 2% so the ABC index is now 2% higher or 4205 points.

Why are indexes important?

If you invest in mutual funds or individual stocks then it’s important to measure the performance of your investments against a relevant market index.  If your investments consistently lag behind the index then it might be time to come up with a new investing strategy.

Dividends are payments from a company to all its stock owners. Not all companies pay a dividend and the amount of each dividend is quite variable between companies. Some companies choose to keep all their profits to reinvest in the company and some companies choose to pay out some of those earnings as dividends. Whether a company pays a dividend or not is not an indicator of how good the company is as an investment.

A dividend is usually a dollar amount per share per payment period.  If a company pays $0.25 per share per quarter then an owner would receive $1.00 (4 x $0.25) per year for each share that they own. If they owned 200 shares, then the dividend amount would be $50.00 per quarter (200 x $0.25).

Payment frequency

Typically, most companies pay dividends on a quarterly basis but there are no set rules regarding the timing. Sometimes a company will pay out a “special” distribution which is essentially an unscheduled dividend.

Taxes on dividends

Dividends are taxed more favorably than interest payments which are considered as regular income so there is less of a tax burden on dividend paying stocks compared to bonds or other fixed income securities which pay interest.

Do mutual funds pay dividends?

Stocks that are owned in a mutual fund will still pay dividends – the managers of the investment fund will add up any dividends received and will pay them out as a dividend to the unit holders (investors).

Reinvested dividends or cash

If you own a stock or mutual fund that pays a dividend then you can elect to receive the dividend as cash (ie they mail you a check or direct deposit) or it can be reinvested. Reinvesting a dividend means that the money from the dividend is used to buy more of the investment you own.

Have you ever heard someone talking about a “hot stock tip” or “playing the markets”?  Were you too embarrassed to admit that you don’t really know what a stock is or how to buy one?  Then keep reading!

What is a stock?

Stocks are shares in companies. If you buy a share of a company – let’s use Google as an example, then you are now a part-owner of Google.

Does this mean you can enjoy a free lunch at the employee cafeteria?  Of course not – large companies issue many shares so if you only own a few then your “ownership” stake is very small.  You normally get a vote for each share you own, so you do get some say in the management of the company.

Are stocks risky?

Yes, they are. This doesn’t mean however that if you invest in stocks that you will necessarily lose money. What it means is that because the stock price changes over time and can go up or down, then there is a chance that you might make money, break even or lose money on your investment. If you were to buy the stock of a company that eventually goes bankrupt then you will lose your entire investment.

How do I buy stocks?

You can buy stocks of individual companies if you have an account set up at a stock brokerage such as Vanguard or E-trade. Many investors don’t buy individual stocks but would rather buy a mutual fund or index fund or exchange traded fund which is like a basket of stocks. Some funds are managed by professional fund managers whereas index funds and exchange traded funds are mostly based on stock market indexes.