There are more ways of controlling securities than
simply buying and selling. Understanding the basics
of how to buy, sell, and other ways of controlling
securities puts you in the driver’s seat. It lets you
make decisions that can increase profits or reduce
losses. These decisions also affect the commissions
you pay for your transactions.
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There is always a difference between the asking
price and the selling price. This difference is called
the ‘spread’. It may be a few points or it may be a
wide gap. This is the profit margin for the market
maker or the broker who holds the securities and
stands ready to buy or sell at any time. The ask
price is the price sellers are willing to part with the
asset. The bid price is what buyers are willing to
pay.
When you buy stocks, ETFs, or options, this
difference is negotiable. For example, ABC
Company’s asking price might be $19.68; the selling
price might be $19.99.
If you place a market order, the price you will pay
for the stock will be whatever is the going rate, in
this case, $19.99. However you could place a limit
order. A limit order tells the market you are only
willing to pay this specific amount, or less to buy
the security. In this case, you might set your limit
order at $19.78. Then the seller gets to decide if
they are willing to take that price or not.
You may get your asset cheaper than others pay…
but if the equity rips higher, your order may not
be filled and you won’t get the asset at that price.
Then your choices are to rebid a limit order, pay
the market price, or forgo the security at this price.
You can almost always get the security for less than
the ask price in a wide spread. Often the order will
be filled even if you choose the midpoint of the
spread because the price tends to uctuate during
the day.
Profitable buying requires patience to wait for the
best entrance and patience to let a trade pass you
by rather than chasing the trade. Chasing the
trade means buying at a more expensive price
than is a good value because the price keeps going
up. This is caused by fear of losing out and often
5.1 Owning the Asset and the Bid/Ask
Spread
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results in a loss when the price settles back down.
Buying: The traditional way to own a security is
to buy it outright. When you own it, you can take
physical possession of the stock certificate, the
gold, or the currency. People who intend to buy
and hold a security for decades or generations will
typically buy the security outright.
The purchase comes with commissions and
perhaps other fees. With traditional investment
brokers equity purchase and sales used to cost
$100 or more per transaction. Fintech has reduced
these fees. Some purchase transactions are now
less than $10, regardless of the number of shares
moved.
eToro now offers buying and selling of stocks, or
stock ownership when purchase are made without
any leverage. Using leverage or short selling
continues to be done with CFDs.
Selling: You face the same commissions when you
sell your equity. Thinly traded securities may not
have enough liquidity to sell right away. You may
have to wait for a buyer.
When you sell your security, you may sell at the
market price (whatever the ask price is) or put in
a limit order. Then you tell the broker or trading
platform you will sell at this set price or higher.
Often traders want to protect their investments
and pre-set a sale price if the equity reaches a
certain point. This point may be determined by
a percent against the asset’s gain or as a fixed
amount. On a price drop, the fixed amount sale
is called a stop loss. A trailing loss is triggered
when the equity falls a certain percentage below
its highest price while you owned the equity. With
ABC Company you could sell when it falls to $15 (or
lower) or when it drops 25%.
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On many trading platforms, the stop loss triggers
do not guarantee you will sell your equity at that
price. In a fast falling market, the price may blow
through your stop. By the time the order is filled,
the price you receive could be much less. Some
trading platforms allow you to protect yourself
from this kind of ash-crash by letting you bracket
your sale. You tell it to sell at $15…but not if it falls
below $13.50, for example. However, in a fast
falling market, your asset might not be sold at all
and you’d be left holding it at a price perhaps far
below $13.50.
Some trading platforms do guarantee the stop loss
price you set. Then the trading platform will take
the loss if the sale cannot be made in time. Check
with your broker or platform to see which rules
apply to you.
Stop loss and profit points can be a significant part
of a trader’s arsenal to reduce risk and increase
protection in a changing market. They can be
immensely helpful many times, but they are not
foolproof.
Options let you control a block of securities without
owning the security. Options are priced individually,
but traded in 100 share lots. When you open 1
option trade, at say $1.15, the cost is multiplied by
100 ($115.00) and you control 100 shares of stock.
Options are for a fixed price and a fixed time. You
can trade options for as short as a few minutes or
as long as two years.
5.2 Options
You may also want to set stops to sell your security
when it reaches a certain profit point. Again, you
can set the sale to trigger when the security rises
a certain percent or a specific fixed amount.
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Most option traders do not want to actually own
the asset. They want to profit from the movement
of the asset. When the price of the asset moves
toward the option price, the option increases in
value. Traders may sell for several reasons:
1.When the option gains an attractive profit
2.When the option falls below the traders
determined stop loss
3.When it looks like the option will expire out of
the money, the trader may salvage some of the
premium by selling the option they bought
When an option is out of the money, it means
the price of the asset has not reached the strike
price, or the agreed upon price the stock needs to
reach to trigger the option. At the end of the option
period an out of the money option expires and has
no value. The trader who sold the option keeps the
profit from the sale. The trader who bought the
option takes the loss.
If the asset price reaches the strike price or higher,
it’s called in the money. If an option is in the
money at the end of the option period, the trading
platform will automatically execute the order to
buy or sell that option. The seller must either buy
the option back or execute the trade. For example:
On February 6th ABC Company sells for $19.99/
share. Frank believes the stock will stay the same
price or go down. So he sells 10 call options of ABC
at $21 a share with an expiration date of 21 April,
2017 for $1 a share. Since options control 100
shares, Frank will earn $100 x 10 = $1000.
If ABC stays below $21 on the expiration date, Frank
keeps the $1000 and has no obligations. But if the
stock grows to $24 a share, the option price will
go up as well— to perhaps $3.25. Now Frank must
either buy back the options at a cost of $3250, (a
$2250 loss) or have the $24,000 in his account to
buy the stock at option expiration. And then turn
around and sell it to the option holder for $21 a
share for a loss of $2000.
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Or Frank may have made a covered call. This is when
he already owns the 1000 shares of ABC Company.
Perhaps he bought them at $17. Then, when the
stock is called at the $21 option price, he still made
$4 a share on the stock… although he missed the
possible profit if he’d kept the stock and sold it at
the current $24.
George took the other side of the trade. He paid
the $1/share to buy the option. If ABC Company
stays below $21 at the expiration date, George
loses the $1000 he invested. He might sell the
option sometime before expiration for perhaps $.70
and have a smaller loss. But if ABC soars to $24,
George can sell his option for $3.25 and his $1000
investment returned him 325% gains.
There are four ways or sides of option trading:
• Buying puts (the option to sell an asset when it
drops to a specific level)
Selling puts (the obligation to buy an asset if it
drops into the money)
• Buying calls (the option to buy an asset if it rises
to a specific level)
Selling calls (the obligation to sell an asset if it
rises above a specific price)
When you sell you incur an obligation and unlimited
risk because the stock could soar or drop to zero
in price. You reduce that risk if you have covered
the option by owning the stock or being willing to
buy the stock at the put price. When you buy you
have a fixed risk. It will be no more than what you
paid for the option.
Selling options uses leverage and thus can give
investors both vast profits and staggering losses.
Buying options gives large upside, but limits losses
to the amount paid for the option. Successful
traders use charts and fundamental analysis to
predict high probability trades and use strict stop
loss orders to reduce losses. They may also use
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complex combinations of these four option trades.
This gives up some potential profits in order to
reduce the risk.
A CFD is a contract between the trader and the
broker to exchange the difference between the
opening and closing price of a specific security. The
trader never owns the security. Rather the CFD is
a derivative because the contract is based on an
underlying security.
These instruments are exceptionally easy to trade.
Some platforms even have one-click trading. Here
are six ways CFDs offer more exibility than other
methods of trading securities.
1. Accessibility: Trades are accessible, and small
investors can trade securities that might otherwise
be impossible to have access to.You can trade
CFDs across a broad range of assets. Stocks,
commodities, currencies, indices, and ETFs can all
be traded with a Contract for Difference. You also
can trade a wide variety of international equities
not always available to traders who buy and sell
securities.
2. Leverage: You can use more leverage for your
trades. CFDs can be traded without leverage or
with high leverage, depending on what your broker
offers. When using leverage, a smaller amount of
your money can fund a larger investment amount.
This may create outsized gains. It can also lead to
your losing more than your original investment.
Some trading platforms limit the amount of money
you can invest in high leverage trades and they
encourage strict stop loss placements to reduce
the risk.
5.3 Contract for Difference (CFD)
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You may balance some of the risks by spreading
your trades over a range of securities in various
sectors. Also, never risk a large sum of your
portfolio on any one trade, or even on multiple
trades of the same security.
3. Low Commissions: The initial cost of the trade
can be much less than buying or selling a security.
Some trading platforms only charge the spread
difference. This is the difference between the buy
and sell price. For stocks and commodities, it may
be a few pence or a small percentage difference.
For currency, it will be listed as ‘pips.’ PIP is short
for ‘price interest point’, and measures the amount
of change in the exchange rate for a currency pair.
A pip is usually 1/10,000 or .0001% of the asset. In
10K currency lots, that comes to about $1 or £1.
There is also an overnight fee that can be a debit
or a credit depending on the direction of the trade.
4. Upside and Downside Profit Potential: You
have the potential to make money in both a rising
and falling market. CFDs let you buy, or go long,
when you believe the market will rise. You can also
sell, or go short, when you believe the market will
Margin or Leverage
X Invest Controls Margin
1 1000 1,000 0.00%
2 1000 2,000 50.00%
5 1000 50,000 80.00%
10 1000 100,000 90.00%
25 1000 250,000 96.00%
50 1000 500,000 98.00%
100 1000 100,000 99.00%
200 1000 200,000 99.50%
400 1000 400,000 99.75%
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fall. Thus, your investment options are not limited
to only a rising market as when you trade stocks.
5. Tax Advantages: There may be tax advantages
to CFDs. In the UK, you avoid Stamp Duty because
you are not actually buying or selling the security.
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6. Insurance: CFDs can be a convenient way to
hedge equities you own if you are concerned they
may be in a temporary downtrend. You can sell
a CFD to earn money on the difference in price
should the equity drop. This compensates for the
lost value of the equity you own.
CFDs are easy to trade for potential profit as the
asset rises or falls. However, on small moves in
equities, the spread, or cost of the transaction,
can eat away at your profit. Some platforms list
their CFDs commissions on the fees page. Other
platforms do not let users know the spread.
Suppose ABC company has a bid/ask difference of
10 pence per trade. If you sell when the asset rises
only 25 pence, you’ve lost 20 of that to your buy
and sell commissions. So your net profit is only 5
pence.
When you use leverage, even a smaller amount
of gain can produce an attractive return on your
investment. Here is an example:
You want to buy XYZ Company that has a sell price
of £9.9 and a buy price of £10.0 and your broker
allows a 10x leverage. You buy 1000 shares for
£1000 using 10x leverage. You expect the stock to
rise. It goes up £1 and now has sell/buy price of
£10.9/£11.0. You sell it at £10.9 and make an £900
profit on the £1000 you invested. That’s an 90%
return.
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‘What is a Contract for Difference’ CMC Markets https://www.cmcmarkets.com/en/learn-cfd-trading/what-are-cfds
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The stock may not move as you anticipate. Suppose
it drops £1 and now has sell/buy price of £8.9/£9.0.
You sell it at £8.9 and incur a loss of £1100. You
just lost 110% or more than your initial investment.
This is why most CFD buyers use stop losses to
close the position before the stock drops below a
certain point. It helps to limit their losses.
Investing can be a remarkably profitable way
to increase your wealth and your retirement
security. As you understand the fundamentals of a
profitable company and as you learn the technical
analysis of market trends you are better able to
take advantage of profitable trades.
You are more likely to see existing trends. You
can trade within the cycles of commodities and
calendars. You can optimise buy and sell timing
and set suitable stop losses to limit the downside.
The more you learn, the more prepared you will be
to manage your risks and make decisions that best
suit your risk tolerance.
Your capital is at risk. Past performance does not guarantee future results. This information is for educational purposes and not investment advice.
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