InvestZ Archives | Page 115 of 160

Oct

2023

How to Read a Financial Statements: The Basics

How to Read Financial Statements: The Basics

By Austin Kilham | Growing Wealth, invest, Investing | Comments Off

A company’s financial statements are like a report card that tells investors how much money a company has made, what it spends on, and how much money it currently has.

Knowing how to read a financial statement and understand the key performance indicators it includes is essential for evaluating a company. Any investor conducting fundamental analysis will pull much of the information they need from past and present financial statements when valuing a stock and deciding whether to buy it.

Each publicly traded company in the United States must produce a set of financial statements every quarter. These include a balance sheet, income statement, and cash flow statement. In addition, companies produce an annual report. These statements tell a fairly complete story about a company’s financial health.

Understanding Each Section of a Financial Statement

Along with a company’s earnings call, reading financial statements can give investors clues about whether or not it’s a good idea to invest in a given company.

Here’s what the different sections of a financial statement consist of.

Balance Sheet

A company’s balance sheet is a ledger that shows its assets, liabilities, and shareholder equity at a given point in time. Assets are anything the company owns with quantifiable value. This includes tangible items, such as real estate, equipment, and inventory, as well as intangible items like patents and trademarks. The cash and investments a company holds are also considered assets.

On the other side of the balance sheet are liabilities — the debts a company owes — including rent, taxes, outstanding payroll expenses and money owed to vendors. When liabilities are subtracted from assets, the result is shareholder value, or owner equity. This figure is also known as book value and represents the amount of money that would be left over if a company shut down, sold all its assets, and paid off its debt. This money belongs to shareholders, whether public or private.

Income Statement

The income statement, also known as the profit and loss (P&L) statement, shows a detailed breakdown of a company’s financial performance over a given period. It’s a summary of how much a company earned, spent, and lost during that time. The top of the statement shows revenue, or how much money a company has made selling goods or providing services.

The income statement subtracts the costs associated with running the business from revenue. These include expenses, costs of goods sold, and asset depreciation. A company’s revenues less its costs are its bottom-line earnings.

The income statement also provides information about net income, earnings per share, and earnings before interest, taxes, depreciation, and amortization (EBITDA).

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Cash Flow Statement

A cash flow statement is a detailed view of what has happened with regards to a business’ cash over the accounting period. Cash flow refers to the money that’s flowing in and out of a company, and it is not the same as profit. A company’s profit is the money left over after expenses have been subtracted from revenue. The cash flow statement is broken down into three sections:

• Cash flow from operating activities is cash generated by the regular sale of a company’s goods and services.

• Cash flow from investment activity usually comes from buying or selling assets using cash, not debt.

• Cash flow from financing activity details cash flow that comes from debt and equity financing.

At established companies, investors typically look for cash flow from operating activities to be greater than net income. This positive cash flow may indicate that a company is financially stable and has the ability to grow.

Annual Report and 10-K

Public companies must publish an annual report to shareholders detailing their operations and financial conditions. Look for an annual report to include the following:

• A letter from the company’s CEO that gives investors insight into the company’s mission, goals, and achievements. There may be other letters from key company officials, such as the CFO.

• Audited financial statements that describe financial performance. This is where you might find a balance sheet, income statement and cash flow statement. A summary of financial data may provide notes or discussion of financial statements.

• The auditor’s report lets investors know whether the company complied with generally accepted accounting principles as they prepared their financial statements.

• Management’s discussion and analysis (MD&A).

In addition, the Securities and Exchange Commission (SEC) requires companies to produce a 10-K report that offers even greater detail and insight into a company’s current status and where it hopes to go. The annual report and 10-K are not the same thing. They share similar data, but 10-Ks tend to be longer and denser. The 10-K must include complete descriptions of financial activities. It must outline corporate agreements, an evaluation of risks and opportunities, current operations, executive compensation and market activity. They must be filed with the SEC 60 to 90 days after the company’s fiscal year ends.

MD&A

The management’s discussion and analysis provides context for the financial statements. It’s a chance for company management to provide information they feel investors should have to understand the company’s financial statements, condition, and how that condition has changed or might change in the future. The MD&A also discloses trends, events and risks that might have an impact on the financial information the company reports.

Footnotes

It can be really tempting to skip footnotes as you read financial statements, but they can reveal important clues about a company’s financial health. Footnotes can help explain how a company’s accountants arrived at certain figures and help explain anything that looks irregular or inconsistent with previous statements.

💡 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.

💡 Recommended: Guide to Off-Balance-Sheet Financing

Financial Statement Ratios and Calculations

Financial statements can be the source of important ratios investors use for fundamental analysis. Here’s a look at some common examples:

Debt-to-Equity

To calculate debt-to-equity, divide total liabilities by shareholder equity. It shows investors whether the debt a company uses to fund its operation is tilted toward debt or equity financing. For example, a debt-to-equity ratio of 2:1 suggests that the company takes on twice as much debt as shareholders invest in the company.

Price-to-earnings (P/E)

Calculate price-to-earnings by dividing a company’s stock price by its earnings per share. This ratio gives investors a sense of the value of a company. Higher P/E suggests that investors expect continued growth in earnings, but a P/E that’s too high could indicate that a stock is overvalued compared to its earnings.

Return on equity (ROE)

Calculated by dividing net income by shareholder’s equity, return on equity (ROE) shows investors how efficiently a company uses its equity to turn a profit.

Earnings per share

Calculate earnings per share by dividing net earnings by total outstanding shares to understand the amount of income earned for each outstanding share.

Current Ratio

This metric measures a company’s abilities to pay off its short-term liabilities with its current assets. Find it by dividing current assets by current liabilities.

Asset turnover

Used to measure how well a company is using its assets to generate revenue, you can calculate asset turnover by dividing net sales by average total assets.

The Takeaway

The financial statements that a company provides are all related to one another. For instance, the income statement reflects information from the balance sheet, while cash flow statements will tell you more about the cash on the balance sheet.

Understanding financial statements can give you clues that could help you determine whether a stock is a good value and whether it makes sense to buy or sell.

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Photo credit: iStock/Traimak_Ivan

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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.

SOIN0723056

Oct

2023

Understanding the Different Stock Order Types

By Austin Kilham | Growing Wealth, invest, Investing | Comments Off

There are several ways to execute stock trades, from the common and relatively simple market order, to more complex stop orders and timing instructions. Each type of order is a tool tailored to specific situations and needs of an investor or trader, and can result in a different outcome.

It’s important to understand the types of order in the stock market thoroughly to know when and how to use them. That way you’ll be able to know which order will best help you reach your goals as you buy and sell stocks.

Stock Order Types Explained

Different types of stock orders have different outcomes for investors. The best stock order type for you will depend on your investing style and risk appetite. You’ll need to understand each of them, particularly if you’re working with a self-directed brokerage account.

Recommended: 50 Investment Terms Decoded

Here’s a look at the different types of stock orders:

Market Order

Market orders are one of the most common types of trade you’ll encounter. A market order is an order to buy or sell a security as soon as possible at its current price. These types of orders make sense when you want to get a transaction done as quickly as possible.

A market order is guaranteed to be carried out, or executed. Investors buying stocks with a market order will pay an amount at or near the “ask” price. Sellers will sell for a price at or near the “bid” price.

However, while you’re guaranteed that your order will execute, you do not get a guarantee on the exact price. In volatile markets, stock prices may move quickly, deviating from the last quoted price, although.

For example, if you put in an order to buy a stock at an ask price of $50 per share, but many other buy orders are executed first, your market order may execute at a higher price as demand rises.

Recommended: What Is a Market-On-Open Order (MOO)?

Limit Order

Limit orders are another common type of stock orders. They are orders to buy or sell stock at a specific price or better within a certain time period. There are two basic types of limit orders:

• Buy limit orders can only be executed at the limit price or lower. For example, say you want to buy shares in a company only when prices hit $40. By placing a limit order for that amount, you can ensure your order only executes when that price, or a lower price, is reached.

• A sell limit order executes when stock hits a certain price or higher. For example, if you don’t want to sell your stock until it hits $40 or more, a sell limit will ensure that you own the stock until it hits that price.

Stop Order

In addition to the more commonly used market orders and limit orders, brokerage firms may also allow investors to use special orders and trading instructions, such as the stop order, also known as a stop-loss order. Stop orders are orders to buy or sell a stock when it reaches a predetermined price, known as the stop price. Stop orders help investors lock in profits and limit losses.

You enter a buy stop order at a price that is above current market price, which can help protect profit, especially if you are selling short. On the other hand, a sell stop order is an order to sell a stock at a price below the current market price, which can help you limit their losses.

When a stock’s price reaches the stop order price, the stop order becomes a market order. Like a market order, the stop price is not a guaranteed price. Fast moving markets can cause the execution price to be quite different.

Stop-Limit Order

Stop-limit orders are a sort of hybrid between stop orders and limit orders. Investors set a stop price, and when a stock hits that price, the stop order becomes limit order, executed at a specific price or better.

Stop-limit orders help investors avoid the risk that a stop order will execute at an unexpected price. That gives them more control over the price at which they’ll buy or sell.

For example, say you want to buy a stock currently priced at $100 but only if it shows signs that it’s on a clear upward trajectory. You could place a stop-limit order with a stop price of $110 and a limit of $115. When the stock reaches $110, the stop order becomes a limit order, and it will only execute when prices reach $115 or higher.

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Trailing Stop Loss Order

Investors who already own stocks and want to lock in gains may use these relatively uncommon orders. While stop-loss orders help investors buy or sell when a stock hits a certain stop price, trailing stop loss orders put guardrails around an investment.

For example, if you buy a stock at $100 per share, you might put a trailing stop loss order of 10% on the stock. That way, if, at any time, the stock’s share price dips below 10%, the brokerage will execute the order to sell.

Bracket Order (BO)

Bracket orders are similar to stop-loss orders in that they’re designed to help investors or traders lock in their profits or gains. They effectively create an order “bracket” with two orders: A buy order with a high-side sell limit, and a sell order with a low-side limit.

With a bracket order set up and in place, an order will execute when a security’s value goes outside of the predetermined range, either too high or too low.

Timing Instructions

Investors use a set of tools, known as timing instructions, to modify the market orders and limit orders and tailor them to more specific needs.

Day Orders

If an investor does not specify when an order will expire, the brokerage enters it as a day order. At the end of the trading day, it expires. If at that point, the brokerage has not executed the trade, it will have to be reentered the following day.

Good ‘Til Canceled (GTC)

A GTC order allows investors to put a time restriction on an order so that it lasts until the completion or cancellation of an order. Brokerage firms typically place a time limit on how long a GTC order can remain open.

Immediate or Cancel (IOC)

IOC orders allow investors to ask that the brokerage execute the buying or selling of stock immediately. It also allows for partial execution of the order. So, if an investor wants to buy 1,000 shares of a company but it’s only possible to buy 500 shares immediately, these instructions will alert the broker to buy the shares available. If the broker can not fulfill the order, or any portion of the order, immediately, the broker will cancel it.

Fill-Or-Kill (FOK)

Unlike IOC orders, fill-or-kill orders do not permit partial execution. The brokerage must execute the order immediately and in its entirety, or cancel it.

All-Or-None (AON)

Similar to FOKs, all-or-none orders require the complete execution of the order. However, AONs do not require immediate execution, rather the order remains active until the broker executes or cancels it.

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Which Order Type Is Best?

The type of order or special instructions you use when buying and selling stock depends on your goals with the transaction. Most beginner investors probably only need to execute market orders and perhaps limit orders.

Those trying to execute more complicated trades in shorter time frames, such as professional traders, may be more likely to use stop orders and special timing instructions.

The Takeaway

There are numerous types of stock orders, including limit orders, stop orders, bracket orders, and more. Investors and traders can use each individually or in concert to execute their strategy, though beginner investors likely won’t dig too far into their order tool kit when learning to navigate the markets.

Before using any of trade orders or timing instructions it’s critical to understand their function and to think carefully about how and whether they apply to your specific needs. Using the right order for your situation can potentially help you reduce risk and protect your portfolio, no matter how many stocks you own.

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FAQ

What is the safest type of stock order to use?

The stock order type that is all but guaranteed to execute per an investor’s desires is a market order, which executes immediately and at a given price. Other order types depend on specific conditions dictated by the investor and the market.

What is the difference between stop-loss vs stop-limit orders?

The main difference between a stop-loss order and a stop-limit order is that a stop-loss order guarantees to execute a market order if the stock hits the stop price, while a stop-limit order triggers a limit order when the assigned value is reached.

What is a standard stop-loss rule?

An example of a more or less standard stop-loss rule would be setting the stop-loss order parameters at 2% of the buy price, which would mean that an investor is not putting more than 2% of their initial investment at risk.

Photo credit: iStock/Alina Vasylieva

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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.

Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN0723175

Oct

2023

A Guide To Derivatives Trading

By Brian Nibley | Growing Wealth, invest, Investing | Comments Off

“Derivative” is an umbrella term that refers to any kind of financial security that derives its value from another asset. A derivative exists as a contract between two parties, and its value fluctuates in direct relation to its underlying asset. Some of the most commonly used assets that derivative contracts focus on include commodities, stocks, bonds, and currencies.

Futures and options contracts are examples of widely known derivatives. Credit-default swaps (CDS) are a lesser used, and riskier, form of derivatives, since they’re traded off of exchanges and the contract parties in that case do not own the underlying asset.

What Is a Trading Derivative?

A trading derivative is any contract that derives its value from an underlying asset. The nature of the relationship between the derivative and the underlying asset varies depending on the type of derivative.

Investors engage in trading derivatives for three main reasons:

• to hedge a position

• to gain leverage on a position

• to speculate on the future price of an asset

They’re a common tool for institutional investors, and also often used as a day trading strategy.

💡 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.

Types of Derivatives

Here are a few examples of different kinds of derivatives and how they work.

Options

An option gives the owner the right (but not the obligation) to buy or sell an asset at a certain price in a specific timeframe. Savvy investors can use options to make a profit regardless of whether the market is going up or down.

The two most basic types of options are call options and put options. Call options give the owner the option to buy an asset at a specific price over a set time frame, while put options give the owner the right to sell an asset at a specific price over a set time frame.

The two main aspects of a put or call option are the strike price and the expiry date. The strike price is the price at which the owner intends to buy or sell the security, and the expiry date is the date by which the option must either expire or be exercised. Employee stock options are one type of derivative, in which the employees can (but do not have to) purchase shares of their company in the future at a price set today.

There are also many complex options trading strategies that include multiple “legs,” or multiple options contracts on the same underlying security. Some investors use “naked options,” which are a riskier form of option, in which the trader does not own the underlying security or have cash set aside to meet the obligation at expiration.

Futures Contracts

Often referred to simply as “futures,” futures contracts represent an obligation between a buyer and seller to exchange an asset for a fixed price on a selected date. Most futures trades take place on large exchanges and involve commodities such as oil, soybeans, or copper.

Farmers have used futures since the 1850s to reduce investment risk over future price fluctuations for their crops. Today, futures exist for many commodities and financial markets. These derivatives are mostly used as a form of speculation, where traders seek to make a quick profit.

Futures are sold on stock exchanges and have a standard form regulated by the U.S. Commodity Futures Trading Commission (CFTC).

Forward Contracts

Forward contracts are similar to futures contracts. But unlike futures, forward contracts are customized between the two parties entering into an agreement, as opposed to being standardized by regulators. Forwards are over-the-counter (OTC) derivatives and are not traded on exchanges. This market is private and unregulated.

Is Derivative Trading Profitable?

Derivatives tend to have high investment risk, but also offer high potential rewards. Large profits can be made quickly, but bets can go bad just as easily.

Depending on how they’re used, derivatives can range from simple speculation to being an integral part of an advanced, sophisticated strategy that incorporates many different types of investments.

Derivatives trading is especially risky for new investors who might not understand the bets they are making. Derivatives contracts involve many more variables than simply buying shares of a stock, and placing trades on an exchange can be confusing.

💡 Quick Tip: Newbie investors may be tempted to buy into the market based on recent news headlines or other types of hype. That’s rarely a good idea. Making good choices shouldn’t stem from strong emotions, but a solid investment strategy.

What Is a Derivative Trading Example?

Imagine an investor has their eye on a particular stock that they think will rise in price soon. One way to profit would be to buy shares. Another way would be to buy a derivative, such as a call option.

Our imaginary investor decides to buy a call option contract on ABC company. The strike price could be ten dollars higher than the current price, while the expiry date could be three months from now.

This could create a profit for the investor in two possible ways. The stock price could rise above the strike price of the call option, at which point the investor can sell the contract for more than it was purchased for.

Or, the investor can wait for the expiry date to come, at which point she will receive shares of the underlying stock at a price lower than their current market value.

How Are Derivatives Valued?

On the most basic level, the market values derivatives according to simple supply-and-demand dynamics as well as variables specific to the option itself, i.e. strike price and expiration date.

An options contract, for example, might be worth whatever people are willing to pay for it. This can change quickly and sometimes dramatically based on market conditions and news. Investors consider an option “out of the money” if its strike price is lower than the market price of the underlying asset.

On a more advanced level, investors can determine what the actual value of a derivative should be, as opposed to its current market value at any given moment.

One method for valuing derivatives is the Black Scholes model, a mathematical formula for determining market value for European call options. This formula takes into account several variables such as the implied volatility of an option, time left until expiration, and the present value of the option.

How Can Derivatives Be Used to Earn Income?

Investors use a variety of derivatives trading strategies. One common approach is a cash-secured put.

This derivatives trading strategy involves selling an out-of-the-money put option while also putting aside the money necessary to buy the underlying stock if it falls to the option’s strike price. The goal is typically to acquire shares of the stock at a price lower than it is trading at today, but investors also earn income in the form of a premium.

A premium is the price an investor pays for acquiring an options contract. Premiums are determined by the relationship between the underlying stock price and the strike price of the option, the length of time until the option expires, and how much the price of the stock fluctuates.

A premium of $0.20 per option contract, for example, would amount to $20 per contract, if one options contract represents 100 shares ($0.20 x 100 = $20).

So, if an investor were to place a cash-secured put with a strike price of $40 for a stock that currently trades at $50, they would need to set aside $4,000 and sell (or “write”) the associated put option.

Recommended: Guide to Writing Put Options

Then, if the price falls to $40 before the expiration time, the investor would buy shares at that price and keep the premium. Or, if the price doesn’t fall to the $40 level, the option will expire, worthless, and the investor will also keep the premium.

The Takeaway

Derivatives trading strategies provide a more advanced way to trade and speculate in the markets, earn income, or hedge a portfolio. Derivatives trading is more complex than simply buying and selling securities, comes with greater risk, and can potentially earn greater rewards. It’s common in certain sectors, such as precious metals or currency trading.

Given their complexities, derivatives may not be the best focus for beginner investors. They are complicated and risky, and it’s easy to find yourself in over your head. It may be a good idea to talk to a financial professional if you do want to explore your options, however.

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

Photo credit: iStock/solidcolours

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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.

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.
Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN0623050

Sep

2023

Is Stock Market Timing a Smart Investment Strategy?

By Inyoung Hwang | Growing Wealth, invest, Investing | No Comments

Timing the market, as it relates to trading and investing, requires a whole lot of luck. In effect, it means waiting for ideal market conditions, and then making a move to try and capitalize on the best market outcome. But nobody can predict the future, and it’s a high-risk strategy.

When seeing stock market charts and business news headlines, it can be tempting to imagine striking it rich by timing investments perfectly. In reality, figuring out when to buy or sell stocks is extremely difficult. Both professional and at-home investors make serious mistakes when trying to time their market entrance or exit.

Why Timing the Stock Market Doesn’t Work

Waiting to start investing could cost an individual thousands of dollars over their lifetime. It’s also important to know that by leaving money in a checking or savings account, a person is not protecting their money from inflation risk. That’s because the value of that cash in a checking or savings account erodes if the prices of goods and services increase.

Meanwhile, stock market timing is incredibly complex. Stock prices can be influenced by global macroeconomic events, political events in a country, developments in specific industries or companies, as well as the sentiment of investors as a collective.

Even professional investors struggle to “beat the market,” which often means simplifying trying to outperform a benchmark stock index. In fact, most investors can’t beat the market, and are likely better off sticking to index investing.

Fear and Greed in Investing

When investing, it’s also important not to let two key emotions – fear and greed – drive decisions. That means if the stock market is plummeting, investors may be fearful, but they can’t let those feelings push them toward a decision to sell. That could cause them to “lock in” losses. There’s even a Fear and Greed Index that investors sometimes use to make contrarian decisions.

Take for instance what happened during the 2008 financial crisis. After Lehman Brothers Holdings Inc. filed for bankruptcy in September 2008, the stock market entered a tumultuous stretch. The S&P 500 finally bottomed on March 9, 2009. However, the index eventually regained all its losses in the course of roughly the next four years. Investors who had hung on likely may have recovered their losses.

Meanwhile, greed can cause investors to make poor decisions as well. For instance, during the dotcom bubble, investors bought into many newly public Internet companies without always doing the research. Some of these stocks weren’t even turning a profit, making their businesses vulnerable to going belly up. Ultimately, many at-home investors suffered losses when the dot-com bubble burst.

Of course there are no guarantees when it comes to investing. There’s always risk and volatility involved. However, one of the most tried and true methods for building wealth has been a buy-and-hold strategy when it comes to stock investing.

💡 Quick Tip: When people talk about investment risk, they mean the risk of losing money. Some investments are higher risk, some are lower. Be sure to bear this in mind when investing online.

Why It May Be a Good Idea to Invest Immediately

One of the most important predictors of your returns is the length of time you’ve invested in the stock market. While it’s difficult to predict what the market will do in the near future, an investor can get a better sense over the long term.

When an investor lets their money grow, it has the chance to weather short-term ups and downs and grow over time. On average, the S&P 500, often used as a market benchmark, has grown 7% a year after adjusting for inflation. That doesn’t mean a person can predict what will happen this year, or even in the next 10 years, but looking at long term trends can give them a better sense of market dynamics.

An individual might put off investing because they want to pay off all debts first or achieve other goals, like buying a house. In some cases, that might be true, like paying off high-interest credit cards or saving for a short-term goal, such as a three to six-month emergency fund.

But once a person has an emergency fund and is out of credit card debt, they should consider investing, even if they have a mortgage or student loan debt. Even if they’re only investing for retirement, it’s a good idea to start as soon as possible.

💡 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.

Consider Investing as Early as Possible

The younger you are when you invest, the better the chances are that you’ll reach your financial goals. For example, imagine Person A invests $200 a month in a retirement account starting at age 25.

Person B invests the same amount starting at age 35. They both continue to add $200 a month to their account. When they both retire at age 65, Person A will have almost twice as much as Person B: $306,689, compared to $167,550, assuming a 6% rate of return, 2% inflation rate, and 15% tax rate.

That’s true even though Person A only contributed 33% more to her account. This is how compound interest grows investments, or the power of how earnings from one’s investments can continue to build wealth.

Percentage of Retail Investors in Stock Market

As mentioned, after the 2008 financial crisis, many people were reluctant to invest in the stock market. But in recent years, that’s changed. Retail investor participation in the U.S. stock market increased considerably in 2020 and 2021, for a variety of reasons.

As of 2023, retail inventors comprise about a quarter of all total trading volume in the stock market. That may change in the future, too, as younger investors – with quicker, easier access to investing tools, in many cases – look at getting into the markets.

The Takeaway

Timing the market is difficult, if not impossible, and involves trying to “time” trading or investing moves to coincide with an increase or decrease in the stock market. Nobody can tell what the future holds, so it’s generally hard to accurately pick the right investments at the right time. That’s not to say that some investors don’t get it right from time to time, but as an overall strategy, it’s likely not advisable.

If an individual is skittish about investing, their anxiety makes sense in light of the dramatic market ups and downs many have witnessed in the past two decades. But trying to time the market doesn’t work. Instead, investing in a diversified portfolio can be a good step toward building individual wealth.

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.

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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.

Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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

SOIN0623021

Sep

2023

Front-Running Explained

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

Front running is when a broker trades a financial asset on the basis of non-public information that will influence the price of the asset in order to profit. In most cases front running is illegal because the broker is acting on information not available to the public markets, for their own gain.

Front running is somewhat different from insider trading, where an individual investor working at a company is able to place a trade based on proprietary information about that company. Insider trading is also illegal.

There is another definition of front running, however, that involves index funds. This type of front running is not illegal.

Key Points

• Front running involves a broker trading a financial asset based on non-public information, typically making it illegal due to unfair market advantage.

• This practice is different from insider trading, although both involve using confidential knowledge for personal profit and are prohibited by regulatory agencies.

• Front running can occur when brokers anticipate significant trades or learn about impactful analyst reports, allowing them to act before the information is public.

• Real-world cases of front running have led to significant penalties, including multi-million dollar fines and prison sentences for those involved in fraudulent trades.

• While most forms of front running are illegal, index front running, which involves publicly announced changes to market indexes, is considered legal and commonly practiced.

What Is Front Running?

In short, front running trading means that an investor buys or sells a security (a stock, bond, etc.) based on advance, non-public knowledge or information that they believe will affect its stock price. Because the information is not widely available, it gives the trader or investor an advantage over other traders and the market at large.

Based on this definition of front running, it’s easy to see how the practice — though illegal — earned its moniker. Traders, making moves based on privately held information, are getting out ahead of a price movement — they’re running out in front of the price change, in a very literal sense.

In addition to stocks, front running may also involve derivatives, such as options or futures.

Again, although front running is technically different from insider trading, the two are quite similar in practice, and both are illegal. Front running is forbidden by the SEC. It also runs afoul of the rules set forth by regulatory groups like the Financial Industry Regulatory Authority (FINRA).

If a trader has inside knowledge about a particular stock, and makes trades or changes their position based on that knowledge in order to profit based on their expectations derived from that knowledge, that’s generally considered a way of cheating the markets.

💡 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.

How Front Running Works

The definition of front running and how it works is pretty straightforward, and there are two main ways front running — also called tailgating — can occur.

• A broker or trader gets wind of a large upcoming trade from one of their institutional clients, and the size of the trade is sure to influence the price.

• Or the broker learns of a specific analyst report about a given security that’s likely going to impact the price.

In either case, the trader gains access to price-relevant information that’s not yet available to the public markets, and the broker is well aware that the upcoming trade will substantially impact the price of the asset. So before they place the trade, they might either buy, sell, or short the asset — depending on the nature of the information at hand — and make a profit as a result.

A Front Running Example

Let’s run through a hypothetical example of how one form of front running may work.

Say there’s a day trader working for a brokerage firm, and they manage a number of client’s portfolios. One of the broker’s clients calls up and asks them to sell 200,000 shares of Company A. The broker knows that this is a big order — big enough to affect Company A’s stock price immediately.

With the knowledge that the upcoming trade will likely cause the stock price to fall, the broker decides to sell some of his own shares of Company A before he places his client’s trade.

The broker makes the sale, then executes the client’s order (blurring the lines of the traditional payment for order flow). Company A’s stock price falls — and the broker has essentially avoided taking a loss in his own portfolio.

He may use the profit to invest in other assets, or buy the newly discounted shares of Company A, potentially increasing his long-term profits essentially by averaging down stocks.

The trader would’ve broken the law in this scenario, breached his fiduciary duties to his client, and also acted unethically.

Recommended: Understanding the Risks of Day Trading

Front Running in the Real World

There are many real-world examples of front running that have led to securities fraud, wire fraud, or other charges. Back in 2009, for instance, 14 Wall Street firms were hit with roughly $70 million in fines by the SEC for front running.

“The SEC charged the specialist firms for violating their fundamental obligation to serve public customer orders over their own proprietary interests by ‘trading ahead’ of customer orders, or ‘interpositioning’ the firms’ proprietary accounts between customer orders,” an SEC release read.

Further research into the topic of front running finds that when people (or firms) have insider knowledge that could benefit them in the markets, they’re likely to use it.

As for another real-world example of front running, there was a case in 2011 involving a large global bank, and some foreign exchange traders who found themselves in hot water. The two traders became privy to a pending order from a client, made some moves to get ahead of it, and ended up making their company money.

It was a $3.5 billion transaction, and by front running the trade, the traders were able to make more than $7 million. It’s not a happy ending, however, the people involved ended up sentenced to prison and ordered to pay hundreds of thousands of dollars in fines.

So, while front running does happen, there can be serious consequences if regulators catch wind of it.

💡 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).

Is Front Running Legal?

No. In almost all cases, front running is illegal.

Are There Times When Front Running Is OK?

Yes, actually. Index front running is not illegal, and is actually fairly common among active investors.

As many investors are aware, index funds track market indexes like the S&P 500 or Dow Jones Industrial Average. These funds are designed to mirror the performance of a market index. And since market indexes are really nothing more than big amalgamations of stocks, they change quite often. Companies are frequently swapped in and out of the S&P 500 index, for instance.

When that happens, the change in an index’s constituents is generally announced to the public, before the swap actually takes place. If a company is being added to the S&P 500, that’s probably considered good news, and can make investors feel more confident in that company’s potential. Conversely, if a company is being dropped from an index, it may be a sign that things aren’t going so well.

That gives some traders an opening to take advantageous positions. Let’s say that an announcement is made that Firm X is being added to the Dow Jones Industrial Average, taking the place of another company. That’s big news for Firm X, and means that it’s likely Firm X’s stock price will go up.

Traders, if they have the right tools, may be able to quickly buy up Firm X shares the next day, and potentially, make a profit if things shake out as expected.

How is this different from regular front running? Because the information was available to the public — there was no secret, insider knowledge that helped traders gain an edge.

The Takeaway

Front-running is the illegal practice of taking non-public information that is likely to impact the price of a certain asset, then placing a trade ahead of that information becoming public in order to profit. Front running is similar to insider trading, although the latter generally involves an individual investor who profits from internal company information.

Fortunately, there are plenty of ways to profit in the markets without resorting to fraudulent activity like front running.

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

FAQ

Why is front-running illegal?

Front running is illegal for a few reasons. First, it’s a form of cheating the market, by using non-public information for a gain. Second, in the case of institutional front running, it’s a violation of a broker’s fiduciary duty to a client.

How can I identify if my trades have been affected by front running?

Unfortunately, owing to the non-public nature of the information that typically leads to front-running, it’s very difficult for individual investors to determine whether or not their own trades have been impacted by a front-running event. Financial institutions have more tools at their disposal to detect incidents of front running.

Are there any technological solutions or tools available to detect and prevent front running?

Yes. With so many traders using remote terminals to place trades since the pandemic, trade surveillance technology and trade reconstruction tools are more important than ever. Fortunately, financial institutions have the resources to employ these tools, and other types of algorithms, to monitor the timing of different trades in order to identify front runners and front running.

Photo credit: iStock/Drazen_

SoFi Invest®

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

How to Read Financial Statements: The Basics

Understanding Each Section of a Financial Statement

Balance Sheet

Income Statement

Cash Flow Statement

Annual Report and 10-K

MD&A

Footnotes

Financial Statement Ratios and Calculations

Debt-to-Equity

Price-to-earnings (P/E)

Return on equity (ROE)

Earnings per share

Current Ratio

Asset turnover

The Takeaway

Understanding the Different Stock Order Types

Stock Order Types Explained

Market Order

Limit Order

Stop Order

Stop-Limit Order

Trailing Stop Loss Order

Bracket Order (BO)

Timing Instructions

Day Orders

Good ‘Til Canceled (GTC)

Immediate or Cancel (IOC)

Fill-Or-Kill (FOK)

All-Or-None (AON)

Which Order Type Is Best?

The Takeaway

FAQ

What is the safest type of stock order to use?

What is the difference between stop-loss vs stop-limit orders?

What is a standard stop-loss rule?

A Guide To Derivatives Trading

What Is a Trading Derivative?

Types of Derivatives

Options

Futures Contracts

Forward Contracts

Is Derivative Trading Profitable?

What Is a Derivative Trading Example?

How Are Derivatives Valued?

How Can Derivatives Be Used to Earn Income?

The Takeaway

Is Stock Market Timing a Smart Investment Strategy?

Why Timing the Stock Market Doesn’t Work

Fear and Greed in Investing

Why It May Be a Good Idea to Invest Immediately

Consider Investing as Early as Possible

Percentage of Retail Investors in Stock Market

The Takeaway

Front-Running Explained

What Is Front Running?

How Front Running Works

A Front Running Example

Front Running in the Real World

Is Front Running Legal?

Are There Times When Front Running Is OK?

The Takeaway

FAQ

Why is front-running illegal?

How can I identify if my trades have been affected by front running?

Are there any technological solutions or tools available to detect and prevent front running?

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