Financial Topics Archives | Page 159 of 802

Aug

2024

What Is Forex Trading and How Does it Work?

What Is Forex Trading? A Guide for Beginners

By Laurel Tincher | Financial Independence, Growing Wealth, invest, Investing | Comments Off

Foreign exchange, also known as “FX,” “forex,” or currency trading, is the exchange of different global currencies. The changes in currency values reflect supply and demand. Traders aim to profit by buying and selling currencies based on their shifting values. The shifting values of currencies in the market affect the prices of goods and services all over the world.

The largest financial market in the world, forex is an extremely popular alternative investment, but many individual investors find it too challenging and risky to participate. Forex has the propensity to generate sizable returns for experienced traders, but it’s also complicated.

Key Points

• Forex trading involves the exchange of global currencies, where traders buy and sell based on fluctuating values influenced by various international events and economic reports.

• The forex market operates 24/5, with trading occurring over-the-counter rather than through physical exchanges, allowing for continuous trading across major global centers.

• Leverage is a key feature in forex trading, enabling traders to control larger positions with less capital, but it also increases the potential for significant losses.

• Understanding currency pairs is essential, as trades involve buying one currency while selling another, with major, minor, exotic, and regional pairs available for trading.

• The forex market is characterized by its liquidity and volatility, making it attractive for investors, though it requires a solid understanding of market dynamics and associated risks.

How Does Forex Trading Work?

Forex operates differently than many other types of investments. The forex market is open for trading 24 hours a day, Monday through Friday. There are four main forex trading centers around the world, covering different time zones: London, New York, Sydney, and Tokyo.

Unlike the stock exchange, there is no physical foreign exchange market. Banks and financial institutions, rather than central exchanges, run the market and all trading takes place over the counter.

All forex trades occur in currency pairs. For instance, an investor can trade U.S. Dollars for Euros, or vice versa. With every transaction they buy one currency and sell the other.

All currencies continuously increase or decrease in value relative to other currencies. Values shift due to international or national events such as elections, wars, economic crises, natural disasters, and more. Bank and federal announcements such as gross domestic product (GDP) and inflation reports, employment figures, and quantitative easing measures can affect currency values. Based on what’s happening in the world, traders make predictions about whether a particular currency will rise or fall in relation to another currency, and trade accordingly.

Traders swap currencies in batches, or lots. A standard lot is 1000,000 units of currency. Traders can also trade mini lots of 10,000 units, or micro lots of 1000 units.

Since traders generally don’t have tens or hundreds of thousands of units of currency to trade, they often use leverage and margin trading to increase their position without having as much capital investment in a trade.

Risks of Forex Trading

One of the primary risks of forex trading involves the use of leverage. Using leverage can result in greater profits, but there is also a risk of losing more money initially invested. The associated risks are one reason that forex institutional investors, rather than individual investors, typically dominate forex trading. For this reason, it’s important to understand the market, the opportunity cost and the risks of day trading before starting to use leverage.

Many investors consider forex an alternative investment, since it may not correlate to stocks and bonds. Alternative investments may have their own unique risks, too, which investors or traders should be aware of.

Benefits of Forex Trading

The use of leverage is also one of the big potential benefits of forex trading, as it allows investors who lack significant resources to make relatively large trades, and thus, generate relatively large returns. Additionally, the forex markets are open longer than stock markets, which may be an advantage for some traders, and there are low barriers to entry, and an extremely liquid market for traders, too.

💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

What Are the Major Currency Pairs?

There are four types of pairs in the FX market:

• Major Pairs: Seven currencies comprise 80% of the global forex market. These major pairs include EUR/USD, USD/JPY, GBP/USD, and USD/CHF

• Minor Pairs: Traded less often, many of these pairs don’t include USD. Minor pairs include EUR/GBP, GBP/JPY, and EUR/CHF

• Exotics: Exotic pairs include one major currency and one currency from an emerging or smaller market. These include EUR/CZK, USD/PLN, and GBP/MXN

• Regional Pairs: Based on geography, these pairs include, such as AUD/NZD and EUR/NOK

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Three Markets to Trade Forex

There are three ways to trade in the forex market, used by both short- and long-term traders.

Spot Forex Market

This involves the physical exchange of currencies. Since it happens physically in real time, traders can complete this type of transaction on the spot. Traders can buy and sell derivatives based on the spot forex market through over-the-counter exchanges.

Forward Forex Market

In this type of forex trading, traders agree to buy or sell a specific amount of a currency at a set price on a set future date.

Futures Forex Market

In the futures market, contracts for these forward transactions are bought and sold.

How to Read Forex Quotes

It can be a bit confusing at first to read and understand forex pairs. This is how to read them.

Here’s an example: EUR/USD 1.13012

The currency on the left (EUR) is the base currency. It is always equal to one unit, which in this case would be 1€.

The currency on the right (USD) is called the quote currency or counter currency.

The number 1.13012 is the value of the quoted currency relative to one unit of the base currency. In this example, 1€ = $1.13012. If the base currency (EUR) rises in value, the quoted currency number increases since one unit of the base currency can buy more of the quoted currency, and vice versa.

When trading forex, investors are buying the base currency, in this case EUR. So, if they want to buy EUR they buy the EUR/USD pair, and if they want to buy USD they sell the EUR/USD pair.

Understanding Bid and Ask

Another important part of reading forex quotes are the bid and ask prices. The bid price is the amount that the dealer pays for the base currency, while the ask price is the price for which they will sell it. Bid prices are always lower than ask prices. The difference between these two prices is known as the spread. A lower spread is better for traders.

Using the example above, the ask price tells a trader how much USD they will need to spend to purchase one unit of EUR. The bid price tells them how much USD they will buy when they sell one unit of EUR.

Generally, the bid and ask are shown as bid/ask. For example, EUR/USD 1.13012/23 would mean that the bid price is 1.13012 and the ask price is 1.13023. A trader could sell 1€ for $1.13012 or buy 1€ for $1.13023.

Forex Trading Terms to Know

“Pips” may be the most important term for forex traders to know.

In forex trading, the units that measure the spread, earnings, and losses are called pips, which are the smallest price movement between pairs of currencies. These are similar to points in the stock market. The actual value of a pip changes depending on the currency pair, but it generally refers to a movement in the fourth decimal place of a currency pair. Micro pips or pipettes are the decimal places after the fourth decimal place.

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The Takeaway

Forex trading involves trading foreign currencies, and typically involves a handful of main currency pairs. The forex markets are relatively easy to learn, have low barriers to entry, and allow for the use of leverage, making them attractive to many investors.

Forex is a popular alternative investment and can be a great way to diversify a portfolio. However, it does involve a significant amount of understanding and practice, and can be very risky. If direct forex investing seems daunting, you can still get exposure to forex markets by purchasing ETFs or other funds that focus on foreign currencies.

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FAQ

Why does forex trading matter for average consumers?

The forex markets can have an impact on prices for consumers, which is why they may be a matter of concern for the typical person. Exchange rates internationally may be affected, which can possibly change prices.

What are the biggest differences between investing in stock and forex?

The forex markets tend to be more liquid and volatile than the stock market, as well as more voluminous, which may make them more attractive to investors. The markets are also open longer, and applicable fees for forex trades may be lower, too.

What is considered a large investment in forex trading?

Forex trades are done in “lots,” and a large lot may involve $100,000 trades while using leverage. This could only include $1,000 in actual capital, and if executed, would likely be considered a large trade for the forex markets.

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Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
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Aug

2024

The Essentials of Stock Float and Its Impact on Investing

By Pam O’Brien | Growing Wealth, Investing | No Comments

Whether you’re a veteran or a rookie when it comes to the stock market, you likely have come across the term “stock float.” And regardless of your experience, the question, “What is a stock float?” may have you stumped.

Finding out the answer can play a major role in your investing future. Read on to learn about stock float.

Key Points

• Stock float represents the number of shares available for public trading, excluding locked-in and restricted shares, which affects how easily investors can buy or sell a stock.

• Lower stock float generally leads to higher volatility, as increased demand can significantly impact stock prices, while higher float stocks tend to be more stable.

• Investors can analyze stock float by calculating the difference between outstanding shares and restricted shares, which helps them assess a stock’s liquidity and potential price movements.

• Low-float stocks can be attractive to day traders due to their potential for rapid price changes but come with increased risks, including market manipulation and liquidity issues.

• Understanding stock float dynamics aids investors in making informed decisions, as it influences trading strategies and the overall market behavior of stocks.

Unpacking the Concept of Stock Float

So, what is a stock float exactly? Floating stock is the number of shares available for trade of a particular stock. The number of floating shares is referred to as the stock float or simply “the float.” Stock float is important because it indicates how many shares of a stock can be bought and traded by investors in general.

To calculate the amount of floating stock available, subtract the number of locked-in shares and restricted stock from a firm’s total outstanding shares.

Restricted stock generally refers to shares that cannot be traded without special exception from the Securities and Exchange Commission (SEC). One such example of this is stocks that are restricted by the SEC from sale during a lock-up period after an initial public offering, where certain shareholders (such as employees and major investors) are not allowed to sell their stock for that given period. This may be done in an attempt to stabilize the price of the stock.

No matter the reason, if there are shares that are not available for trade in the market, then they will not be tallied in the final float count.

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How Stock Float Influences Market Dynamics

Stock float is something investors find helpful because it indicates the ownership structure of a company. Also, the lower the stock float, the more volatile the stock may be. If there is more demand from investors than available stock to buy, that could send the price of the stock up. And if demand for the stock drops, the stock’s price could fall.

The Significance of Stock Float in Investing

Investors find stock float useful because it tells them how many shares of stock are available to be publicly bought and sold. It also offers an indication of a stock’s volatility, as noted above. A stock float that’s low could push up the price of the stock if there is great demand for it.

Analyzing the Impact of Float on Stock Performance

Stock float can indicate to investors how many shares of stock are available to buy and sell, and thus, how volatile a stock may be. Stocks with a higher float tend to be less volatile, while those with a lower float tend to have higher volatility.

Stock float is just one metric or tool investors can use to analyze a stock and how it might potentially perform.

Stock Float Compared: Authorized, Outstanding, and Floating Shares

Authorized shares are the most shares of stock that a company can issue. Outstanding shares are the number of shares the company actually has issued. A company does not have to issue all of its authorized shares.

Floating shares refers to the number of a company’s shares that can be bought and sold. Stock float is calculated by subtracting a company’s restricted shares from their outstanding shares. If a company has 100 million outstanding shares, with 15 million of them locked in, this company’s float would be 85 million.

This means that 85 million shares of this company’s stock are available for trade on the open market. These are the shares that you could hypothetically purchase with a broker, brokerage account, or other trading platforms that have access to the major stock exchanges.

Identifying and Interpreting the Float of a Stock

Identifying the float of a stock requires a fairly simple calculation. You can find a stock’s float by subtracting any restricted shares of the stock from the outstanding shares.

Typically, you can also look at a company’s balance sheet to find the number of outstanding shares and floating shares.

Interpreting What the Float Tells You About a Stock

The float of a stock tells you how many shares of that stock are available for buying or selling. Low float stocks (those with fewer shares available to buy and sell) tend to be more volatile, as discussed earlier, because there are fewer shares available for trading.

The Implications of Low vs High Stock Float

When considering low float stocks and high float stocks, the following are some things investors might want to keep in mind.

Advantages and Risks of Low-Float Stocks

The benefits of low-float stocks apply mainly to day traders who hope to earn big profits in a short period of time. Each trade of a low-float stock could have a big impact on the value of the stock. For example, if there’s good news about a company whose stock float is low, demand for the stock may rise, and the stock’s price could go up.

Conversely, if news about the company is bad, demand for the stock could plummet, along with the stock’s price. This leads to a greater level of risk for investors.

The Stability and Volatility Factor in High-Float Stocks

High-float stocks tend to be less volatile because there are more shares available for public trading. That makes them more stable overall because there are more shares of the stock in circulation. The price of high-float stocks tends to be more stable than low-float stocks.

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The Investor’s Guide to Low-Float Stocks

Trading low-float stocks can be one strategy day traders use. Here’s what to know about evaluating and trading these stocks.

Best Practices for Trading Low-Float Stocks

Trading low-float stocks involves risks. Because there are few shares available, it may be difficult to buy them when an investor wants them and also to sell them in time to make a profit — this is referred to as a lack of liquidity.

One way traders might handle this is to look for stocks with low float and high volume, which is the number of shares of stock being traded daily. The more shares being traded, the lower the chances might be that an investor will have to deal with lack of liquidity.

Strategies for Evaluating Low-Float Stock Potential

Traders can use technical analysis and look at indicators like candlestick charts and moving averages to help evaluate a low-float stock. This typically requires some knowledge and experience as an investor.

Other methods of evaluating a low-float stock include:

Low-float stocks with a high relative volume. Relative volume is a way to help gauge a stock’s liquidity. It indicates a stock’s volume currently compared to other times in the company’s history. A stock with low liquidity might be difficult for an investor to sell.

News about the company. Both good and bad news about a company can affect a low-float stock’s value. It could quickly go up or down.

Float percentage. This refers to the percentage of total shares of stock available for trading. Most traders look for a percentage between 10% and 25%.

Insights Into Stock Float and Market Manipulation

Stocks with a low float may be more vulnerable to market manipulation. When a stock has fewer shares available for trading, it could easily be affected by comments on social media, for instance. There are also schemes such as a “pump and dump” in which unscrupulous investors buy up many of the shares of a low-float stock, which could affect the price dramatically. They might then dump the stock.

Day trading is risky and can result in investors losing significant amounts (although they could potentially make significant gains). And low-float stocks can be susceptible to practices like market manipulation. Those with a low tolerance for risk may find that low-float stocks are not the best investment for them.

Deep Dive: Case Study and Example of Floating Stock

One recent example of a low-float stock is General Electric (GE). In early fall 2023, there were 1.088 billion outstanding shares of GE stock. Of this number, approximately 76% of shares were not available for public trading. The float in this case was 260 million shares. Consequently, GE’s stock price is considered fairly volatile.

Practical Tips for Trading and Investing in Floating Stocks

Low-float stocks can be highly volatile and their price can go up and down in minutes or even seconds. This volatility could eliminate a significant chunk of an investor’s portfolio. Of course, low-float stocks could also present substantial profit opportunities with potentially big gains. But they are risky.

Low-float stocks are typically appealing to those who are hoping to make larger gains in a short amount of time, such as day traders.

To successfully trade low-float stocks, investors should look at technical indicators and also follow the news. Watching the market every day is critical since the prices of these stocks can change so quickly.

Whether you’re investing in low-float stocks or any stock, remember that diversifying your portfolio is important and can help mitigate risk and potentially increase your returns, studies show.

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FAQ

Is a Low-Float Stock Good for Day Trading?

A low-float stock could potentially lead to big profits for day traders if the stock is in high demand. However, these stocks can be very risky since they are volatile. If demand drops, a trader could lose large sums.

How Does a Stock’s Float Affect Its Liquidity?

Stocks with a higher float have more liquidity, which can make it easier for investors to buy and sell them. Low-float stocks have less liquidity, which could make it more challenging to buy or sell them.

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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Aug

2024

What Is Bond Valuation?

By Mike Zaccardi, CMT, CFA | Growing Wealth, invest, Investing, Terminology | Comments Off

Bond valuation is a way of determining the fair value of a bond. Bond valuation involves calculating the present value of the bond’s future coupon payments, its cash flow, and the bond’s value at maturity (or par value), to determine its current fair value or price. The price of a bond is what investors are willing to pay for it on the secondary market.

When an investor buys a bond from the issuing company or institution, they typically buy it at its face value. But when an investor purchases a bond on the open market, they need to know its current value. Because a bond’s face value and interest payments are fixed, the valuation process helps investors decide what rate of return would make that bond worth the cost.

Key Points

• Bond valuation is the process of determining a bond’s fair value by calculating the present value of future coupon payments and its value at maturity.

• Investors must consider the bond’s current price, which may differ from its face value, as it reflects market conditions and the issuing company’s creditworthiness.

• The valuation involves discounting the bond’s future cash flows using a realistic discount rate, which is essential due to the time value of money.

• Changes in interest rates significantly affect bond pricing; rising rates usually decrease bond prices, while falling rates can increase them.

• Investing in bonds can diversify a portfolio, as they tend to be less risky than stocks and provide a predictable income stream through fixed payments.

How Bond Valuation Works

First, it’s important to remember that bonds are generally long-term investments, where the par value or face value is fixed and so are the coupon payments (the bond’s rate of return over time) — but interest rates are not, and that impacts the present or fair value of a bond at any given moment.

To determine the present or fair value of a bond, the investor must calculate the current value of the bond’s future payments using a discount rate, as well as the bond’s value at maturity to make sure the bond you’re buying is worth it.

Some terms to know when calculating bond valuation:

• Coupon rate/Cash flow: The coupon rate refers to the interest payments the investor receives; usually it’s a fixed percentage of the bond’s face value and typically investors get annual or semi-annual payments. For example, a $1,000 bond with a 10-year term and a 3% annual coupon would pay the investor $30 per year for 10 years ($1,000 x 0.03 = $30 per year).

• Maturity: This is when the bond’s principal is scheduled to be repaid to the bondholder (i.e. in one year, five years, 10 years, and so on). When a bond reaches maturity, the corporation or government that issued the bond must repay the full amount of the face value (in this example, $1,000).

• Current price: The current price is different from the bond’s face value or par value, which is fixed: i.e. a $1,000 bond is a $1,000 bond. The current price is what people mean when they talk about bond valuation: What is the bond currently worth, today?

The face value is not necessarily the amount you pay to purchase the bond, since you might buy a bond at a price above or below par value. A bond that trades at a price below its face value is called a discount bond. A bond price above par value is called a premium bond.

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How to Calculate Bond Valuation

Bond valuation can seem like a daunting task to new investors, but it is not that onerous once you break it down into steps. This process helps investors know how to calculate bond valuation.

Bond Valuation Formula

The bond valuation formula uses a discounting process for all future cash flows to determine the present fair value of the bond, sometimes called the theoretical fair value of the bond (since it’s calculated using certain assumptions).

The following steps explain each part of the formula and how to calculate a bond’s price.

Step 1: Determine the cash flow and remaining payments.

A bond’s cash flow is determined by calculating the coupon rate multiplied by the face value. A $1,000 corporate bond with a 3.0% coupon has an annual cash flow of $30. If it’s a 10-year bond that has five years left until maturity, there would be five coupon payments remaining.

Payment 1 = $30; Payment 2 = $30; and so on.

The final payment would include the face value: $1,000 + $30 = $1,030.

This is important because the closer the bond is to maturity, the higher its value may be.

Step 2: Determine a realistic discount rate.

The coupon payments are based on future values and thus the bond’s cash flow must be discounted back to the present (thanks to the time value of money theory, a future dollar is worth less than a dollar in the present).

To determine a discount rate, you can check the current rates for 10-year corporate bonds. For this example, let’s go with 2.5% (or 0.025, when expressed as a decimal).

Step 3: Calculate the present value of the remaining payments.

Calculate the present value of future cash flows including the principal repayment at maturity. In other words, divide the yearly coupon payment by (1 + r)^t, where r equals the discount rate and t is the remaining payment number.

$30 / (1 + .025)¹ = $29.26

$30 / (1 + .025)² = 28.55

$30 / (1 + .025)³ = 27.85

$30 / (1 + .025)⁴ = 27.17

$1030 / (1 + .025)⁵ = 1,004.87

Step 4: Sum all future cash flows.

Sum all future cash flows to arrive at the present market value of the bond : $1,117.70

Understanding Bond Pricing

In this example, the price of the bond is $1,117.70, or $117.70 above par. A bond’s face or par value will often differ from its market value — and in this case its current fair value (market value) is higher. There are a number of factors that come into play, including the company’s credit rating, the time to maturity (the closer the bond is to maturity the closer the price comes to its face value), and of course changes to interest rates.

Remember that a bond’s price tends to move in the opposite direction of interest rates. If prevailing interest rates are higher than when the bond was issued, its price will generally fall. That’s because, as interest rates rise, new bonds are likely to be issued with higher coupon rates, making the new bonds more attractive. So bonds with lower coupon payments would be less attractive, and likely sell for a lower price. So, higher rates generally mean lower prices for existing bonds.

The same logic applies when interest rates are lower; the price of existing bonds tends to increase, because their higher coupons are now more attractive and investors may be willing to pay a premium for bonds with those higher interest payments.

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Is Investing in Bonds Right for You?

Investing in bonds can help diversify a stock portfolio since stocks and bonds trade differently. In general, bonds are seen as less risky than equities since they often provide a predictable stream of income. Investors can consider bonds as an investment, and those with a lower risk tolerance might be better served with a portfolio weighted highly in bonds.

Performing proper bond valuation can be part of a solid research and due diligence process when attempting to find securities for your portfolio. Moreover, different bonds have different risk and return profiles. Some bonds — such as junk bonds and fixed-income securities offered in emerging markets — feature higher potential rates of return with greater risk. “Junk” is a term used to describe high-yield bonds. You can take on higher risk with long-duration bonds and convertible bonds. Some of the safest bonds are short-term Treasury securities.

You can also purchase bond exchange-traded funds (ETFs) and bond mutual funds that own a diversified basket of fixed-income securities.

The Takeaway

Bond valuation is the process of determining the fair value of a bond after it’s been issued. In order to price a bond, you must calculate the present value of a bond’s future interest payments using a reasonable discount rate. By adding the discounted coupon payments, and the bond’s face value, you can arrive at the theoretical fair value of the bond.

A bond can be priced at a discount to its par value or at a premium depending on market conditions and how traders view the issuing company’s prospects. Owning bonds can help diversify your portfolio. Many investors also find bonds appealing because of their steady payments (one reason that bonds are considered fixed-income assets).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/Tempura

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Aug

2024

What Is Maintenance Margin? How Margin Maintenance Requirements Work

What Is Maintenance Margin? How Its Requirements Work

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Maintenance margin, as it relates to margin accounts and trading, refers to the necessary amount of funds an investor needs to maintain in their brokerage account in order to utilize margin. Margin accounts work differently than other trading accounts. Instead of allowing the trader to do regular trades, the margin account allows leveraged trades.

This means that the trader can buy securities including stocks, bonds, or options for more than the amount that they have in their account, paying only a deposit on the trade. They borrow the rest of the cash needed for the investment from the broker.

Key Points

• Maintenance margin represents the minimum balance required in a trader’s margin account to avoid a margin call and continue leveraged trading.

• The Financial Industry Regulatory Authority mandates a minimum maintenance margin of 25%, but individual brokerage firms often set higher requirements for added security.

• Margin trading carries significant risks, as traders can incur losses exceeding their account balance, leading to margin debt owed to brokers.

• If a trader’s account balance falls below the maintenance margin, the broker can issue a margin call, requiring additional funds or asset liquidation within a specified timeframe.

• Understanding the distinction between maintenance margin and initial margin is crucial, as the initial margin is the upfront deposit required to open a margin account.

Maintenance Margin Definition

In margin trading, the maintenance margin is the minimum amount of funds that a trader must hold in their portfolio to avoid being issued a margin call, for as long as they are actively involved in a trade. If a trade they enter decreases in value, the trader may owe money, which is taken from their account.

Minimum margin requirements for leveraged accounts are regulated by the government. Currently the Financial Industry Regulatory Authority (FINRA) sets the maintenance margin at 25% of the total value of securities that a trader holds in their margin account.

Specific brokerage firms also maintain their own requirements. It is common for brokerage requirements to be higher than the government required amount to provide the firm with greater financial security.

Margin maintenance requirements shift based on various factors, including market liquidity and volatility. And different stocks have differing maintenance requirements: if they are more likely to be volatile, the requirements may be higher.

Does a Maintenance Margin Mitigate Risk?

Maintenance margin doesn’t mitigate risk for traders. Margin investing is risky because traders can lose more money than they have in their account, creating a debt with the broker, called margin debt.

When a trader opens a margin account, they must sign an agreement and deposit a certain amount into the account before they can start trading. To pay off any debt from assets that have lost value, the trader will need to deposit additional funds, deposit securities, or sell off holdings.

Therefore, margin trading isn’t recommended for beginner traders, and it’s important for traders to understand the risks and how it works before trying it out.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

Increase your buying power with a margin loan from SoFi.

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Maintenance Margin Requirement Examples

Let’s look at an example of how maintenance margin requirements work.

Let’s say a trader wants to purchase 100 shares of Company XYZ at $40 per share. They don’t have sufficient funds to purchase the entire number of shares. The trader can use a margin account which allows them to purchase the entire amount of shares but only deposit a percentage of the total price into the trade and also pay a financing fee. This deposit amount is known as the initial margin requirement.

In this example, the initial maintenance margin requirement is 40% of the purchase price of the trade. For the trader to purchase the full 100 shares, they need to maintain a balance of 40% of the trade purchase amount in their margin account.

When Maintenance Margin Requirements Aren’t Met

If the amount in their account dips below the minimum requirement, their broker will issue a margin call notification. Generally, the trader will have between 2-5 days to either add more funds to their account or sell some of the assets they are invested in to move enough cash funds back into their account.

If the trader doesn’t sell holdings or add funds to their account to meet the margin maintenance requirement, the broker may sell the trader’s securities without notifying them, and they have the right to decide which ones they sell. They are also allowed to charge the trader commissions and even sue the trader for losses.

A margin call can also be sent out if the brokerage firm changes their requirements, which they can do at any time.

Calculating Maintenance Margin

Each brokerage firm has their own maintenance margin requirements. The formula to calculate the maintenance margin is:

Account value = (Margin Loan) / (1 – Maintenance Margin %)

This can be used to determine the stock price that will trigger a margin call.

For example, a trader opens a margin account and deposits $20,000 into it, then borrows $10,000 from the broker in a margin loan in order to purchase 200 shares of stock at a price of $100 each. The broker’s maintenance margin is 30%. Here is what the calculation would be to figure out what account balance would trigger the margin call:

($10,000 Margin Loan) / (1 – 0.30 Maintenance Margin %) = $14,285.71

That means that if the trader’s account dips below $14,285.71, or if the price of the stock falls below $71.43 ($14,285.71 / 200 shares) then the broker will issue a margin call.

Maintenance Margin vs Initial Margin

When traders open a margin account, there is an initial margin amount they are required to deposit before they can start trading. This is set by FINRA, and brokers may also have their own additional requirements. The initial margin required by FINRA is currently $2,000 in cash or securities.

After a trader starts buying on margin, they must meet the maintenance margin on their account — at least 25% of the market value of the securities in their account.

The Takeaway

A maintenance margin is a monetary buffer for traders with margin accounts. The maintenance margin is a minimum balance required to execute leveraged trades. If a trader’s margin account dips below the minimum set by FINRA and the broker, the broker will issue a warning, or margin call, so that the trader can add cash to their account or sell holdings to cover the gap.

Maintenance margins do not mitigate risks for traders, and if an investor is utilizing margin as a part of their investment strategy, they should know what they’re getting into. Margin accounts have their pros and cons, but it’s important to keep the risks in mind.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

What happens if you go below maintenance margin?

Generally, if a trader or investor’s account goes below the maintenance margin, their brokerage will send them a margin call, or otherwise warn them that they need to deposit funds or sell holdings.

What does current maintenance margin mean?

Current maintenance margin refers to the literal current maintenance margin set by financial regulators or by a specific brokerage. For example, it may be 25% of the value of an investor’s total holdings.

What is the difference between maintenance margin and minimum margin?

Minimum margin refers to the minimum amount of collateral needed in a margin account to execute leveraged trades, while maintenance margin is the total capital that needs to remain in the account as the investor continues to utilize a margin account.

Who sets the maintenance margin?

FINRA currently sets the maintenance margin, which is 25%. But specific brokerage firms can set their own beyond that, and often, at a higher threshold.

Why is my maintenance margin so high?

Maintenance margin requirements can be determined by a number of factors beyond regulatory minimums, such as market conditions and volatility, and the specific types of securities an investor is trading.

What does 25% maintenance margin mean?

Twenty-five percent maintenance margin means that an investor must hold 25% of the total value of their holdings in their account. It is the minimum amount of equity that must be maintained in their margin account.

Photo credit: iStock/StockRocket

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Aug

2024

The Growth of Socially Responsible Investing

Guide to SRI Investing

By MP Dunleavey | Growing Wealth, invest, Investing | No Comments

Socially responsible investing (SRI) strategies help investors put their capital into a range of securities — e.g., stocks, bonds, mutual funds — that focus on socially positive aims: e.g., clean energy, air and water; equitable employment practices, and more.

Despite market volatility driven by interest rate changes and geopolitical conflicts in recent years, SRI investing strategies have garnered steady interest from investors.

Various analyses of SRI funds suggest that the philosophy of doing well by doing some good in the world may have an upside worth exploring.

Key Points

• Socially responsible investing (SRI) involves allocating capital into securities that promote positive social and environmental outcomes, aiming for both impact and financial returns.

• The popularity of SRI has grown, with a notable increase in assets allocated to ESG-focused ETFs, rising from $5 billion in 2006 to $480 billion in 2023.

• Different investing strategies exist within the realm of SRI, including impact investing, ESG investing, and sustainable investing, each with distinct criteria and goals.

• Historical phases of SRI have evolved from exclusionary strategies to proactive investing, ultimately leading to a focus on measurable impacts and accountability.

• Recent data indicates that sustainable funds often perform on par with traditional funds, suggesting that ethical investing can also be financially advantageous.

What Is Socially Responsible Investing?

While SRI investing goes by many names — including ESG investing (for environmental, social, and government factors), sustainable, or impact investing — the fundamental idea is to channel capital into entities that are working toward specific environmental and/or social policies in the U.S. and worldwide. The aim of SRI is to generate both positive changes across various industries, while also delivering returns.

Generally, investors that embrace SRI strategies find ways to assess an organization’s environmental and social impact when deciding whether to invest in them. However, there are important distinctions between the various labels in this sector of investing.

Socially responsible investing can be seen as more of an umbrella term (similar to impact investing). Within SRI, some strategies focus specifically on companies that meet certain criteria — either by supporting specific practices (e.g., green manufacturing, ethical shopping) or avoiding others (e.g., reducing reliance on fossil fuels).

For that reason it’s incumbent on each investor to assess different SRI options, to make sure they match their own aims. This is no different from the due diligence required for anyone starting to invest.

Interest in SRI Investing Strategies

The tangible merits of socially responsible investing have always been subject to debate. But in the last couple of years there has been criticism of some of the underlying principles of SRI, as well as questions about the overall financial value of this investing approach.

Nonetheless, the value of global assets allocated to ETFs with an ESG focus have shown steady growth in the last two decades. As of November 2023, according to data from Statista, the value of these assets was $480 billion — a substantial increase since 2006, when the value of those assets was about $5 billion.

And according to a report published in 2023 by Morningstar, a fund rating and research firm, investors in conventional funds as well as SRI funds are likely to see returns over time.

SRI vs ESG vs Other Investing Strategies

While the various terms for SRI investing are often used interchangeably, it’s important for investors to understand some of the differences.

Impact Investing

Impact investing is perhaps the broadest term of all, in that it can refer to a range of priorities, goals, or values that investors may want to pursue. To some degree, impact investing implies that the investor has specific outcomes in mind: i.e. the growth of a certain sector, type of technology, or societal issue.

Impact investing may also refer to strategies that avoid certain companies, products, or practices. This could include so-called sin stocks (e.g. alcohol, tobacco), companies that adhere to principles that are in opposition to an investor’s or institution’s belief system, and more.

Socially Responsible Investing

SRI or socially conscious investing are two other broad labels, and they’re typically used to reflect progressive values of protecting the planet and natural resources, treating people equitably, and emphasizing corporate responsibility.

While SRI can be considered a type of impact investing, there may be impact investing strategies that are diametrically opposed to SRI, simply because they have different aims.

ESG Investing

Securities that embrace ESG principles, though, may be required to adhere to specific standards for protecting aspects of the environment (e.g. clean energy, water, and air); supporting social good (e.g. human rights, safe working conditions, equal opportunities); and corporate accountability (e.g. fighting corruption, balancing executive pay, and so on).

For example, some third-party organizations have helped create ESG metrics for companies and funds based on how well they adhere to various environmental, social, or governance factors.

Investors who believe in socially responsible investing may want to invest in stocks, bonds, or exchange-traded funds (ETFs) that meet ESG standards, and track ESG indexes.

Sustainable Investing

Sustainable investing is often used as a shorthand for securities that have a specific focus on protecting the environment. This term is sometimes used interchangeably with green investing, eco-friendly investing, or even ESG.

Unlike ESG — which is anchored in specific criteria having to do with a company’s actions regarding environmental, social, or governance issues — the phrase “sustainable investing” is considered an umbrella term. It’s not tied to specific criteria.

Corporate Social Responsibility (CSR)

Last, corporate social responsibility (CSR) refers to a general set of business practices that may positively impact society. Often, companies establish certain programs to support local or national issues, e.g. educational needs, ethical labor practices, workplace diversity, social justice initiatives, and more.

Ideally, CSR strategies work in tandem with traditional business objectives of hitting revenue and profit goals. But since CSR goals are specific to each company, they aren’t formally considered part of socially responsible, sustainable, or ESG investing.

A Focus on Results

Investors may want to bear in mind that, with the steady growth of this sector in the last 20 or 30 years, there are a number of ways SRI strategies can come together. For example, it’s possible to invest in sustainable pharmaceuticals and even green banks.

Either way, the underlying principle of these strategies is to make a profit by making a difference. By putting money into companies that embrace certain practices, investors can support organizations that embody principles they believe in, thereby potentially making a difference in the world, and perhaps seeing a financial upside as well.

Socially Responsible Investment Examples

These days, thousands of companies aim — or claim — to embrace ethical, social, environmental, or other standards, such as those put forth in the United Nations’ Principles of Responsible Investing, or the U.N.’s 17 Sustainable Development Goals. As a result, investors today can choose from a wide range of stocks, bonds, ETFs, and more that adhere to these criteria.

Understanding SRI Standards

In addition, there are also standards set out by financial institutions or other organizations which are used to evaluate different companies. It may be useful when selecting stocks that match your values to know the standards or metrics that have been used to verify a company’s ESG status.

Depending on your priorities, you could consider companies in the following sectors, or that embrace certain practices:

• Clean energy technology and production

• Supply chain upgrades

• Clean air and water technology, products, systems, manufacturing

• Sustainable agriculture

• Racial and gender equality

• Fair labor standards

• Community outreach and support

Exploring Different Asset Classes

Investors can also trade stocks of companies that are certified B Corporations (B Corps), which meet a higher standard for environmental sustainability in their businesses, or hit other metrics around public transparency and social justice, for example. B Corps can be any company, from bakeries to funeral homes, and may or may not be publicly traded.

Companies issue green bonds to finance projects and business operations that specifically address environmental and climate concerns, such as energy-efficient power plants, upgrades to municipal water systems, and so on.

These bonds may come with tax incentives, making them a more attractive investment than traditional bonds.

Another option for investors who don’t want to pick individual SRI or ESG stocks is to consider mutual funds and exchange-traded funds (ETFs) that provide exposure to socially responsible companies and other investments.

There are a growing number of index funds that invest in a basket of sustainable stocks and bonds. These funds allow investors to diversify their holdings by investing in one security.

There are numerous indexes that investors use as benchmarks for the performance of socially responsible funds. Three of the most prominent socially responsible indexes include: the MSCI USA Extended ESG Focus Index; Nasdaq 100 ESG Index; S&P 500 ESG Index. (Remember, you cannot invest directly in an index, only in funds that track the index.)

The Growing Appeal of Socially Responsible Investments

While many investors find the idea of doing good or making an impact appealing, the question of profit has long been a point of debate within the industry. Do you sacrifice performance if you invest according to certain values?

Unfortunately, the lack of consistency in terms of what constitutes a sustainable or socially/environmentally responsible investment has made it difficult to compare SRI strategies to conventional ones. One financial company may use one set of criteria when developing its sustainable offerings; another company may use its own proprietary set of standards.

That said, as the universe of sustainable offerings continues to grow, it’s possible to create more apples-to-apples comparison sets. According to Morningstar data, sustainable equity funds saw median returns of 16.7% for 2023 versus 14.4% for traditional equity funds. The relative outperformance of SRI strategies was consistent across equity fund styles and most market caps, but particularly large-cap equities. Over 75% of SRI and conventional funds include large-cap equities.

In addition, sustainable fund assets under management (AUM) globally were up 15% over 2022, growing to $3.4 trillion.

The Evolution of Responsible Investing

Socially conscious investing is not a new concept: People have been tailoring their investment strategies for generations, for a number of reasons, not all of them related to sustainability. In fact, it’s possible to view the emergence of socially conscious investing in three phases.

Phase 1: Exclusionary Strategies

Exclusionary strategies tend to focus on what not to invest in. For example, those who embrace Muslim, Mormon, Quaker, and other religions, were (and sometimes still are) directed to avoid investing in companies that run counter to the values of that faith. This is sometimes called faith-based investing.

Similarly, throughout history there have been groups as well as individuals who have taken a stand against certain industries or establishments by refusing to invest in related companies. Non-violent groups have traditionally avoided investing in companies that produce weapons. Others have skirted so-called “sin stocks”: companies that are involved in alcohol, tobacco, sex, and other businesses.

On a more global scale, widespread divestment of investor funds from companies in South Africa helped to dismantle the system of racial apartheid in South Africa in the 1980s.

Phase 2: Proactive Investing

Just like exclusionary strategies, proactive strategies are values-led. But rather than taking an avoidant approach, here investors put their money into companies and causes that match their beliefs.

For example, one of the earliest sustainable mutual funds was launched in 1971 by Pax World; the founders wanted to take a stand against chemical weapons in the Vietnam war and encourage investors to support more environmentally friendly businesses.

This approach gained steady interest from investors, as financial companies launched a range of funds that focused on supporting certain sectors. So-called green investing helped to establish numerous companies that have built sustainable energy platforms, for example.

Phase 3: Investing With Impact

With the rise of digital technology in the last 30 years, two things became possible.

First, financial institutions were able to create screening tools and filters to help investors gauge which companies actually adhered to certain standards — whether ethical, environmental, or something else. Second, the ability to track real-time company behavior and outcomes helped establish greater transparency — and accountability — for financial institutions evaluating these companies for their SRI fund offerings.

By 2006, the United Nations launched the Principles for Responsible Investment (PRI), a set of global standards that helped create a worldwide understanding of Environmental, Social, and Governance strategies.

ESG became the shorthand for companies that focus on protecting various aspects of the environment (including clean energy, water, and air); supporting social good (including human rights, safe working conditions, equal opportunities); and fair corporate governance (e.g. fighting corruption, balancing executive pay, and so on).

Why Choose Socially Responsible Investing?

While the three phases of socially responsible investing did emerge more or less chronologically, all three types of strategies still exist in various forms today. But the growing emphasis on corporate accountability in terms of outcomes — requiring companies to do more than just green-washing their policies, products, and marketing materials — has shifted investors’ focus to the measurable impacts of these strategies.

Now the reasons to choose SRI strategies are growing.

Investors Can Have an Impact

The notion of values-led investing is that by putting your money into organizations that align with your beliefs, you can make a tangible difference in the world. The performance of many sustainable funds, as noted above, indicates that it’s possible to support the growth of specific companies or sectors (although growth always entails risk, and past performance is no guarantee of future results).

Socially Responsible Strategies May Be Profitable, Too

As discussed earlier, the question of whether SRI and ESG funds are as profitable as they are ethical has long been a point of debate. But that skepticism is ebbing now, with new performance metrics suggesting that sustainable funds are on par with conventional funds.

Socially Responsible Investing May Help Mitigate Risk

The criteria built into ESG investment standards may also help identify companies with poor governance practices, or those with exposure to environmental and social risks that could lead to financial losses.

Do Retirement Accounts Offer Socially Responsible Investments?

Generally speaking, individual retirement accounts may include socially responsible or ESG investment options. For example, when investing in different types of IRAs, e.g., a traditional, Roth, or SEP IRA, investors typically have access to all the securities offered by that financial institution, including stocks, bonds, and ETFs that may reflect ESG standards. The choice is up to individual investors.

That hasn’t always been the case with employer-sponsored 401k or 403b plans. But in 2023, the Department of Labor issued a rule allowing plan fiduciaries to consider ESG investment options for plan participants.

While some plans may now offer socially responsible or ESG investments, there is a push from some lawmakers to restrict or eliminate the availability of these funds. ERISA standards for retirement plans dictate that the investment options offered by employer-sponsored plans “must be based on risk return factors that the fiduciary prudently determines are material to investment value.” Some lawmakers argue that ESG funds are higher risk and not suitable for employees in company plans.

The Takeaway

Socially responsible investing is a broad term that can mean different things to different groups, but no matter which term you use — socially conscious investing, impact investing, ESG investing — it comes down to the compelling idea that by investing your money in organizations that match your values, you can make a difference in the world.

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FAQ

Is socially responsible investing profitable?

Socially responsible investing can be profitable, as multiple reviews of fund performance have shown over the last several years. That said, some believe that the financial strength of ESG or SRI strategies is debatable. While any investment strategy has its own risks, it’s best to assess them according to your own aims.

What is the difference between ESG investing and socially responsible investing?

Socially responsible investing is considered a broad term that can encompass a range of practices and standards. ESG investing stands for environmental, social, and governance factors, is a set of principles that is often used to assess how well companies meet specific, measurable criteria. While there is no single industry-wide metric for ESG standards, investors can consider various proprietary tools.

How many socially responsible investment opportunities are there?

It’s impossible to say how many SRI opportunities there are, as the stocks, bonds, and other securities that embrace ESG standards continue to grow. More than 120 new sustainable funds entered the SRI landscape in 2021, in addition to 26 existing funds that took on a sustainable mandate.

What is the socially responsible investment theory?

The theory behind socially responsible investing can be summed up by the old saying about “Doing well by doing good.” In other words, by investing in companies that support positive social and environmental products and policies, it’s possible to help investors realize a profit.

How do you start socially responsible investing?

Investors who are interested in SRI or ESG investing can begin by getting to know companies that adhere to certain eco-friendly or socially responsible standards. In addition, many financial institutions offer clients a way to screen for stocks or mutual funds that have an ESG focus.

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For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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What Is Forex Trading? A Guide for Beginners

How Does Forex Trading Work?

Risks of Forex Trading

Benefits of Forex Trading

What Are the Major Currency Pairs?

Alternative investments, now for the rest of us.

Start trading funds that include commodities, private credit, real estate, venture capital, and more.

Three Markets to Trade Forex

Spot Forex Market

Forward Forex Market

Futures Forex Market

How to Read Forex Quotes

Understanding Bid and Ask

Forex Trading Terms to Know

The Takeaway

FAQ

Why does forex trading matter for average consumers?

What are the biggest differences between investing in stock and forex?

What is considered a large investment in forex trading?

The Essentials of Stock Float and Its Impact on Investing

Unpacking the Concept of Stock Float

How Stock Float Influences Market Dynamics

The Significance of Stock Float in Investing

Analyzing the Impact of Float on Stock Performance

Stock Float Compared: Authorized, Outstanding, and Floating Shares

Identifying and Interpreting the Float of a Stock

Interpreting What the Float Tells You About a Stock

The Implications of Low vs High Stock Float

Advantages and Risks of Low-Float Stocks

The Stability and Volatility Factor in High-Float Stocks

The Investor’s Guide to Low-Float Stocks

Best Practices for Trading Low-Float Stocks

Strategies for Evaluating Low-Float Stock Potential

Insights Into Stock Float and Market Manipulation

Deep Dive: Case Study and Example of Floating Stock

Practical Tips for Trading and Investing in Floating Stocks

FAQ

Is a Low-Float Stock Good for Day Trading?

How Does a Stock’s Float Affect Its Liquidity?

What Is Bond Valuation?

How Bond Valuation Works

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How to Calculate Bond Valuation

Bond Valuation Formula

Step 1: Determine the cash flow and remaining payments.

Step 2: Determine a realistic discount rate.

Step 3: Calculate the present value of the remaining payments.

Step 4: Sum all future cash flows.

Understanding Bond Pricing

Is Investing in Bonds Right for You?

The Takeaway

What Is Maintenance Margin? How Its Requirements Work

Maintenance Margin Definition

Does a Maintenance Margin Mitigate Risk?

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 11%* and start margin trading.

Maintenance Margin Requirement Examples

When Maintenance Margin Requirements Aren’t Met

Calculating Maintenance Margin

Maintenance Margin vs Initial Margin

The Takeaway

FAQ

What happens if you go below maintenance margin?

What does current maintenance margin mean?

What is the difference between maintenance margin and minimum margin?

Who sets the maintenance margin?

Why is my maintenance margin so high?

What does 25% maintenance margin mean?

Guide to SRI Investing

What Is Socially Responsible Investing?

Interest in SRI Investing Strategies

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Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

SRI vs ESG vs Other Investing Strategies

Impact Investing

Socially Responsible Investing

ESG Investing

Sustainable Investing

Corporate Social Responsibility (CSR)

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