InvestGen Archives | Page 37 of 65

Sep

2023

Cyclical vs Non-Cyclical Stocks: Investing Around Economic Cycles

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Cyclical investing means understanding how various stock sectors react to economic changes. A cyclical stock is one that’s closely correlated to what’s happening with the economy at any given time. The performance of non-cyclical stocks, however, is typically not as closely tied to economic movements.

Investing in cyclical stocks and non-cyclical stocks may help to provide balance and diversification in a portfolio. This in turn may help investors to better manage risk as the economy moves through different cycles of growth and contraction.

Cyclical vs Non-Cyclical Stocks

There are some clear differences between cyclical vs. non-cyclical stocks, as outlined:

	Cyclical Stocks	Non-Cyclical Stocks
Perform Best During	Economic growth	Economic contraction
Goods and Services	Non-essential	Essential
Sensitivity to Economic Cycles	Higher	Lower
Volatility	Higher	Lower

A cyclical investing strategy can involve choosing both cyclical and non-cyclical stocks. In terms of how they react to economic changes, they’re virtual opposites.

Cyclical stocks are characterized as being:

• Strong performers during periods of economic growth

• Associated with goods or services consumers tend to spend more money on during growth periods

• Highly sensitive to shifting economic cycles

• More volatile than non-cyclical stocks

When the economy is doing well a cyclical stock tends to follow suit. Share prices may increase, along with profitability. If a cyclical stock pays dividends, that can result in a higher dividend yield for investors.

Non-cyclical stocks, on the other hand, share these characteristics:

• Tend to perform well during periods of economic contraction

• Associated with goods or services that consumers consider essential

• Less sensitive to changing economic environments

• Lower volatility overall

A non-cyclical stock isn’t completely immune from the effects of a slowing economy. But compared to cyclical stocks, they’re typically less of a roller-coaster ride for investors in terms of how they perform during upturns or downturns. A good example of a non-cyclical industry is utilities, since people need to keep the lights on and the water running even during economic downturns.

💡 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.

Cyclical Stocks

In the simplest terms, cyclical stocks are stocks that closely follow the movements of the economic cycle. The economy is not static; instead, it moves through various cycles. There are four stages to the economic cycle:

• Expansion. At this stage, the economy is in growth mode, with new jobs being created and company profits increasing. This phase can last for several years.

• Peak. In the peak stage of the economic cycle, growth begins to hit a plateau. Inflation may begin to increase at this stage.

• Contraction. During a period of contraction, the economy shrinks rather than grows. Unemployment rates may increase, though inflation may be on the decline. The length of a contraction period can depend on the circumstances which lead to it.

• Trough. The trough period is the lowest point in the economic cycle and is a precursor to the beginning of a new phase of expansion.

Understanding the various stages of the economic cycle is key to answering the question of what are cyclical stocks. For example, a cyclical stock may perform well when the economy is booming. But if the economy enters a downturn, that same stock might decline as well.

Examples of Cyclical Industry Stocks

Cyclical stocks most often represent companies that make or provide things that consumers spend money on when they have more discretionary income.

For example, that includes things like:

• Entertainment companies

• Travel websites

• Airlines

• Retail stores

• Concert promoters

• Technology companies

• Car manufacturers

• Restaurants

The industries range from travel and tourism to consumer goods. But they share a common thread, in terms of how their stocks tend to perform during economic highs and lows.

Examples of Non-Cyclical Industry Stocks

Non-cyclical industry stocks would be shares of companies that are more insulated from economic downturns than their cyclical counterparts. It may be easier to think of them as companies that are probably going to see sales no matter what is happening in the overall economy. That might include:

• Food producers and grocers

• Consumer staples

• Gasoline and energy companies

Cyclical Stock Sectors

The stock market is divided into 11 sectors, each of which represents a variety of industries and sub-industries. Some are cyclical sectors, while others are non-cyclical. The cyclical sectors include:

Consumer Discretionary

The consumer discretionary sector includes stocks that are related to “non-essential” goods and services. So some of the companies you might find in this sector include those in the hospitality or tourism industries, retailers, media companies and apparel companies. This sector is cyclical because consumers tend to spend less in these areas when the economy contracts.

Financials

The financial sector spans companies that are related to financial services in some way. That includes banking, financial advisory services and insurance. Financials can take a hit during an economic downturn if interest rates fall, since that can reduce profits from loans or lines of credit.

Industrials

The industrial sector covers companies that are involved in the production, manufacture or distribution of goods. Construction companies and auto-makers fall into this category and generally do well during periods of growth when consumers spend more on homes or cars.

Information Technology

The tech stock sector is one of the largest cyclical sectors, covering companies that are involved in everything from the development of new technology to the manufacture and sale of computer hardware and software. This sector can decline during economic slowdowns if consumers cut back spending on electronics or tech.

Materials

The materials sector includes industries and companies that are involved in the sourcing, development or distribution of raw materials. That can include things like lumber and chemicals, as well as investing in precious metals. Stocks in this sector can also be referred to as commodities.

Cyclical Investing Strategies

Investing in cyclical stocks or non-cyclical stocks requires some knowledge about how each one works, depending on what’s happening with the economy. While timing the market is virtually impossible, it’s possible to invest cyclically so that one is potentially making gains while minimizing losses as the economy changes.

For investors interested in cyclical investing, it helps to consider things like:

• Which cyclical and non-cyclical sectors you want to gain exposure to

• How individual stocks within those sectors tend to perform when the economy is growing or contracting

• How long you plan to hold on to individual stocks

• Your risk tolerance and risk capacity (i.e. the amount of risk you’re comfortable with versus the amount of risk you need to take to realize your target returns)

• Where the economy is, in terms of expansion, peak, contraction, or trough

For example, swing trading is one strategy an investor might employ to try and capitalize on market movements. With swing trading, you’re investing over shorter time periods to reap gains from swings in stock prices. This strategy relies on technical analysis to help identify trends in stock pricing, though you may also choose to consider a company’s fundamentals if you’re interested in investing for the longer term.

How to Invest in Cyclical Stocks

Investors can invest in cyclical stocks the same way they do any other type of stock: Purchasing them through a brokerage account, or from an exchange.

One way to simplify cyclical investing is to choose one or more cyclical and non-cyclical exchange-traded funds (ETFs). Investing in ETFs can simplify diversification and may help to mitigate some of the risk of owning stocks through various economic cycles.

The Takeaway

Cyclical stocks tend to follow the economic cycle, rising in value when the economy is booming, then dropping when the economy hits a downturn. Non-cyclical stocks, on the other hand, tend to behave the opposite way, and aren’t necessarily as affected by the overall economy.

Investing around economic cycles is a viable strategy, but it has its potential pitfalls. Investors who do their homework may be able to successfully invest around economic cycles, but it’s important to consider the risks involved.

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).

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 are indicators of cyclical stocks?

A few examples of indicators of cyclical stocks include the earnings per share data reported by public companies, which can give insight into the health of the economy, along with beta (a measure of volatility of returns) and price to earnings ratios.

What is the difference between cyclicality vs. seasonality?

While similar, cyclicality and seasonality differ in their frequency. Seasonality refers to events or trends that are observed annually, or every year, whereas cyclicality, or cyclical variations can occur much less often than that.

How do you mitigate the risk of investing in cyclical stocks?

Investors can use numerous strategies to mitigate the risk of investing in cyclical stocks, such as sector rotation and dollar-cost averaging.

Photo credit: iStock/Eoneren

SoFi Invest®

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

SOIN0723162

Sep

2023

What Are Pink Sheet Stocks?

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Pink sheet stocks are stocks that trade through the over-the-counter market or OTC rather than through a major stock exchange. The term “pink sheets” comes from the paper that stock quotes used to be printed on, though today, stock quotes and stock trading takes place electronically.

The over-the-counter market may appeal to smaller companies, companies that are reorganizing after bankruptcy or shell companies. A pink sheet stock does not face the same level of regulation as stocks from publicly traded companies that are traded on the New York Stock Exchange or NASDAQ.

What Is a Pink Sheet OTC?

Pink sheet stocks are those that trade over the counter (OTC), rather than via stock exchanges. OTC Markets Group provides quotes for pink sheet stocks, and broker-dealers execute trades directly with each other.

Pink sheet OTC stock trading happens on an open market that lacks the financial reporting rules mandated by trading on the NYSE, NASDAQ or another stock exchange. It’s not illegal, though the Securities and Exchange Commission (SEC) warns investors to stay vigilant for potential scams or fraudulent trading involving the pink sheets market and microcap or penny stocks.

A company may choose to sell shares on the over-the-counter market if it can not meet the listing requirements established by the SEC, or does not want the expense of going through the IPO process. Many pink sheet stocks are penny stocks.

Investors looking for bargain buys may consider dipping into the pink sheets market. But pink sheet stocks — and penny stocks, in particular — can be highly volatile so it’s important to understand both the risks and potential rewards.

Listing Requirements

In order for a company to get listed on OTC pink sheets, they must file Form 211 with the Financial Industry Regulatory Authority (FINRA). Companies do this through a sponsoring market maker, or registered broker dealer firm. The sponsoring market maker accepts the risk of holding a certain number of shares in a pink sheet company to facilitate trading of those shares.

The Form 211 asks for financial information about the listed company. The broker dealer can then use this information to generate a stock price quote. Pink sheet over-the-counter stocks do not need to adhere to the same financial reporting requirements as stocks that trade on major exchanges.

Are Pink Sheets and OTC the Same?

The terms pink sheet stocks, and OTC or over the counter, loosely refer to the same thing: Trades that take place outside of the traditional stock exchanges. The company OTC Markets provides quotes for companies listed on the pink sheets, as well as the OTCQX and the OTCQB trading marketplaces.

The OTCQX allows for trading of companies that are not listed on traditional exchanges but still subject to SEC rules. The OTCQB includes emerging companies with a stock price of at least a penny that are not in bankruptcy, have a minimum of 50 beneficial shareholders who each own 100 shares, and annually confirm that information is up to date. Of the three, the pink sheet OTC marketplace has the fewest financial reporting requirements.

There are also companies that adopt regulatory and reporting standards to list with the Over the Counter Bulletin Board (OTCBB) system. This was another electronic stock quote system that displays stock prices for securities not listed on a national exchange. It had regulation requirements, which means pink sheet stocks wouldn’t be listed, but has ceased operations.

Are Pink Sheets and Stocks the Same?

Pink sheet stocks are stocks, meaning each one represents an ownership share in a company. The primary difference between pink sheet stocks and other types of stocks, such as Blue Chip stocks, is how investors trade them. Investors trade pink sheet stocks over the counter, and other types of stocks on an exchange.

Pink sheet stocks may have much lower valuations than small-cap, mid-cap or large-cap stocks, or they may be newer companies that have yet to establish themselves in the market. This is why it’s possible to buy penny stocks or microcap stocks on the pink sheets for pennies on the dollar.

Companies that Use Pink Sheets

There are many companies that use pink sheet stocks, and that includes some big-name, well-known companies that most people would recognize. That said, most likely wouldn’t be recognizable immediately to the average investor. A quick internet search would yield many results and examples.

💡 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.

Pros and Cons of Pink Sheet Stocks

Pink sheet stocks have benefits and disadvantages, both for the companies that list over the counter and for investors. These may differ from exchange-traded stocks. Here are some of the most important pros and cons to consider when investing in pink sheet stock:

Benefits of Pink Sheet Stocks

From a business perspective, being listed on the pink sheets can save companies resources. Rather than going through the IPO process to become a publicly-traded company, pink sheet stocks circumvent the major stock exchanges and their listing requirements.

Foreign companies may choose the pink sheets to avoid SEC financial reporting rules. Additionally, companies delisted from a stock exchange may seek to trade on the pink sheets OTC market.

For investors, the appeal of pink sheet stock trading is the potential to pick up stocks at rock-bottom prices. If a company listed on the pink sheets takes off, that could result in significant profits for investors who bought in early. Because there are fewer reporting requirements, it’s possible to find a much broader range of stocks to invest in when trading on the OTC pink sheets.

Disadvantages of Pink Sheet Stocks

Trading on the pink sheets OTC can call a company’s reputation or credibility into question. Investors may wonder why a company is not seeking an IPO to get listed on a stock exchange or why a company has been delisted. That can make it difficult for a company to cement its footing in the marketplace and attract attention from new investors.

Investing in pink sheet stocks may have more risk than trading stocks on a major exchange, since there is less transparency around their finances. It can be difficult to “look under the hood,” so to speak, and get an accurate picture of a company’s fundamentals. That means investors are inherently taking on more risk when investing in the pink sheets simply because they may not know exactly what they’re buying.

In addition, pink sheet stocks may be thinly traded, meaning it can be more difficult to buy or sell shares. Allocating assets to pink-sheet stocks may not be appropriate for investors who want or need liquidity within their portfolio.

Finally, investors must consider the fees associated with trading pink sheet stocks, as fees can erode net returns and stock profit.

How to Find Pink Sheet Stocks

Finding pink sheet stocks can be as simple as searching the OTC Markets website. You can use the platform’s stock screener to filter for pink sheet stocks. The filter can tell you at a glance the stock’s ticker symbol, its country of origin, price and trading volume. You can also identify pink sheet stocks by looking for ‘PK’ at the end of their symbol on a stick ticker.

It may be helpful to use an online trading simulator to find pink sheet stocks. A simulator can help you to learn more about pink sheet stocks and penny stocks while simulating trades to estimate potential gains or losses. This can make it easier to familiarize yourself with how pink sheet stocks trade and what kind of volatility you might be able to expect before investing real money.

Pink Sheet Stock Investment Risks

Part of investing strategically means paying attention to risk management. Pink sheet stocks can present greater risk in a portfolio for a few reasons. For starters, there’s less liquidity surrounding these stocks due to lower trading volume. That could make it harder to unload shares of a penny stock or pink sheet stock if you decide that it’s no longer a good fit for your investment strategy.

The pink sheets market and over-the-counter trading in general can be more susceptible to stock volatility. Rapid price fluctuations could generate higher than anticipated losses if the price of a pink sheet stock nosedives unexpectedly.

Share dilution can also reduce the value of penny stocks or other pink sheet stocks. Dilution occurs when a company issues more shares of stock, watering down the value of the existing shares on the market.

Another issue with pink sheet stocks is that they can be susceptible to price manipulation or fraud. Unusual suspects might use shell companies, for example, to trade on the pink sheets for the purpose of laundering money or otherwise defrauding investors. Because there’s so little regulation and transparency surrounding these stocks, it’s important to do thorough research before investing to make sure the company is legitimate.

💡 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.

How to Invest in Pink Sheet Stocks

If you’re interested in investing in pink sheet stocks, you’ll need a brokerage account to get started. Specifically, you need a broker that offers pink sheet trading. Not all brokers offer this service so you may need to research different options for where to trade pink sheet stocks online.

Once you find a brokerage you can decide how much you want to invest in pink sheet stock. Given the higher degree of risk involved, it’s important to consider how much you could realistically afford to lose if a pink sheet stock or penny stock gamble doesn’t pay off. This can help you come up with a number to invest.

When choosing a broker, ask about any applicable commission fees. Brokerages may charge higher trading fees for pink sheet stocks versus stocks that trade on a major exchange, so it’s important to factor cost in when estimating your risk/reward potential.

Pink Sheet Trading Time and Access

Trading pink sheet or OTC stocks occurs during normal market hours: Monday through Friday, 9:30am ET to 4:00pm ET, except on holidays. Investors can also place orders after hours, however.

The Takeaway

Pink sheet stocks, or OTC stocks, are stocks that do not trade on traditional large exchanges, and instead, trade “over the counter.” The over-the-counter market may appeal to smaller companies, companies that are reorganizing after bankruptcy, or shell companies, and listing OTC may be a way to circumvent the IPO process.

Investing in stocks may help you to build wealth for the long term. If you’re new to investing, you may want to start with trading stocks through an online brokerage account before diving into the over the counter market.

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

Why do companies use pink sheets?

Companies may choose to use pink sheets or list their stocks OTC if they can’t meet listing requirements set forth by the SEC, or if they don’t want to go through the IPO process, which can be resource-consuming.

What is the commission on pink sheet penny stocks?

Commissions or fees levied on pink sheet penny stock trading will vary depending on the platform being used to trade them. But in many cases, there are no commissions or fees to execute a trade.

What is the difference between pink sheets vs. OTCBB?

Pink sheets is a term used to describe over the counter, or OTC stocks. OTCBB, on the other hand, is the Over-the-Counter Bulletin Board, and was a quotation service offered by FINRA.

Photo credit: iStock/PeopleImages

SoFi Invest®

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

Sep

2023

The Monte Carlo Simulation & Its Use in Finance

The Monte Carlo Method & Its Uses in Finance

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

A Monte Carlo simulation is a mathematical technique used by investors and others to estimate the probability of different outcomes given a situation where multiple variables may come into play.

Monte Carlo simulations are used in such a wide range of industries — e.g., physics, engineering, meteorology, finance, and more — that the term doesn’t refer to a single formula, but rather a type of multivariate modeling technique. Multivariate modeling is a statistical method that uses multiple variables to forecast outcomes. A Monte Carlo simulation is an example of this type of calculation, which provides a range of potential outcomes using a probability distribution.

What Is the Monte Carlo Method?

A Monte Carlo simulation calculates a probability distribution for any variable that has inherent uncertainty. It then recalculates the results thousands of times over, each time using a different set of random numbers pertaining to each variable, to produce a vast array of outcomes that are then averaged together. In this way, a Monte Carlo analysis enables researchers from many industries to run multiple trials, and thus to define the potential outcome or risk of an event or a decision.

Applying mathematics to investment or business scenarios is difficult precisely because there are so many random variables involved in any single decision or any single investment or portfolio of investments. That’s why a Monte Carlo analysis can be more informative compared with predictive models that use fixed inputs.

The ability to apply mathematics to situations where many elements are probable, and then rank the likelihood of possible outcomes in order to gauge the potential for risk, is a chief advantage of Monte Carlo simulations.

💡 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.

Monte Carlo Method History

Using simulations to solve problems dates back to the 19th century, and perhaps even earlier, when simulations were an experimental way to test theories, analyze data, or support scientific intuition using statistics. But these simulations typically dealt with established deterministic problems. A modern Monte Carlo analysis, however, inverts that structure by using probabilities to solve the problem.

One of the first known uses of a modern Monte Carlo simulation dates back to the 1930s, when physicist Enrico Fermi experimented with an early form of the method to understand the diffusion of neutrons.

Physicists Stanislaw Ulam and John von Neumann are credited with developing and refining the current Monte Carlo method while working at the Los Alamos National Laboratory on nuclear weapons in the 1940s. Of course, the technique needed a code name, and Monte Carlo was chosen because the element of chance also drives the games at a casino (the Monte Carlo region of Monaco is well-known as a gambling hub).

Soon, the simulation method gained traction in the fields of physics, chemistry, and operations research, thanks to its adoption by the Rand Corporation and the U.S. Air Force. From there, it spread to many of the natural sciences, and eventually found its way to finance.

How the Monte Carlo Method is Used in Finance

In terms of practicality in the financial space, the Monte Carlo method has numerous potential uses.

For instance, money managers might use a Monte Carlo analysis to estimate risk levels for different investments when constructing a portfolio. Corporate finance managers might use a Monte Carlo simulation to assess the impact of variables like future sales, commodities prices, interest rates, currency fluctuations, and so on. Brokers might use a Monte Carlo analysis to calculate the risks of stock options.

Monte Carlo Simulation Method

The Monte Carlo simulation works by constructing a model of possible outcomes based on an estimated range of possible conditions. It does this by creating a curve of different variables for each unknown variable, and inserting random numbers between the minimum and maximum value for each variable, and running the calculation over and over again.

A Monte Carlo experiment will run the calculation thousands upon thousands of times. Along the way, it will produce a large number of possible outcomes.

But even for a simple investment, there are a host of factors that will affect its outcome. There are interest rates, regulations, market swings, as well as factors innate to that investment, such as the sales and revenue of the underlying business, or its competitive landscape, or disruptive technology, and so on.

And as an investor seeks to peer further into the future, more possible variables emerge. Using a Monte Carlo simulation to understand those potential investment risks requires using a growing number of inputs as the time horizon grows longer.

After an investor runs a Monte Carlo simulation, the calculation will deliver a range of possible outcomes, with a probability score assigned to each outcome. By weighing the probability scores of different outcomes, an investor can proceed with a better sense of the risks and possible rewards of a given investment decision.

Monte Carlo Simulation Steps

Using a Monte Carlo simulation is a complicated process that requires a background in mathematics, though some investors have created Monte-Carlo-like models using spreadsheet software. Some of those homespun programs can be used to try to project possible price trajectories of a given asset.

If you wanted to get an idea of how the Monte Carlo method could be used to estimate potential stock movements, the steps to do so would look something like the following — but note that this is a very simplistic, pared down model.

• Step 1: Use historical price data of a stock to generate a set of daily returns data

• Step 2: Use that data set to determine further variables, such as standard deviations and variance

• Step 3: Define a random input or variable

• Step 4: Run a simulation (again, this will require software or a program) and analyze the results

In Monte Carlo fashion, the user will repeatedly run the equation an arbitrary number of times, to see how often each outcome occurs. The frequency of each outcome will reflect the likelihood of each outcome.

The results will most likely form a bell curve, with the most likely result in the middle of the curve. But as with any bell curve, those results also indicate that there is an equal chance that the actual result will be either higher or lower than the number in the middle.

Estimating Risk Using the Monte Carlo Method

The Monte Carlo method can be used to determine the likelihood of certain risks when investing, but there are some important things to take into consideration.

For one, a Monte Carlo simulation is only as good as the data that’s programmed into it. No matter how well the simulation is run, its predictive powers can easily be undone by factors that haven’t been added into the equation. For example, when using a Monte Carlo simulation to decide whether or not to buy a given stock, the model could seem to deliver a clear picture of the risks and rewards of the investment.

In that example, the problems arise if the programmer or investor leaves out one single factor, such as macro trends, the effectiveness of company leadership, cyclical factors, political changes, and so on.

There’s a chance that factor could be the one that completely subverts the simulation. And those variables are potentially without limit.

Who Uses Monte Carlo Simulations, and How

Nonetheless, large institutional investors might use Monte Carlo simulations as a tool in their projections and decision making. And its use for investors isn’t limited to hedge fund managers and spreadsheet wizards. There are even online Monte Carlo simulators that can help people save for retirement.

Those tools are designed for the average investor to input some basic information like their savings, and years until retirement to help them understand the likelihood that they will be able to reach their financial goals, and whether they will have enough income in retirement. Those calculators use a generic set of parameters for their calculations, with inputs such as interest rates, and a generic portfolio allocation.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

The Takeaway

A Monte Carlo simulation is a mathematical technique used to estimate possible outcomes of an uncertain event, such as the movement of securities.

The basis of this analysis is that the probability of different outcomes cannot be determined because random variables cannot be predicted. Therefore, a Monte Carlo simulation will constantly repeat random samples to achieve certain results that can be used to gauge the likelihood of various outcomes, and therefore different risk levels associated with different choices.

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 are the advantages of using the Monte Carlo method compared to other numerical techniques?

Though many other numerical techniques have the same goal as the Monte Carlo method, it may be advantageous in that it tests out numerous random variables and then works to an average, rather than starting from an average — which is not to say that it’ll always provide a superior result than another technique.

How is randomness or probability incorporated into the Monte Carlo method?

The Monte Carlo method incorporates randomness or probability into the mix by using random numbers and distributions of probability, which could include formulas or data sets associated with random variables.

Are there any techniques to improve the efficiency or speed of Monte Carlo simulations?

There are potential techniques and strategies to improve upon the base Monte Carlo method model, and they’re all fairly high-level and abstract (remember, it was developed by physicists at Los Alamos!). For the typical investor, it may not be worth looking too far into.

What are some historical origins and applications of the Monte Carlo method?

The Monte Carlo method’s origins can be traced back to the 1930s and the experiments of physicist Enrico Fermi, and later, others during the 1940s working on nuclear weapon development. It can be used to determine the probability of different outcomes or results that may not easily be predicted.

Photo credit: iStock/PeopleImages

SoFi Invest®

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

Sep

2023

Advance/Decline Line: Definition, Formula, Examples

By Paulina Likos | Growing Wealth, invest, Investing, Terminology | Comments Off

The Advance/Decline line, or A/D line, is a technical stock market indicator used by traders to measure the overall health of the stock market. This measurement tells market participants whether there are more stocks rising or falling on a trading day, and whether a majority of stocks are pushing the market in either direction.

For traders who are looking for greater insight into market trend analysis, the A/D line may be a suitable indicator to help determine where the market is trending, how strong that trend is, and the direction the market could be going in the short-term.

What Is the Advance/Decline Line (A/D)?

The advance/decline line (A/D) is a market indicator that traders use during stock technical analysis to estimate the breadth, or the overall strength or weakness of the stock market. The A/D line monitors how many stocks are currently trading above or below the previous day’s close. Traders may follow these changes over time to try to forecast the direction of the market.

In a particular index, like the S&P 500, Nasdaq, or Dow Jones Industrial Average, stocks go up and down. But just because some stocks move in one direction, it doesn’t mean that all stocks move in that same direction. Sometimes it can be difficult for investors to discern whether the direction of the market is being influenced by larger stocks that hold more weight in an index, or by a majority of stocks that are pushing the markets in a particular direction.

The purpose of the A/D line is to see how it correlates with the price movement of the index it’s being compared to. Traders and investors can use the A/D line to see how many stocks are rising or declining to form an estimate on market direction.

Where Is the Advance/Decline Line on a Chart?

Market participants can find the advance/decline line above or below a stock index chart. Investors can reference the A/D line and compare it to the chart stock market indexes to better understand the strength of the market and to help gauge the direction of where the market might be headed.

Advance/Decline Line vs the Arms Index

The Arms Index — also known as the story-term trading index (TRIN) — is another technical analysis indicator used to estimate market sentiment and measure volatility. It’s a ratio between advancing and declining stocks versus the volume of stocks whose price increases or decreases. In other words, the TRIN compares advancing and declining stocks to their volume and shows whether the volume is flowing toward advancing or declining stocks.

If more volume is trending toward declining stocks, the TRIN for that day will be greater than one. If more A/D volume correlates with advancing stocks, then the TRIN will be below one for that day. A high TRIN reading could signal to traders that stock selling may be on the horizon. A TRIN reading below one could indicate a buying opportunity.

Traders may use the TRIN ratio as a short-term market gauge to measure overbought or oversold market levels, while the A/D line can be used to gauge longer term market sentiment by measuring the rise and fall of stock over a period of time.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Advance/Decline Line Formula

The A/D Line is calculated by taking the difference between the number of stocks that advance and the number of stocks that decline, compared to the prior close. This value is added to the previous day’s A/D Line value. If there are more declining stocks versus advancing stocks on a particular day, then traders will see the A/D line start to move downward. If there are more stocks that are advancing, the A/D number is going to be increasing. Here is the formula:

Advance/Decline Line = Number of advancing stocks – Number of declining stocks + Previous A/D Line value

Calculating the Advance/Decline Line (A/D)

The A/D line is a cumulative, daily calculation that is plotted each day so market participants can see the direction of where stocks are moving. When reading the A/D line, it’s important for traders to look at the direction of the line and not its value.

Traders may use the A/D line to help decide which trades to place next. For example, if the market shows more declining stocks than advancing stocks, this means a majority of stocks closed at a lesser value than their previous day close. As a result, traders may anticipate that the market will fall in the near term, and may choose to sell because the market trend is moving in a bearish direction.

Some indexes, like the S&P 500, are market-cap weighted, which means the larger companies hosted in the index influence the direction of the index. The A/D line allows investors to look at stocks on a level playing field. When a market rises, for example, the A/D line shows investors whether this rise was driven by a majority of stocks increasing or if the rise was caused by a select few of stocks that hold a larger weight in the index.

What Does the Advance/Decline Line Show?

The advance/decline line shows traders the degree of participation of stocks in a market that is either rising or falling and whether the majority of stocks are moving in a similar direction of the market.

The line is a representation of stocks that are ticking up or down cumulatively, adding stock movements each day to see the trend of advancing stocks vs. declining stocks. If there were more declining stocks than advancing stocks on a particular day, the A/D line would start to slope downward. If there were more advancing stocks than declining stocks on the day, then the A/D line would slope upwards.

Sometimes there might be a difference in direction between the index and the A/D line. This is called a divergence, and it can happen in one of two ways.

Bearish Divergence: Declining Line

If the index is on an upward trend but the A/D line has a negative slope, this is known as a bearish divergence. The increase in the index may be driven by some stocks, but this scenario signals to traders the market may reverse and trend downward in the short term.

Bullish Divergence: Rising Line

If the index is on a downward trend but the A/D line has a positive slope, this is called a bullish divergence. The index seems to be bearish, but the A/D line tells market participants there are more advancing than declining stocks during the period that the index is declining. This may signal a trend reversal in market prices and indicate the market has more strength than meets the eye.

Example of Using the A/D Line

Traders use the A/D line to compare it to the price movement of the index.

For example, when an index you’re monitoring is moving to new highs, you want to see the A/D line moving new highs to confirm the index’s direction.

If the index and the A/D line are both hitting new highs, the market is hitting a bullish trend. If the stock market reaches a new peak but the A/D line reaches a lower peak than the previous rally, that means fewer stocks are participating in a higher move and the rally could be coming to an end. This could suggest that the strength of the market is driven by a few names with larger market caps.

Is the A/D Line a Good Indicator?

The A/D line is considered a reputable and popular measurement for traders to gather reliable insight into the strength of a market trend. Note that there are many market indicators out there, and each will have good and bad use cases. But generally, the A/D line may be a good choice for many investors to utilize.

When the price of an asset changes, traders will want to know whether it’s best to buy or sell. With the A/D line, traders can estimate price trends of assets and potential reversals by reviewing the direction of the A/D line, which is considered to be a reasonably reliable indicator in predicting trends since it shows market participants how the market is behaving.

Pros of the A/D Line

Traders can find the A/D Line indicator either above or below a stock chart on a trading platform and may use it as a tool to try to time the market and potentially catch a particular stock price.

By gauging the direction of where markets are headed, the A/D Line can help traders forecast stock price movements on the upside or downside. This may help market participants position their trades favorably.

Cons of the A/D Line

It’s important for market participants to be careful to not rely on the A/D Line as their only market indicator. While the A/D Line offers insight into overall market direction, it may not be able to capture minor market changes.

The A/D Line does not capture price changes between trading gaps, or when a stock’s price moves higher or lower throughout the trading day even though there’s not much trading going on.

Another limitation is that even though the line shows the general direction of where the market is trending, either a positive or negative slope, the A/D line doesn’t show the precise percentage the stock moved.

How Investors Can Use the Advance/Decline Line

The A/D line is positioned against an index to help spot market trends and reversals. Traders who trade on the major indexes can use the A/D line to gauge overall market sentiment. Market participants can look at a historical A/D line to see how the market performed in different periods of time.

💡 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.

The Takeaway

The Advance/Decline Line is a tool used by traders and investors to forecast the direction of where the overall stock market is headed. The A/D Line is a well-known market indicator used to predict and confirm trends and forecast market reversals.

The A/D Line offers a great visual guide that may help traders make decisions on market strategies and positions in the short term. But while there are benefits of using this metric, it’s important for market participants to know the A/D line’s drawbacks as well.

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 is considered a good Advance/Decline ratio?

An advance/decline ratio of one or more is generally considered to be good, as it’s a signal that a stock is in a stable or on an upward trend. Conversely, a ratio of less than one is a sign that it could be declining.

What is the 10-day Advance/Decline line?

The 10-day advance/decline line is a technical indicator that allows investors to get a measure of the average number of daily advancers minus decliners within an index or specific sector over the previous ten trading days.

What does a period of decline in investment mean?

A period of decline in investment is a broad description of a period of deflation in the investment market. It could take the form of an overall drop in the value of investments.

Photo credit: iStock/utah778

SoFi Invest®

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

SOIN0723136

Sep

2023

What Are IPO Proceeds?

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

Initial public offerings (IPO) are a common tool for companies to raise capital, and the funds raised in an IPO are known as IPO proceeds.

When investors purchase IPO stocks, the company gets to keep the proceeds, after paying underwriters, the exchange, and others that helped with the IPO process.

By opening up to public investment, a previously private company can bring in significant funds that can be used for various activities, rather than turning to debt as a means of expansion.

Companies can use the capital brought in through an IPO in a variety of ways, but they must disclose their plans to investors.

Key Points

• Initial public offerings (IPOs) are a common tool for companies to raise capital, with proceeds known as IPO proceeds.

• Companies must disclose their plans to investors for how they will use the proceeds.

• Common uses for IPO proceeds include paying off debt; funding additional research and development; and general corporate purposes.

• Companies must file an S-1 with the Securities and Exchange Commission (SEC) to disclose how they intend to use the proceeds.

• While companies get to keep most of their IPO proceeds, a portion also goes to investment banks, accountants, lawyers, and others who helped them with the IPO process.

IPO Proceeds Defined

When a company holds an initial public offering (IPO) they must publish their plans for how they will use the proceeds. This helps investors understand how the company will use their money, and decide whether they agree with the company’s plans before they invest.

This is important because even though the IPO process is highly regulated, it’s also highly risky. Some companies that issue their stock for the first time can see the stock price soar; others can see it plunge. It’s also possible for the IPO to have an IPO pop, or price spike, before dropping. This kind of volatility is common to IPOs, which is why investors must proceed with caution.

Companies preparing for an IPO file an S-1, a several-hundred-page document, with the Securities and Exchange Commission (SEC) which includes a disclosure about the planned use of IPO proceeds.

They must also show investors a business plan. Potential investors can evaluate the business plan and see if they think they will receive a satisfactory return on their investment if they buy stock in that IPO.

While companies get to keep most of their IPO proceeds, a portion also goes to all investment banks, accountants, lawyers, and others who helped them with the IPO process, including valuing the company and setting an IPO cutoff price. According to PWC, underwriting fees alone eat up 3.5% to 7% of IPO proceeds.

💡 Quick Tip: Keen to invest in an initial public offering, or IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.

What Are IPO Proceeds Used For?

There are a few areas where companies tend to spend IPO proceeds. Generally companies mention multiple uses in their S-1 filings, and it may also be something that they discuss with investors during their IPO roadshow. These might include:

General Corporate Purposes

General corporate purposes is a very common area companies talk about in their use of proceeds statements. It is a broad category that covers a lot of uses such as capital expenditures, operating expenses, and working capital, and getting more money for this is a major reason that many companies go public. Companies can use this term to describe broad activities without going into detail about their plans.

This allows them to keep their plans private and also lets them keep their options open and decide exactly how to spend money at a later date. Some companies do go into greater detail about the meaning of their general corporate purposes statement.

Research & Development

Companies might also use proceeds from an IPO to fund research and development. They spend funds developing new products and services, which can take years and significant amounts of money. Since R&D is so expensive, it is a major reason companies choose to hold IPOs.

Without R&D, some companies might struggle to keep up with competition and stay relevant in their industry. Some companies go into detail about the types of R&D projects they plan to work on using IPO proceeds, while others keep their plans vague.

Company Growth

Companies often choose to hold an IPO to raise funds for company growth. Company growth plans often appear in their business plan, and can include capital expenditures, working capital, sales and marketing plans to help a company grow its reach and revenue.

Companies want to create long-term, sustainable growth so that a company can stay in business for a long time. Like other uses of IPO proceeds, companies may go into detail about their plans for company growth expenditures or they may keep their plans vague.

💡 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.

Acquisitions

Companies can use IPO proceeds to merge with or acquire other businesses, something that can be very expensive. Without holding an IPO a company might not have the funds required to complete an acquisition. Acquisitions and mergers can help a company grow their customer base, eliminate competition, and expand their product and service offerings.

When a company includes an acquisition in its S-1 filing, they must state which company they intend to acquire. If they don’t yet have a company in mind to acquire, they can just list acquisitions as one possible use of IPO proceeds. A company does not have to state the exact company they are interested in acquiring if it will harm the potential of the acquisition plan.

Some companies take a unique path to acquisitions using IPO proceeds, known as a “blank check” IPO or special purpose acquisition company (SPAC). Companies create a shell company that they take public with an IPO and then use the IPO proceeds to complete an acquisition.

Debt Repayment

Another common use of IPO proceeds is to pay off debt. By paying off any existing debts, companies no longer have interest payments, so they reduce their operating costs, and they can also gain access to more funds from loans. Although it can be beneficial to a company to pay off their debts, this use of IPO proceeds is not popular with investors.

Other uses of IPO Proceeds

In addition to the uses described above, there are many other ways companies can use IPO proceeds, including paying taxes and charitable actions.

SEC Requirements on IPO Proceeds

The SEC requires companies file a “use of proceeds” section in their S-1 IPO submission. The S-1 explains to investors the goals of the IPO and what the company plans to do following the IPO, including how they will use proceeds. Requirements for what must be included in the S-1 are fairly broad, so companies can choose how much to share with potential investors, and they have a lot of choice about how they can use IPO proceeds.

There are several specific requirements for what must be included in the S-1, a document scrutinized by investors as part of their IPO due diligence. The “use of proceeds” section must include a brief outline of how proceeds from an IPO will be used. The requirements for what the brief outline includes are broad, giving companies a lot of freedom in what they want to disclose. Companies are allowed to use broad statements about planned use of funds, such as listing the categories described above.

Later sections in the S-1 submission require companies to go into greater detail about spending plans if they plan to use funds for certain activities. Just because a company states they plan to use funds in a certain way doesn’t legally bind them to actually use the funds in that way. However, companies need to inform investors that plans may change later if that is the case.

The Takeaway

With many companies going public per year, knowing how a company is going to use its IPO proceeds — the funds earned from the public offering itself — is important if you’re thinking about investing in that company’s IPO. You can find that and other useful information about a planned IPO in a company’s S-1.

Common uses for IPO proceeds include paying off debt; funding additional research and development; general corporate purposes, and more.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

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

FAQ

Who gets the proceeds from an IPO?

When a company holds an IPO, they receive money from banks and institutional investors who have agreed to invest prior to the start of the IPO. The company receives proceeds from the initial sale of stock. Any money exchanged after the IPO from the sale of stock doesn’t go directly to the company.

What are secondary IPO proceeds?

Primary proceeds are those made from the initial sale of stock in an IPO. Secondary IPO proceeds are those made in the stock market following the IPO.

How does an IPO raise money?

An IPO raises money by offering shares of stock in a company to institutional and retail investors. When investors purchase those stocks, the company gets to keep the proceeds, after paying underwriters, the exchange, and others that helped with the IPO process.

Photo credit: iStock/Charday Penn

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.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

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.

SOIN0623078