Aug
18
2023
Credit Checks For Employment - What To Know

Guide To Credit Checks For Employment

By | Financial Independence, Life & Career, money | Comments Off on Guide To Credit Checks For Employment

The process of looking for a job is complex, as is the hiring process that can follow. You may be psyched to be offered a position but then learn that a credit check is part of the vetting.

This step can be concerning for some prospective employees, as it makes them wonder why their financial history matters, how their credit will look, and whether it could be considered a strike against them.

Not all companies run credit checks, but if you are negotiating with one that does, here are answers to your questions about this procedure, including:

•   What is a credit check for employment?

•   Why do employers check credit?

•   What are employers looking for when they check credit?

•   What requirements and limitations govern credit checks?

What’s a Credit Check for Employment?

Pre-employment credit checks happen when a company uses a third-party company to check a candidate’s credit history and see their past approach to consumer debt.

Sometimes, what’s called a background check may include a credit check as well as a scan for criminal activity and is a tool that helps the potential employer make a decision about whether or not to hire the candidate.

Credit checks are more commonly used in industries that deal directly with money, like accounting, banking, and investing, but any employer could decide to run pre-employment credit checks.

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How Does a Pre-Employment Credit Check Work?

Here’s how a pre-employment credit check works: Once the job offer is on the table, an employer will solicit a third-party provider to run a credit check for employment purposes that features the following information about the potential employee:

•   Full name and previous names

•   Current address and past addresses

•   Social Security number

•   Incurred debts such as credit card debt, car loans, mortgages, student loans, and personal loans, including the full payment history on each account and any late payments.

One thing pre-employment credit checks cannot include is the potential employee’s date of birth because it could allow their age to be used against them in a discriminatory manner.

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What Do Employers See on Credit Checks?

You’re likely curious to know exactly what a prospective employer could see when they peek at your credit. Here’s the answer.

What They See

A potential employer will only see some aspects of your credit report. Typically, they will access:

•   Your name and address

•   Your payment history

•   What credit accounts you hold and your available credit

•   Information on your work history that you have reported

•   Any bankruptcies or liens.

What They Don’t See

Next, consider what they don’t see when accessing your data as part of a credit check:

•   Your credit score

•   Your income

•   The account numbers connected to your credit accounts

•   Medical bills

•   Details such as your age, marital status, race, or ethnicity. These are protected as part of discrimination protection (more on that in a moment).

And also worth noting: There is a seven-year restriction on certain kinds of background information for positions that pay less than $75,000 per year, including that relating to bankruptcy and liens.

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Federal Limits on Pre-Employment Credit Checks

The Federal Trade Commission’s Fair Credit Reporting Act (FCRA) is federal legislation that protects the personal information collected by consumer reporting agencies and ensures that any entity that uses the information notifies the consumer of adverse actions taken on the basis of the report.

Here are a few of the FCRA requirements for employers who run a background credit check for employment on potential or current employees:

•   Employers cannot legally obtain background information on an employee “based on a person’s race, national origin, color, sex, religion, disability, genetic information (including family medical history), or age (40 or older).”

•   Employers must inform employees in writing of their intention to perform a background check or credit check, indicating they might use the information to make decisions about their employment.

•   Employers must then get written approval from the applicant or employee to perform the background check and certify to the third-party provider that the employer:

◦   Notified the applicant and received their permission to obtain a background report.

◦   Fully complied with FCRA requirements.

◦   Will refrain from discriminating against the applicant or employee or misusing the information as a violation against Equal Opportunity laws or regulations.

•   Before taking any adverse employment actions against an applicant or employee, employers must provide them with a notice that includes a copy of the report itself and a copy of A Summary of Your Rights Under the Fair Credit Reporting Act.

•   After taking any adverse employment action, the employer must inform the applicant or employee:

◦   Of the name, address, and phone number of the company that conducted the background check, and the fact that it did not make the final decision.

◦   That they were rejected because of information in the report.

◦   That they reserve the right to dispute the report’s accuracy or completeness and receive a free report from the same reporting company within 60 days.

State and Local Limits on Pre-Employment Credit Checks

For the most part, many US states allow employers to obtain credit reports in the hiring process in a fair and equitable way. Certain states, however, restrict how the obtained information can be used. Those states include California, Colorado, Connecticut, Hawaii, Illinois, Maryland, Nevada, Oregon, Vermont, and Washington, as well as the District of Columbia. Delaware has a law that prohibits these checks by public employers until an applicant has been offered a job conditionally.

Several other states have legislation pending that could prohibit or place restrictions on credit inquiries for employment.

Certain localities also have prohibitions and restrictions on pre-employment credit checks, including New York City, Philadelphia, and Chicago.

What Are Employers Looking for in Your Credit Report?

So, if they’re digging deep into your credit history to determine whether or not to hire you, what exactly are employers looking for in a credit report? Here are a few things that could help them with their hiring decision:

History of Handling Money

Particularly in cases where a potential employee would be handling large amounts of money on behalf of a company’s clients (like an investment broker or a banker), a pre-employment credit check can help ensure trustworthiness and the ability to keep their funds safe and secure.

If there’s a history of mismanaging money in a credit report, it can be seen as a red flag for potential employers who are concerned the candidate would mismanage the business’s money.

Decision-Making Ability

Even in cases where a potential employee isn’t directly handling money, certain dings in their credit history can still signal a red flag to employers. Negative credit events like foreclosures, numerous bank account closings, late payments, high credit utilization rate, or liens against a job applicant can be seen as signs of negligence or carelessness that they don’t necessarily want in their workforce.

Potential for Criminal Activity

Another reason for running a background credit check for employment is to assess whether a job candidate could be a risk for criminal behavior. For example, if a potential employee has several large debts, it could leave the employer wondering whether they’d be tempted to embezzle or commit fraud to cover their own debts and financial issues.

Recommended: How to Check Your Credit Score for Free

Anticipating an Employer Credit Check

Being prepared in advance of an employer credit check can sometimes be half the battle.

Here are a few steps you can take before the job interview even begins:

1.   Obtain a copy of your credit report as soon as you can. Wondering how to review your file? You’re entitled to one free copy of your credit report per year from all three of the major credit bureaus (Equifax, Experian, and TransUnion).

  You can get it by visiting AnnualCreditReport.com . Allow plenty of time to look into any errors and file disputes, if necessary.

2.    Address any errors on your credit report. If you notice any discrepancies when you pull up your free credit report, you can provide a brief statement to dispute the findings and get on top of it before the potential employer sees it. You can also write statements that explain the cause for a discrepancy like a late payment. For example, perhaps you were late on a mortgage payment because of a disability or illness.

3.    Provide your written permission for the employer to run the credit check. This way, you’re fully prepared for the next step in the hiring process and have done everything you can to put your best foot forward.

Does an Employer Credit Check Hurt Your Credit?

You may wonder, Can an employer background check affect your credit score? Typically, the answer is no. These kinds of inquiries are known as a soft pull versus a hard pull. It won’t take points off your credit score the way a deeper inquiry (from, say, a credit card company you applied to) could.

Why Employer Credit Checks Are Controversial

Some employers may feel that credit checks provide them with additional important information on a candidate before they make a hire.

However, the controversy around employer credit checks is this: Others would say that a credit report has no impact on a person’s ability to do most jobs.

They also feel that delving into a credit report could reflect negatively on minority job seekers and others who may not have as positive credit history. In this way, accessing credit information could contribute to discrimination.

The Takeaway

A credit check for employment purposes can throw you for a real loop in the job interview process. If you’re prepared for an employment credit check in advance, there’s a good chance you can present your case in a clear and compelling manner that resonates with the employer.

Checking your credit reports is the first step to knowing what information a potential employer might access. After that, handling your finances responsibly with the right banking partner can help get you on the right track.

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FAQ

What do employers look for when doing credit checks?

When an employer does a credit check, it is typically to assess how reliably a candidate handles financial responsibilities, decision-making ability, and possible propensity towards money-related crimes.

Why is an employer asking for a credit check?

An employer may ask for a credit as a way of gaining more insight into your financial habits and how well you make decisions. If they see high levels of debt and late payments, they might think twice about your abilities, especially in a financial position.

Can a job offer be rescinded due to bad credit?

It is legal in many states for a job offer to be rescinded after a credit check. Your prospective employer might see too many signals that your have poor decision-making and money-management skills.

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Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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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Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

This article is not intended to be legal advice. Please consult an attorney for advice.

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Aug
18
2023

What Is College Like?

By | Going to College, Student Loans, student_loan | Comments Off on What Is College Like?

Whether you’re leaving home for the first time or enrolling in your local community college, you might have a lot of misconceptions about the college experience.

So, what is college really like? Keep reading to learn about some of the myths and realities of being a college student.

Common College Myths

Pop culture has altered how we view the quintessential college experience, and though some of these myths are rooted in some level of truth, many don’t hold up nowadays.

College myths can stoke anxiety for incoming students. So let’s look for truths.

Myth 1: Most Students Graduate in 4 Years

Although traditionally students head to college for a “four-year degree,” many of them take more than four years to graduate. In reality, only about 33.3% of students attending public colleges and universities earn a bachelor’s degree within four years.

Nearly 60% of students at public universities and colleges take six years to graduate.

There are lots of legitimate reasons it can take students more than four years to get a degree. Some may change their major and need extra classes to meet their new major requirements. Others may take on a minor or a double major that requires extra classes. Adventurous students might take time to study abroad, which could potentially slow their progress.

Others may decide to transfer schools or might have to work to pay their way through school, which could lead to finishing required classes at a slower pace.

A student may simply need more time to master the coursework. Taking your time to make sure you get the most value from your education and accomplish everything you want matters more than following a strict timeline.


💡 Quick Tip: Some lenders help you pay down your student loans sooner with reward points you earn along the way.

Myth 2: Your Major Will Determine Your Career Path

Some students know exactly what career path they want to take and choose a major accordingly. Others may need more time to discover their passions and interests.

There is a misconception that you have to major in a subject that relates to your career path. Many degrees teach skills that can transfer to a variety of fields.

Philosophy and history degrees can teach perspective. English literature degrees can enhance the art of critical thinking. Majoring in graphic design may lead to a career in marketing.

The bottom line is, if you focus on the skills you learn while earning your degree more than the specific subject matter, you can apply those skills to many different career paths.

Myth 3: You Have to Live on Campus to Have the Full Experience

Here’s a fun fact for students who are debating whether or not they have to live on campus to get the full college experience: Only around 22% of university students live in on-campus dormitories. Living on campus can be convenient, but can also be expensive and a big step for students fresh out of high school.

Even if students don’t live on campus, they will still have access to on-campus resources and perks such as clubs, events, libraries, and gyms.

Choosing to live on campus is a personal decision and needs to be one made based on a student’s particular financial, social, and educational needs.

Recommended: How to Find Affordable Student Housing in Your College Town

Myth 4: No One Transfers From Community College

Around 30% of community college students end up transferring to a four-year school. Attending community college has multiple benefits worth considering. Students can receive a high-quality education for a fraction of the price by taking their general education classes at a community college. Taking these classes at a cheaper tuition price can give students more time and leeway to experiment with subject matter they are interested in.

Attending community college has multiple benefits worth considering. Students can receive a high-quality education for a fraction of the price by taking their general education classes at a community college. Taking these classes at a cheaper tuition price can give students more time and leeway to experiment with subject matter they are interested in.

For those who have their hearts set on prestigious universities, it can be easier to transfer to one of those schools from community college than it is to be accepted straight out of high school.

Some community colleges have deals with local universities that can guarantee admission to your dream school if you meet certain qualifications. It’s known as a transfer admission guarantee, or TAG.

In California, six University of California campuses offer guaranteed admission to students from all California community colleges who have completed at least 30 semester UC-transferable units.

And in Florida, state community college graduates with an associate degree are guaranteed admission to one of the 11 state universities (except to limited access programs, which call for additional admission requirements).

Major College Realities

If you’re looking for a dose of reality before you start college, consider these tidbits. Knowledge is power, after all, so it can’t hurt to know what to expect.

Reality 1: Anyone Can Get Help Paying for School

Let’s start with some good news. Almost any student can find help paying for college, no matter what their financial background is.

While students from more privileged economic backgrounds may qualify for less federal student aid such as grants, both colleges and private businesses offer a variety of merit-based scholarships and grants that students can apply for.

It’s worth considering all of your aid options before you foot your entire college bill by yourself.


💡 Quick Tip: Would-be borrowers will want to understand the different types of student loans that are available: private student loans, federal Direct Subsidized and Unsubsidized loans, Direct PLUS loans, and more.

Reality 2: Follow Your Passions

You’ve heard it from your teachers, you’ve heard it from your parents, and chances are you’ve heard it from countless other adults who like to reminisce about the good ol’ days: Your time spent in college will be some of the best years of your life.

College is a unique time when young adults can follow their passions. Even if you choose a major that doesn’t align with all of your interests, there are many elective classes you can take and clubs you can join that will help you foster your passions.

Learn Portuguese, take a class in 3D printing, hit the stage for some dramatic arts, or simply explore the library archives. Take advantage of this special time in your life to learn more about what interests you.

Recommended: How to Get Involved on Campus in College

Reality 3: You Can Change Your Mind

You’ve known your whole life that you want to be a doctor. Or a lawyer. Or a beekeeper. Or so you thought. One of the many joys of college is that you have the time and space to learn and grow.

You may discover after two years of being a psychology major that the statistics classes you had to take were more interesting than your clinical psychology classes.

It’s never too late to switch majors (that extra year of sticking around campus will be worth it) or start interning in a new career field.

Some students may find that the college they chose while they were still in high school isn’t a good fit. Guess what? You can transfer to a new school if you wish. You can change your mind about what you want to study and what career path you want to take, too.

Reality 4: Partying Can Take a Toll

For some, college parties are a rite of passage. For others, they are stressful and distracting. If the party lifestyle is something you’re not interested in or is something you know you’ll get swept up in, it’s OK to stay home on a Friday night.

Focusing on your studies is why you’re at college, so don’t let peer pressure or societal expectations make you feel bad for prioritizing that.

Another Reality: Financing College

As mentioned, students can apply for scholarships and grants to help pay for their college education. But if a student needs a little more help in the funding department to supplement their college savings, grants or scholarships, chances are either they or their parents will consider student loans.

Students can apply for federal and private student loans. Federal student loans often have lower interest rates than private student loans do and don’t have to be paid back until a student graduates or leaves school. If you qualify for a subsidized federal loan, you won’t have to pay any interest on the loan while you are in school and for six months after you graduate.

Private student loan lenders may require the borrower to begin paying back the loans before graduation day. That said, private student loans can help with college costs that federal student loans may not completely cover.

If students consider private student loans, they should research each lender and review the terms and rates offered. Also keep in mind that private loans may not offer the same protections, such as income-based repayment plans, that come with federal student loans.

If you’ve exhausted all federal student aid options, no-fee private student loans from SoFi can help you pay for school. The online application process is easy, and you can see rates and terms in just minutes. Repayment plans are flexible, so you can find an option that works for your financial plan and budget.

Cover up to 100% of school-certified costs including tuition, books, supplies, room and board, and transportation with a private student loan from SoFi.


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SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Private Student Loans
Please borrow responsibly. SoFi Private Student Loans are not a substitute for federal loans, grants, and work-study programs. You should exhaust all your federal student aid options before you consider any private loans, including ours. Read our FAQs. SoFi Private Student Loans are subject to program terms and restrictions, and applicants must meet SoFi’s eligibility and underwriting requirements. See SoFi.com/eligibility-criteria for more information. To view payment examples, click here. SoFi reserves the right to modify eligibility criteria at any time. This information is subject to change.

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
17
2023
What is the VIX Volatility Index? How Investors Can Use It

What Is the VIX Volatility Index? How Investors Can Use It

By | Growing Wealth, invest, Investing | Comments Off on What Is the VIX Volatility Index? How Investors Can Use It

The Cboe Global Markets Volatility Index, known as the VIX for short, is a tool used to measure implied volatility in the market. In simple terms, the VIX index tells investors how professional investors feel about the market at any given time.

This can be helpful for gauging and assessing risk in order to capitalize on anticipated market movements. Depending on which way the VIX is trending, it may throw off buy or sell signals to investors.

The volatility index is sometimes referred to as the “fear index” or “fear gauge” because traders rely on it as an indicator of the fearfulness of sentiment surrounding the market. While not a crystal ball, understanding the VIX and how it works can provide a useful predictor of investor behavior.

What Is the VIX Index?

The VIX Index is a real-time calculation designed to measure expected volatility in the U.S. stock market. One of the most recognized barometers of fluctuations in financial markets, the VIX measures how much volatility investing experts expect to see in the market over the next 30 days. This measurement reflects real-time quotes of S&P 500 Index (SPX) call option and put option prices.

Stock volatility represents the up and down price movements of various financial instruments that occur over a set period of time. The larger and more frequent price swings, the higher the volatility.

Implied volatility reflects market sentiment and which way it expects a security or financial instrument’s price to move.


💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

How Does the VIX Work?

The VIX Index is a forward-looking trend indicator used to quantify expectations for future volatility. Cboe designed the index to estimate expected volatility by aggregating weighted prices of S&P 500 Index puts and calls over a wide range of strike prices.

In options trading, the strike price represents the price at which a trader can exercise an option. Call options give an investor the right to buy shares of an underlying security; put options give them the right to sell shares of an underlying security.

The Cboe Options Exchange (Cboe Options) calculates the VIX Index using standard SPX options and weekly SPX options listed on the exchange. Standard SPX options expire on the third Friday of every month. Weekly SPX options expire on all other Fridays. VIX index calculations include:

•   SPX options with Friday expirations

•   SPX options with more than 23 days and less than 37 days to their Friday expiration

The index weights these options to establish a constant-maturity, 30-day measure of the amount of volatility the S&P 500 Index is likely to produce. The VIX index works differently from the Black Scholes model, which estimates theoretical value for derivatives and other financial instruments based on a number of factors, including volatility, time, and the price of underlying assets.

The VIX is one of seven inputs used by CNN to determine its Fear and Greed Index.

What Does the VIX Tell You?

In securities trading, the VIX index is a measure of market sentiment. The volatility index has a negative correlation with stock market returns. If the VIX moves up that means investor fear is on the rise. The S&P 500 tends to see price drops in that scenario as investors may begin to sell off securities to hedge against expanded volatility that may be on the horizon.

On the other hand, when the VIX declines, that could signal a decline in investor fear as well. In that situation, the S&P may be experiencing lower levels of volatility and higher prices as investors buy and sell with confidence. This doesn’t necessarily mean that prices will remain high, however, as volatility is fluid and can increase or decrease sharply due to changing market conditions.

The volatility index can be read as a chart, with each day’s reading plotted out. Generally, a reading of 0 to 12 represents low volatility in the markets, while a range of 13 to 19 is normal volatility.

Once the VIX reaches 20 or above, that means you can typically expect volatility to be higher over the coming 30 days. For perspective, the VIX notched a 52-week high of 34.88 and a 52-week low of 12.73 as of August 11, 2023.

Example of VIX in Action

The beginning of 2020 saw a gradual rise in the level of concern surrounding the coronavirus and its potential to become a public health crisis. As more cases appeared in the United States, the financial markets began to react. The VIX index, which had hovered around 20 or below since January 2019, began to climb in the third week of February. By March 16, it had reached a peak of 82.69 and the Dow Jones had dropped 12.93%.

After the market crashed, the VIX began to slowly decline. By early November 2021, the volatility index was once again implying volatility on par with pre-pandemic levels, measuring 18.58 as of November 24.


💡 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.

How Investors Can Trade the VIX

Investors interested in trading the VIX index have a few options for doing so. Cboe offers both VIX options and VIX futures as a starting point.

VIX options are not exactly the same as traditional stock options. They trade nearly 24 hours a day, five days a week during extended trading hours. Investors can trade a call option or put option to make speculative investments based on anticipated volatility in the markets.

Cboe introduced VIX futures in 2004 to allow investors to trade a liquid volatility product using the VIX index as a guide. The difference between options and futures lies largely in the execution.

With options trading, the investor has the right but not the obligation to buy or sell a particular investment. A futures contract, on the other hand, requires the buyer to purchase shares and the seller to sell them at an agreed-upon price.

With VIX options or VIX futures, you’re making investments based on what you expect to happen in the markets based on how the volatility index is trending. Options and futures are speculative investments that carry more risk than some other types of investments. If you’re looking for another way to trade the VIX, you might look to VIX exchange-traded funds (ETFs) or volatility ETFs instead.

Volatility ETFs

Exchange-traded funds hold a basket of securities but they trade on an exchange like a stock. VIX ETFs and volatility ETFs often hold futures contracts or track the movements of a volatility index.

Choosing volatility or VIX ETFs in lieu of trading VIX options or VIX futures directly doesn’t eliminate risk. But it can help you to spread the risk out over a diverse group of investments. If you’re already trading stocks and other securities through an online brokerage account, VIX or volatility ETFs may be included as an investment option.

The Takeaway

The volatility index or VIX is a highly useful tool for measuring market sentiment. While it’s impossible to predict exactly which way the market will move, the VIX index can help with interpreting implied volatility when making investment decisions.

That’s information you can use whether you’re trading options or less risky investments such as stocks or ETFs.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).


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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
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.

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.

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.

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17
2023
What Is a Volatility Smile?

What Is a Volatility Smile?

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Is a Volatility Smile?

A volatility smile is a common graphic visualization of the strike prices and the implied volatility of options with the same underlying asset and expiration date. Understanding an implied volatility smile can help traders make decisions about their portfolio or certain securities.

Volatility Smile Definition

Implied volatility smiles involve the plotting of strike prices and implied volatility of a bunch of different options on a graph with levels of implied volatility and different strike prices along its axes. Each of the options plotted share the same underlying asset and expiration date. On a graph, they appear in a U shape (or a smile).

The volatility smile is a graphical pattern that shows that implied volatility for the options in question increases as they move away from the current stock or asset price.

Recommended: A Guide to Options Trading

What Do Volatility Smiles Indicate?

When plotted out, volatility smiles illustrate different levels of implied volatility at different strike prices. So, at strike price X, the level of implied volatility would be Y, and so on. At an extremely basic level, the “smile” appearing on a chart could be an indication that the market is anticipating certain conditions in the future.

The appearance of a volatility smile could also indicate that demand is higher for options that are “in the money” or “out of the money” than it is for those that are “at the money.”


💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

Understanding Volatility Smiles, and How to Use Them

A volatility smile can have an effect on options prices. If a trader is considering buying or selling a new option, the chart can help the trader understand the likely pricing of that option, given its strike price and how the market values volatility at a given time. Some options (like those related to currency) have a higher likelihood of producing a volatility smile, and some options will never produce one.

Volatility Smiles and Skews and Smirks

It’s not all smiles when it comes to volatility. There are also volatility skews and volatility smirks in the mix, too.

Volatility Skew

A volatility skew, as seen on a graph, is the difference of measured implied volatility between different options at different strike prices. Basically, a skew appears when there’s a difference in implied volatility between options that are out-of-the-money, at-the-money, and in-the-money. In effect, different options would then trade at different prices.

That means a volatility smile is actually one form of a skew.

Volatility Smirk

Volatility smirks are another form of skew, except rather than having a symmetrical “U” shape, a smirk has a slope to one side.

Instead of a straight line on a graph that would indicate no difference in volatility between the in-the-money, out-of-the-money, and at-the-money options, a smirk shows three different measures of volatility depending on where in “the money” the option lands. This is different from a volatility smile in that a smile indicates that in-the-money and out-of-the-money options are at similar, if not equal, levels of implied volatility.

A smirk is commonly seen when plotting the volatility skew of equity options, where implied volatility is higher on options with lower strikes. One explanation for this phenomenon is that traders favor downside protection, and so purchase put options to compensate for risk.


💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.

Volatility Smile Limitations

An important thing for traders to remember about volatility smiles and skews is that they are theoretical, and reality may not necessarily line up with what’s being portrayed on a graph. In other words, it’s not a fool-proof way to get a read on current market conditions.

Also, not all types of options will showcase smirks or smiles, and for those that do, those smirks or smiles may not always be so clearly defined. A volatility smile may not look like a clear-cut semi-circle — depending on the factors at play, it can look like a much rougher grin than some traders expect.

Volatility Smiles and the Black-Scholes Model

The Black-Scholes Model is a formula that takes several assumptions and inputs — strike prices, expiration dates, price of the underlying asset, interest rates, and volatility — and helps traders calculate the chances of an option expiring in-the-money. It’s a tool to help measure risk, including tail risks.

While popular with many traders for years, it fails to predict volatility smiles — exposing a flaw in its underlying assumptions. Because of that, the Black-Scholes Model may not be as accurate or reliable as previously thought for calculating volatility and corresponding options values.

The Takeaway

Experienced options traders may use volatility smiles as one tool to evaluate the price and risk of a specific asset. They’re typically used by more experienced traders who have advanced tools to help plot securities and who are comfortable trading options and other derivatives.

However, you don’t need such advanced tools to start building a portfolio. It’s possible to begin investing for your future goals without using complicated models or processes.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).


Invest with as little as $5 with a SoFi Active Investing account.

Photo credit: iStock/zakokor

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.

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.

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
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.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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17
2023
Simple Moving Average (SMA): What Is a Simple Moving Average?

Simple Moving Average (SMA): Definition & How to Use It

By | Growing Wealth, invest, Investing | Comments Off on Simple Moving Average (SMA): Definition & How to Use It

Simple moving averages are one of the indicators that investors use in technical analysis to help them choose stocks. They’re the average of a range of the prices of a stock over a given time period.

Here’s how to calculate simple moving averages, what they represent, and how to use the information they provide.

What Is Simple Moving Average (SMA)?

A simple moving average is the average price of a stock, often its closing price, over a specific period of time. It’s called “moving” because stock prices always change. As a result, charts that track SMA move forward as each new data point is plotted. Investors use simple moving averages and other technical indicators to help them get an idea of the direction a stock price is moving based on previous prices.

While simple moving averages can give investors a sense of what could happen in the future, they have limitations. That’s because simple moving averages reflect past data, so they only represent past trends.


💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Formula for Simple Moving Average

To calculate a simple moving average, Investors take the average closing price of a financial security and divide it by a set number of periods.

The formulas is as follows:

SMA = (P1 + P2 + P3…+ Pn)/n

P is price and n is the number of periods.

Let’s take a look at an example of stock price over a period of 10 days.

Day (n)

Closing price (P)
1 $40
2 $42
3 $47
4 $51
5 $46
6 $44
7 $40
8 $38
9 $37
10 $36

To arrive at the simple moving average, first total the closing prices and divide by the number of periods.

SMA = (40 + 42 + 47 + 51 + 46 + 44 + 40 + 38 + 37 + 36)/10 = 421/10 = $42.10

On day 11, if an investor wants to continue looking at a 10-day average, they would drop the first data point in the list above and add the closing price from the eleventh day, shifting the moving average forward by one data point. They would continue to do this for each subsequent day, and in this way, the average continues to move.

What Does SMA Show You?

Analysts often plot simple moving averages as a line on a chart of individual data points. The line helps smooth out movement, making it easier to identify trends. If the line representing the SMA is moving up, then the price of the stock is trending up. Conversely, if the SMA is moving down, prices are also trending downward.

For long-term trends investors typically look at SMA over 200 days, while intermediate trends may focus on a 50-day period. Short-term trends typically use fewer than 50 data points.

Longer-term SMAs can help smooth out stock volatility, but they also have the biggest lag when compared to current prices.

What Are Crossover Signals?

Investors may chart two SMAs — one relatively short and the other long — to generate crossover signals, points when the lines cross, which can help identify moments to buy or sell a stock.

When the shorter moving average crosses above the longer moving average, it is known as a “golden cross.” This is a bullish signal that tells investors that stock prices are trending in the upward direction. On the other hand, a bearish “death cross” occurs when the shorter moving average crosses below the longer moving average. This is a signal that prices are trending down.

What Are Price Crossovers?

Price crossovers are another signal investors may generate to help them identify moments to buy and sell. When a stock’s prices crosses over the moving average, it generates a bullish signal, and it generates a bearish signal when stock prices crosses under the moving average.

One Step Behind

Though analysts use SMAs to identify trends, they are still lagging indicators. SMAs reflect events that have already taken place, making it a “trend following” metric. In other words, they’ll always be a step behind what is happening in real time. As a result, SMAs do not predict future prices, but they can provide investors with some insight into where prices may be going.


💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

SMA vs Other Moving Averages

There are other moving averages investors may use when performing technical analysis on a stock. These help investors flesh out recent trends in stock price movement, but they also tend to be a bit more complicated to calculate.

SMA vs Weighted Moving Average

Like SMAs, weighted moving averages (WMAs) help establish the direction in which a stock price is likely moving. However, they put more emphasis on recent prices than SMAs.

Investors calculate a WMA by multiplying each data point by a weighting factor. That gives more weight to recent data and less weight to data farther in the past. The sum of the weighting must add up to 1, or 100%. Simple moving averages, on the other hand, assign an equal weight to each data point.

The formula for WMAs is:

WMA = Price1 x n + Price2 x (n-1) +…Pricen/[n x (n+1)]/2

Where n is the time period.

SMA vs Exponential Moving Average

An exponential moving average (EMA) also gives more weight to more recent prices. However, unlike WMAs, the rate increase between one price and the next is not consistent — it is exponential. Analysts typically use EMAs over a shorter period of time, making them more sensitive to price movements than SMAs are.

The formula for EMA is:

EMA = K x (Current Price – Previous EMA) + Previous EMA

K = 2/(n+1)

n = The selected time period.

For first-time EMA calculations, previous EMA is equal to SMA, an average of all prices over a number of periods, “n”.

Which Moving Average Is Better?

Each moving average has its own place in an investor’s tool belt. Investors may use WMAs and EMAs — which emphasize recent data — if they are worried that lags in data will reduce responsiveness. Some investors believe that the exponential weight given by EMAs makes them a better indicator of price trends than WMAs and SMAs.

Some more complicated indicators require a simple moving average as one input for calculations.

The Takeaway

If you’re just starting out as an investor, it can be hard to know which stocks to buy and when to buy them. Technical analysis strategies, such as moving averages, can help narrow your search and clue you in to potentially advantageous times to buy or sell.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).


Invest with as little as $5 with a SoFi Active Investing account.

Photo credit: iStock/SrdjanPav

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.

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.

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
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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