glasses on desk with colored paper

What Is a Direct Consolidation Loan?

A Direct Consolidation Loan combines federal student loans into a single loan with one monthly payment. If you have multiple federal student loans, this could be one way to simplify the repayment process and more easily stay on top of student loan payments. With a Direct Consolidation Loan, you are also eligible for student loan forgiveness and income-driven repayment programs.

A Direct Consolidation Loan, however, doesn’t typically lower your interest rate. Instead, this type of loan is geared toward borrowers who want to streamline their monthly payments or qualify for loan forgiveness, as opposed to borrowers who want to save money on interest.

While consolidation of student loans can lower your monthly payment by extending your repayment timeline, you typically end up paying more overall due to the additional interest you pay when lengthening your loan term. Before you commit, make sure to run the numbers and consider the pros and cons of a Direct Consolidation Loan.

Is a Direct Consolidation Loan a Good Idea?

Deciding if student loan consolidation is right for you depends on whether your desire to simplify your payments outweighs the potential loss of some benefits.

Pros of Direct Consolidation Loans

Can simplify repayment: The first thing to consider is if you currently have multiple federal student loans with different servicers, meaning you have to log in to two or more separate accounts to pay your student loan bills each month. In this instance, consolidation can make life a little easier because the process will give you a single loan with a single bill each month.

Can lower your monthly payments: Consolidation can also lower your monthly payment amount by giving you up to 30 years to repay your loan or by giving you access to income-driven repayment plans. Keep in mind, though, that by extending your loan term and reducing your monthly payment, you will end up paying more in interest over the life of the loan.

Can allow you to switch from a variable to a fixed rate: If you have any variable-rate loans, consolidation will make it so you can switch to a fixed interest rate.

Can make loans eligible for forgiveness: If you consolidate loans other than Direct Loans, such as Perkins Loans (drawn before the program was discontinued), those loans may become eligible for Public Service Loan Forgiveness (PSLF) once consolidated.

Recommended: Fixed vs. Variable Rate Loans

Cons of Direct Consolidation Loans

Can lead you to make more payments and pay more in interest: When you consolidate your federal loans, your repayment period will be extended between 10 and 30 years. This means you will make more payments and pay more in interest, unless you switch to a different student loan repayment plan.

Can make you lose some benefits: Consolidation can also cost you some benefits that only non-consolidated loans are eligible for, such as access to some loan cancellation options. It’s a good idea to check in with your loan program before opting for a Direct Consolidation Loan.

Can cause you to lose credit for payments toward loan forgiveness: One of the most important things to consider before consolidating student loans is that if you are currently paying your loans using an income-driven repayment plan or have already made qualifying payments toward PSLF, consolidating your loans will result in the loss of credit for payments already made toward loan forgiveness. However, there is now a one-time income-driven repayment account adjustment that allows borrowers to not lose credit from past payments if they choose to consolidate their loans.

How to Apply for a Federal Direct Consolidation Loan

The Direct Consolidation Loan application process is available through StudentLoans.gov and comes with no fees. You simply fill out the online application or you can print out a paper version and mail it. The entire online application process takes less than 30 minutes, on average.

Almost all federal student loans are eligible for consolidation. If you have private education loans, you cannot consolidate them with your federal loans. Also note that you can’t consolidate your loans while in school and must graduate, leave school, or drop below half-time enrollment in order to pursue consolidation. Parent PLUS Loans cannot be consolidated with loans in the student’s name.

You can also select which loans you do and do not want to consolidate on your loan application. For instance, if you have a loan that will be paid off in a short amount of time, you might consider leaving it out of the consolidation.

Remember to keep making payments on your loans during the application process until you are notified that they have been paid off by your new Direct Consolidation Loan. Your first new payment will be due within 60 days of when your Direct Consolidation Loan is paid out.

Repayment Plans for Consolidation Loans

A Direct Consolidation Loan will have a fixed interest rate that is the weighted average of all of the interest rates for the loans you are consolidating, rounded up to the nearest one-eighth of a percent. This means that the interest rate on your largest loan will have the most impact on your consolidation interest rate, whether that interest rate is high or low.

When you apply for a Direct Consolidation Loan, you must also be prepared to select a repayment plan. Many repayment plans are available for Direct Consolidation Loans, including:

•   Standard Repayment Plan

•   Graduated Repayment Plan

•   Extended Repayment Plan

•   Revised Pay As You Earn Repayment Plan (REPAYE)

•   Pay As You Earn Repayment Plan (PAYE)

•   Income-Based Repayment Plan (IBR)

•   Income-Contingent Repayment Plan (ICR)

Recommended: What Student Loan Repayment Plan Should You Choose? Take the Quiz

Consolidation for Defaulted Student Loans

Consolidation can also help student loans that are currently in default. Student loans will go into default after 270 days without payment, which can result in consequences and loss of benefits, such as damaging your credit score or possible wage garnishment.

Since loans in default are accelerated and the entire unpaid balance becomes due when you enter default, consolidation is worth considering since it allows you to pay off one or more federal student loans with the new Direct Consolidation Loan.

Once your consolidated loan is out of default, you can repay the Direct Consolidation Loan under an income-driven repayment plan or make three consecutive payments. Direct Consolidation Loans are eligible for benefits such as student loan deferment, forbearance, and loan forgiveness.

Refinancing vs Consolidation for Student Loans

For those interested in a better interest rate or more favorable loan terms, you could consider refinancing your student loans instead of consolidating them. Unlike consolidation, refinancing can combine both federal student loans and private student loans into one new loan with one monthly payment.

Keep in mind that refinancing can result in the loss of federal benefits since you’re working with a private company and not the government. If you plan on using income-driven repayment plans or student loan forgiveness, for example, it is not recommended to refinance with a private lender. However, for someone looking for lower interest rates or lower monthly payments, refinancing is an option to consider.

The Takeaway

A Direct Consolidation Loan combines your federal loans into one new loan with one monthly payment. Pros may include lowering your monthly payments, allowing you to switch from a variable to a fixed interest rate, and making certain loans eligible for forgiveness. The major con of Direct Consolidation Loans is possibly paying more in interest over the life of the loan due to the extension of your loan term.

If the idea of consolidation appeals to you but the weighted consolidation interest rate won’t save you much over the life of your loan, you could consider applying for student loan refinancing with SoFi. SoFi offers an easy online application, competitive rates, and flexible terms. But remember, refinancing makes it so you’re no longer eligible for federal benefits.

See if you prequalify with SoFi in just two minutes.


SoFi Student Loan Refinance
If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.


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


Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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

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unicorns eggshells

What Are Unicorn Companies?

Unicorns are private companies with valuations of $1 billion or more. The term was coined by venture capitalist Aileen Lee in her 2013 piece “Welcome to the Unicorn Club: Learning From Billion-Dollar Startups.” She used the word “unicorn” in order to convey the rarity of startups that hit the $1 billion mark.

When Lee came up with the term, she counted 39 unicorns in the U.S. It was still considered exceptional for a private company to grow to that size without having an initial public offering or IPO. These days, a combination of trends — companies staying private longer, widespread technological changes, and abundant money in capital markets — has enabled the creation of numerous unicorns.

Top 10 Most Valuable Unicorns

As of July 2023, there are over 1,200 unicorns worldwide, with a cumulative business valuation of $ $3.84 trillion, according to research by CB Insights, a business analytics platform.

Unicorns can be exciting for investors because they can represent rapid — even seemingly magical — growth. But are unicorns actually good investments? It’s important for investors to remember that these companies haven’t yet come under the scrutiny of public markets.

Below is a chart of the unicorn companies with the highest valuations, according to CB Insights, as of May 2023.

Company

Valuation

Date Added

Country

Industry

Bytedance $225 billion 4/7/2017 China A.I.
SpaceX $137 billion 12/1/2012 U.S. Space
SHEIN $66 billion 7/3/2018 China eCommerce
Stripe $50 billion 1/23/2014 U.S. Fintech
Canva $40 billion 1/8/2018 Australia Internet software & svcs.
Revolut $33 billion 4/26/2018 U.K. Fintech
EpicGames $31.5 billion 10/26/2018 U.S. Other
Databricks $31 billion 2/5/2019 U.S. Data management
Fanatics $31 billion 6/6/2012 U.S. eCommerce

Source: CB Insights

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Characteristics of Unicorn Companies

The rapid increase in the number of unicorns has meant that these companies come from a range of industries or sectors, and geographics. Answers to questions like ‘How old are these companies?’ and ‘Who are the founders?’ have also started to vary. Let’s look at some broad-stroke trends.

Unicorns by Industry

According to Embroker, an insurance brokerage, the bulk of unicorns come from seven sectors: e-commerce, fintech, internet software, AI, healthcare, travel technology, and education technology.

Unicorns by Geography

While the Bay Area’s Silicon Valley is still synonymous with startups, a greater number of unicorn businesses have sprung from elsewhere.

Cities Home to Most Unicorns, as of May 2023

City

Number of Unicorns

San Francisco 64
Beijing 51
New York 34
Shanghai 27
London 15
Hangzhou 13
Shenzhen 13
Boston 10

Source: Statista, CB Insights

Other Traits of Unicorns

Lately, U.S. unicorns have tended to be older when they enter the stock market. When Aileen Lee coined the term in 2013, the median age of a tech IPO company was nine years, data from University of Florida shows. Going back further in time, during the height of the dot-com bubble in 1999, the median age was four years. Fast forward to 2023, and the median age has jumped to 12.5 years.

When it comes to profitable businesses, though, the number has dwindled. According to Statista’s most current research, as of June 30, 2022: “The share of companies in the United States which were profitable after their IPO has been decreasing year-on-year over the past decade from a peak of 81% in 2009. In 2021, only 28 percent of companies were profitable after their IPO.”

When it comes to who’s founding these unicorns, there has been some increase in diversity. Back in 2012 or 2013, when Aileen Lee did her initial IPO research, no unicorns had female founding CEOs. However, by 2019, 21 startups founded or co-founded by a woman became unicorns.

Why Are There So Many Unicorns?

There are several reasons behind the proliferation of unicorn companies. Here are a couple.

1.    Expansion of Private Markets: As mentioned above, companies are waiting longer before they go public. Part of the reason for that has been that private investments have exploded. Startups can continue to get investments from venture-capital firms (VCs) and private-equity funds in their later stages, and some prefer that option over the risky, complex process of having an IPO.

2.    Sweeping Technological Change: Significant innovations — such as the rise of social media, smartphones and cloud computing — fueled growth in many unicorns. For example, the iPhone debuted in 2007, while the first Android hit the market in 2008. These events led to businesses that operate mobile apps or capitalize on smartphones to drive up sales.

3.    Well-Funded Capital Markets: Since the 2008-2009 financial crisis, growth in the economy has been sluggish. That’s meant central banks worldwide have kept monetary policies easy, injecting capital into markets that have found their way into fledgling companies.

Meanwhile, tech investing has been one of the few bright spots for investors hungry for growth opportunities, driving up startup valuations.

How Do Unicorns Get Valued?

Many startups — even ones of unicorn size — are unprofitable. Investors put in money under the assumption that profits will eventually come, and that’s why businesses may rely on longer-term forecasting. Similar to how it works when it comes to growth vs. value stocks, valuation metrics like price-to-sales ratios may be used in order to measure the company’s worth.

Investors may also come up with valuations by comparing unlisted firms with similar businesses that are publicly traded. Hence, a rising stock market may also lead to higher valuations for privately held companies.

However, an academic study updated in January 2020 concluded that out of 135 venture-backed unicorns, 48% were overvalued on average, with 14 being 100% above fair value. That means around half of these supposed unicorns aren’t actually unicorns.

How to Invest in Unicorns

Accredited investors — those with $200,000 in annual income or $1 million in assets — can get exposure to unicorns by putting money into venture-capital funds: capital pools that invest in private companies. In recent years, because of the soaring success of some unicorns, they’ve attracted not just venture-capitalists, but also hedge funds, asset-management firms like mutual funds as well as sovereign wealth funds.

When it comes to exiting unicorn investments, a Crunchbase article pointed out that the majority of unicorns — two-thirds over a five-year period — conducted an IPO, giving their investors the opportunity to cash out. But in 2020, the majority of unicorn exits have been through acquisitions.

Can Average Investors Invest in Unicorns?

Unicorns don’t generally accept modest investments from individual or retail investors.

Jay Clayton, former chairman of the Securities and Exchange Commission, argued that smaller investors should get access to private-market investments. The fact that companies are staying private for longer has also made it true that individual investors are missing out more on businesses in their early stages.

But skeptics say private markets don’t have the same disclosure requirements that public markets require, a situation that could leave retail investors in the dark about a company’s financials and increase the risk of fraud. Mutual funds can put up to 15% of assets in illiquid assets, but often they don’t allocate that much to private companies since these investments are tougher to sell.

Deep-pocketed retail investors can get in early with some startups via angel investing — when individuals provide funding to very young businesses. But these businesses tend to have valuations nowhere near $1 billion.

💡 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.

Risks of Investing in Unicorns

Not all unicorns successfully transition into stock market stars. Some see their valuations dip in late private funding rounds. Some have even scrapped IPO plans at the last minute. Others disappoint after their debut in the public markets, finding that first-day pop in trading elusive or underperforming in the weeks after the IPO.

How do you know whether a unicorn is destined to be the next market darling or flame-out? There is no way to know for sure, but there are a number of risks when it comes to unicorn investing. Here are some:

•   Lack of Profitability: Many unicorns offer deeply discounted services in order to supercharge growth. While venture capitals are used to subsidizing startups, public market investors may be tougher on unprofitable businesses.

•   Market Competition: No matter how great an idea is and how much funding they bring in, there are always competitors. If another company has superior marketing, more users and higher sales, this may not bode well for a unicorn.

•   Consumer/Business Need: Just because a founder has a cool idea and they can build it, doesn’t mean anybody will spend money on it.

•   Management Team: Who are the company’s founders, and what is the culture they are creating at their startup? Many startups fail, and a founder’s management style and lack of experience can be cited as major reasons why.

•   Regulatory Changes: Some unicorns represent new business models or disrupt existing industries. Such changes may come with regulatory oversight that makes operating difficult.

Alternative to Unicorns in Startup Terminology

The surge in private-market tech investing has led to a new vernacular that’s specific to startup valuations. Here’s a table that covers some popular lingo.

List of Unicorn Terminology

Startup Term

Definition

Pony Company worth less than $100 million
Racehorse Company that became unicorns very quickly
Unitortoise Company that took a long time to become a unicorn
Narwhal Canadian company with a valuation of at least $1 billion
Minotaur Company that has raised $1 billion or more in funding
Undercorn Company that reached a $1 billion valuation then fell below it
Decacorn Company with a valuation of at least $10 billion
Hectocorn Company with a valuation of at least $100 billion
Dragon Company that returns an entire fund, meaning the single investment paid off as much as a diversified portfolio

The Takeaway

While they started out as rarities, unicorns have since multiplied. And now a herd founded over the past decade is headed for the stock market.

For investors, unicorn companies may appear to be a good way to diversify and get access to a high-growth business. But it’s important to remember that many unicorns are unprofitable businesses that secure $1 billion valuations by making very long-term projections. Plus, financial information isn’t as readily available as for a company that’s already listed.

It’s important to look closely at a new company’s management team, history, as well as financials before investing in it. Whether you’re a new or seasoned investor, researching which stocks to buy and when to buy them can be time-consuming and challenging.

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.


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.

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

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How to Use a Trailing Stop Loss Properly

How to Use a Trailing Stop-Loss Properly

A trailing stop loss allows investors to create a built-in safety mechanism to insulate themselves against downward pricing trends. It’s an important exit strategy that day traders can use to manage their risk.

Understanding how a trailing stop order works and how to use it properly can help cap potential losses when day trading investments.

What Is a Trailing Stop-Loss?

A trailing stop-loss offers a flexible approach to minimizing investment losses. A trailing stop order trails the price of the underlying investment by a percentage or a specific dollar amount. So, if an investor buys shares at $50 each, they might impose a trailing stop limit of 10%. If the stock’s share price dipped by 10% they’d be sold automatically.

To understand trailing stop-loss, it helps to have a basic understanding of how limit orders and stop orders work.

A limit order is an order to buy or sell a security once it reaches a specific price. If the order is to buy, it only gets triggered at or below the limit price. If the order is to sell, the order can only get executed at or above the limit price. Limit orders are typically filled on a first-come, first-served basis in the market.

A stop order, also referred to as a stop-loss order (yet another of the stock order types), is also an order to buy or sell a particular investment. The difference is that the transaction occurs once a security’s market price reaches a certain point. For example, if you buy shares of stock for $50 each, you might create a stop order to sell those shares if the price dips to $40. Once a stop or limit order is executed, it becomes a market order.

Stop orders help you either lock in a set purchase price for an investment or cap the amount of losses you incur when you sell if the security’s price drops. While you can use them to manage investment risk, stop orders are fixed at a certain share price.

💡 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.

How a Trailing Stop Order Works

Using a trailing stop to manage investments can help you capitalize on stock market movements and momentum. You determine a preset price at which you want to sell a stock, based on how a particular investment is trending, rather than pinpointing an exact dollar amount.

You can decide where to set a trailing stop limit, based on your risk tolerance and what you expect an investment to do over time. What remains consistent is the percentage by which you can control losses as the investment’s price changes.

Example

So, assume that you purchase 100 shares of stock at $50 each. You set a trailing stop order at 10%. If the share price dips to $45, which reflects a 10% loss, those shares would be sold automatically capping your total loss on the investment at $500.

Now, assume that the stock takes off instead and the share price doubles to $100 with the same 10% trailing stop in place. Your stop order would only be triggered if the stock’s price falls to $90. If you had set a regular stop order at $40 instead, there’d be a much wider margin for losses since the stock’s price has further to fall before shares would be sold. Thus, trailing stops enhanced downside protection compared to a regular stop order.

3 Advantages of Using a Trailing Stop Order

There are several benefits that come with using a trailing stop limit to manage your investments.

1. Tandem Movements

First, trailing stops move in tandem with stock pricing. As a stock’s per share price increases, the trailing stop follows. In the previous example, when the stock’s price doubled from $50 to $90, the trailing stop price moved from $45 to $90. In effect, it’s a hands-off tool — which can be great for some investors.

2. Confidence

Implementing a trailing stop limit strategy can offer reassurance since you know shares will be sold automatically if the stop order is triggered. That can offer investors some confidence in what may be a chaotic market environment. That, for many, can be very valuable.

3. Take Emotion Out of the Equation

Trailing stop limits rely on math rather than emotions when making decisions. That can also help you avoid the temptation to try to time the market and either sell too quickly or hold on to a stock too long, impacting your profit potential.


💡 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.

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How Do You Set up a Trailing Stop Order?

If you’re day trading online, it’s relatively simple to set up a trailing stop loss order for individual securities. Because the orders are flexible, you can choose where you want to set the baseline percentage at which stocks should be sold. For example, if you’re less comfortable with risk you might set a trailing stop at 5% or less. But if you’re a more aggressive portfolio, you may bump the order up to 20% or 30%.

You can also control whether you want buy or sell actions to happen automatically or whether you want to place trades manually. Automating ensures that the trades happen as quickly as possible, but performing them manually may be preferable if you’re more of a hands-on trader.

Example of a Trailing Stop-Loss Order

Though we’ve already given some quick examples of how a trailing stop-loss order might work in a practical sense, let’s run through it again.

Say that you buy 100 shares of Company A stock for $10. You set up a trailing stop-loss order at 10%, meaning that if Company A stock falls to $9 or below, a sell order will automatically be executed. The next week, Company A stock’s value rises to $12 — the trailing stop loss order follows. The week after, Company A’s stock loses 15% of its value, falling from $12 to $10.20.

The stop-loss order kicked in when the stock lost 10%, so your shares were sold at $10.80, saving you $0.60 per share, for a total of $60.

Again, this can be helpful if investors want to “lock in” their gains and cash out stocks with a positive return.

Are There Any Downsides of Using a Trailing Stop?

Investing is risky by nature, and no strategy is foolproof. While trailing stops can help minimize losses without placing a cap on profits, there are some downsides to consider.

Accessibility

Depending on which brokerage account you’re using, you may face limits on which investments you can use trailing stop loss strategy with. Some online brokerages don’t allow any type of stop loss trading at all.

Potential to Lock-in Losses

If a stock you own experiences a two-day slide in price, your stop loss order might require your shares be sold. If on the third day, the stock rebounds with a 20% price increase, you’ve missed out on those gains and locked in your losses. If you want to repurchase the stock you’ll now have to do so at a higher price point, and you’ve missed your chance to buy the dip.

Velocity Challenges

If share prices drop too quickly there may be some lag time before your trailing stop order can be fulfilled. In that scenario, you might end up incurring bigger losses than expected, regardless of where you placed your stop price limit.

No Market for the Security

It’s possible an investor finds themselves holding a stock that nobody wants — meaning that it has no liquidity, and can’t be traded. This is unlikely, but in this case, a stop-loss order couldn’t execute as there’s no one to trade with.

Market Closure

If you’ve set up trailing stop-loss orders, they can’t and won’t execute when the market is closed. Security prices can go up and down after-hours, but market orders can only be executed during normal operating hours for stock exchanges.

Using a market-on-open order may be another tool to consider if investors are concerned about this scenario.

Gaps

On the same note as market closures, pricing gaps — which may occur due to after-hours pricing movements, for instance — can and do occur. A stop-loss order may not help in those cases, and investors may lose more than anticipated as a result.

How to Use a Trailing Stop-Loss Strategy

Using trailing stops is better suited as part of a short-term trading strategy, rather than long-term investing. Buy-and-hold investors focused on value don’t need to worry as much about day-to-day price movements.

With that in mind, there are a few things to consider before putting trailing stop orders to work. A good starting point is your personal risk tolerance and the level of loss you’d be comfortable accepting in your portfolio. This can help determine where to set your trailing stop loss limit.

Again, if you’re a more conservative investor then it might make sense to set the percentage threshold lower. But if you have a larger appetite for risk, you could go higher. You can also tailor thresholds to individual investments to balance out your overall risk exposure.

Technical Indicators

Becoming familiar with technical indicators could help you become more adept at reading the market so you can better gauge where to set trailing limits. Unlike fundamental analysis, technical analysis primarily focuses on decoding market signals regarding trends, momentum, volatility and trading volume.

This means taking a closer look at a security’s price movements and understanding how it’s trending. One indicator you might rely on is the Average True Range (ATR). The ATR measures how much a security moves up or down in price on any given day. This number can tell you where to set your trailing loss limit based on whether price momentum is moving in your favor.

In addition to ATR you might also study moving averages and standard deviation to understand where a stock’s price may be headed. Moving averages reflect the average price of a security over time while standard deviation measures volatility. Considering these variables, along with your risk tolerance and overall investment goals, can help you use trailing losses in your portfolio correctly.

Applying Your Stock Trading Knowledge With SoFi

Whether you plan to use trailing stop strategies in your portfolio or not, making sure you’re working with the right brokerage matters. Ideally, you’re using an online brokerage that offers access to the type of securities you want to invest in with minimal fees so you can keep more of your portfolio gains.

Keep in mind, though, that utilizing stop-loss orders isn’t foolproof, and that there can be pros and cons to doing so. It’s also a somewhat advanced tool to incorporate into your strategy — if you don’t feel like you fully understand it, it may be worth discussing with a financial professional.

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

How does a trailing stop-loss work?

A trailing stop-loss is a built-in mechanism that automatically sells an investor’s holdings when certain market conditions are met — specifically, when a stock loses a predetermined amount of value.

What is a disadvantage of a trailing stop-loss?

There are several potential disadvantages to using trailing stop-losses, including the fact that they won’t execute during market closures. Securities may lose value during that time, and traders could experience a pricing gap as a result.

What is a good trailing stop-loss percentage?

A good stop-loss percentage will depend on the individual investor’s risk tolerances, but many investors would likely be comfortable with a 5% or 10% trailing stop-loss.


Photo credit: iStock/akinbostanci

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.

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 $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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What Is the Spot Market & How Does It Work?

The spot market of a commodity is a market where buyers meet sellers and make an immediate exchange. In other words, delivery takes place at the same time payment is made. This is the simplest spot market definition available.

Commodity markets are somewhat different from the markets for stocks, bonds, mutual funds, and ETFs, all of which trade exclusively through brokerages. Because they represent a physical good, commodities have an additional market — the spot market. This market represents a place where the actual commodity gets bought and sold right away.

Spot Markets Definition

If you’re trying to define the spot markets, it may be helpful to think of it as a public financial market, and one on which commodities are bought and sold. They’re also bought and sold for immediate, or quick, delivery. That is, the asset being traded changes hands on the spot.

Prices quoted on spot markets are called the spot price, naturally.

One example of a spot market is a coin shop where an individual investor goes to buy a gold or silver coin. The prices would be determined by supply and demand. The goods would be delivered upon receipt of payment.

Understanding Spot Markets

Spot markets aren’t all that difficult to understand from a theoretical standpoint. There can be a spot market for just about anything, though they’re often discussed in relation to commodities (perhaps coffee, corn, or construction materials), and specific things like precious metals.

But again, an important part of spot market transactions is that trades take place on the spot — immediately.

Which Types of Assets Can Be Found on Spot Markets

As noted, all sorts of assets can be found on spot markets. That ranges from food items or other consumables, construction materials, precious metals, and more. If you were, for instance, interested in investing in agriculture from the sense you wanted to trade contracts for oranges or bananas, you could likely do so on the spot market.

Some financial instruments may also be traded on spot markets, such as Treasurys or bonds.

How Spot Market Trades Are Made

In a broad sense, spot market trades occur like trades in any other market. Buyers and sellers come together, a price is determined by supply and demand, and trades are executed — usually digitally, like most things these days. In fact, a spot market may and often does operate like the stock market.

You may be surprised to learn that stock markets are, in fact, spot markets, with financial securities trading hands instantly (in most cases).

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

What Does the Spot Price Mean?

As mentioned, the spot price simply refers to the price at which a commodity can be bought or sold in real time, or “on the spot.” This is the price an individual investor will pay for something if they want it right now without having to wait until some future date.

Because of this dynamic, spot markets are thought to reflect genuine supply and demand to a high degree.

The interplay of real supply and demand leads to constantly fluctuating spot prices. When supply tightens or demand rises, prices tend to go up, and when supply increases or demand falls, prices tend to go down.

The Significance of a Spot Market

The spot market of any asset holds special significance in terms of price discovery. It’s thought to be a more honest assessment of economic reality.

The reason is that spot markets tend to be more reliant on real buyers and sellers, and therefore should more accurately reflect current supply and demand than futures markets (which are based on speculation and can be manipulated, as recent legal cases have shown. More on this later.)

Types of Spot Markets

There’s only one type of spot market — the type where delivery of an asset takes place right away. There are two ways this can happen, however. The delivery can take place through a centralized exchange, or the trade can happen over the counter.

Over-the-counter

OTC trades are negotiated between two parties, like the example of buying coins at a coin shop.

Market Exchanges

There are different spot markets for different commodities, and some of them work slightly differently than others.

The spot market for oil, for example, also has buyers and sellers, but a barrel of oil can’t be bought at a local shop. The same goes for some industrial metals like steel and aluminum, which are bought and sold in much higher quantities than silver and gold.

Agricultural commodities like soy, wheat, and corn also have spot markets as well as futures markets.

Spot Market vs Futures Market

One instance that makes clear the difference between a spot market and a futures market is the price of precious metals.

Gold, silver, platinum, and palladium all have their own spot markets and futures markets. When investors check the price of gold on a mainstream financial news network, they are likely going to see the COMEX futures price.

COMEX is short for the Commodity Exchange Inc., a division of the New York Mercantile Exchange. As the largest metals futures market in the world, COMEX handles most related futures contracts.

These contracts are speculatory in nature — traders are making bets on what the price of a commodity will be at some point. Contracts can be bought and sold for specific prices on specific dates.

Most of the contracts are never delivered upon, meaning they don’t involve delivery of the actual underlying commodity, such as gold or silver. Instead, what gets exchanged is a contract or agreement allowing for the potential delivery of a certain amount of metal for a certain price on a certain date.

For the most part, futures trading only has two purposes: hedging bets and speculating for profits. Sophisticated traders sometimes use futures to hedge their bets, meaning they purchase futures that will wind up minimizing their losses in another bet if it doesn’t go their way. And investors of all experience levels can use futures to try to profit from future price action of an asset. Predicting the exact price of something in the future can be difficult and carries high risk.

The spot market works in a different manner entirely. There are no contracts to buy or sell and no future prices to consider. The market is simply determined by what one party is willing to purchase something for.

Spot Market vs Futures Market

Spot Market

Futures Market

No contracts to buy or sell Contracts are bought and sold outlining future prices
Trades occur instantly Trades may never actually occur at all
Non-speculative Speculative by nature

Another important concept to understand is contango and backwardation, which are ways to characterize the state of futures markets based on the relationship between spot and future prices. Some background knowledge on those concepts can help guide your investing strategy.

Note, too, that some investors may be confused by the concepts of margin trading and futures contracts. Margin and futures are two different concepts, and don’t necessarily overlap.

💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

Example of a Spot Market

Consider the spot and futures markets for precious metals.

Precious-metal prices that investors see on financial news networks will most often be the current futures price as determined by COMEX. This market price is easy to quote. It’s the sum of all futures trading happening on one central exchange or just a few central exchanges.

The spot market is more difficult to pin down. In this case, the spot market could be generally referred to as the average price that a person would be willing to pay for a single ounce of gold or silver, not including any premiums charged by sellers.

Sometimes there is a difference between prices in the futures market and spot market. The difference is referred to as the “spread.” Under ordinary circumstances, the difference will be modest. During times of uncertainty, though, the spread can become extreme.

Futures Market Manipulation

To fully answer the question “What does the spot price mean?” it’s important to include one final note on futures markets. This will illustrate a key difference between the two markets.

Recent high-profile cases brought by government enforcement agencies like the Securities and Exchange Commision and Commodities and Futures Trading Commission highlight the susceptibility of futures markets to manipulation.

Some large financial institutions have been convicted of engaging in practices that artificially influence the price of futures contracts. Again, we can turn to the precious-metals markets for an example.

During the third quarter of 2020, JP Morgan was fined $920 million for “spoofing” trades in the gold and silver futures markets and lying about it to COMEX.

Spoofing involves creating large numbers of buy or sell orders with no intention of fulfilling the orders.

Because order book information is publicly available, traders can see these orders, and may act on the perception that big buying or selling pressure is coming down the pike. If many sell orders are on the books, traders may sell, hoping to get ahead of the trade before prices fall. If many buy orders are on the books, traders may buy, thinking the price is going to rise soon.

Cases like this show that futures markets can be heavily influenced by market participants with the means to do so.

Spot markets, on the other hand, are much more organic and more difficult to manipulate.

3 Tips for Spot Market Investing

For those interested in trying their hand in the spot market, here are a few things to keep in mind.

1. Know What’s Going On

Often, prices in the spot market can change or be volatile in relation to the news or other current events. For that reason, it’s important that investors know what’s happening in the world, and use that to assess what’s happening with prices for a given asset or commodity.

2. Keep Your Emotions in Check

Emotional investing or trading is a good way to get yourself into financial trouble, be it in the spot market, or any other type of trading or investing. You’d likely do well to keep your emotions in check when trading or investing on the spot market, as a result.

3. Understand the Market

It’s also a good idea to do some homework and make a solid attempt at trying to understand the market you’re trading in. There may be jargon to learn, terms to understand, price discovery mechanisms that could otherwise be foreign to even a seasoned investor — do your best to do your due diligence.

Spot-on Investing

Spot markets are where commodities are traded, instantly. There are numerous types of spot markets, and there are numerous types of commodities that might be traded on them. Investors would be wise to know the basics of how they work, and come armed with a bit of background knowledge about the given commodity they’re trading, in order to reach their goals.

Spot market trading can be a part of an overall trading strategy, but again, investors should know the ropes a bit before getting in over their heads. It may be a good idea to speak with a financial professional before investing.

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 is spot market vs a futures market

Trades on a spot market occur instantly, on the spot. Trades in the futures market involve contracts for commodities with prices outlined for some time in the future — if they occur at all.

What does spot market mean?

The term spot market refers to a financial market where commodities are bought and sold by traders. The trades occur on the spot, or instantly, for immediate delivery.

What is the difference between spot market and forward market?

Forward markets involve trading of futures contracts, or transactions that take place at some point in the future, whereas spot market trades occur instantly, often for cash.


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.

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 $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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Guide to Yield to Maturity (YTM)

When investors evaluate which bonds to buy, they often take a look at yield to maturity (YTM), the total rate of return a bond will earn over its life, assuming it has made all interest payments and repaid the principal.

Calculating YTM can be complicated. Doing so takes into account a bond’s face value, current price, number of years to maturity and coupon, or interest payments. It also assumes that all interest payments are reinvested at a constant rate of return. With these figures in hand, they will be better equipped to understand the bond market and which bonds will offer the greatest yield if held to maturity.

What Is Yield to Maturity (YTM)?

The yield to maturity (YTM) is the estimated rate investors earn when holding a bond until it reaches maturity or full value. The YTM is stated as an annual rate and can differ from the stated coupon rate.

The calculations in the yield to maturity formula include the following factors:

•   Coupon rate: Also known as a bond’s interest rate, the coupon rate is the regular payment issuers pay bondholders for the right to borrow their money. The higher the coupon rate, the higher the yield.

•   Face value: A bond’s face value, or par value, is the amount paid to a bondholder at its maturity date.

•   Market price: A bond’s market price refers to how much an investor would have to pay for a bond on the open market currently. The price buyers pay on the secondary market may be higher or lower than a bond’s face value. The higher the price of the bond, the lower the yield.

•   Maturity date: The date when the issuer repays the principal is known as the maturity date.

The YTM formula assumes all coupon payments are made as scheduled, and most calculations assume interest will be reinvested.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Get up to $1,000 in stock when you fund a new Active Invest account.*

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*Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

How to Calculate Yield to Maturity

Calculating yield to maturity can be done by following a formula — but fair warning, it’s not simple arithmetic!

Yield to Maturity (YTM) Formula

To calculate yield to maturity, investors can use the following YTM formula:

yield to maturity formula

In this calculation:

C = Interest or coupon payment
FV = Face value of the investment
PV = Present value or current price of the investment
t = Years it takes the investment to reach the full value or maturity

Example of YTM Calculation

Here’s an example of how to use the YTM formula.

Suppose there’s a bond with a market price of $800, a face value of $1,000, and a coupon value of $150. The bond will reach maturity in 10 years, with a coupon rate of about 14%.

By using this formula, the estimated yield to maturity would calculate as follows:

example of yield to maturity formula

The Importance of Yield to Maturity

Knowing a bond’s YTM can help investors compare bonds with various maturity and coupon rates, and ultimately, what their dividend yield could look like. For example, consider two bonds of varying maturity: a five-year bond with a 3% YTM and a 10-year bond with a 2.5% YTM. Investor’s can easily see that the five-year bond is more valuable.

YTM is particularly useful when attempting to compare older bonds sold in a secondary market, which can be priced at a premium or discounted — meaning they cost more or less than the bond’s face value. Understanding the YTM formula also helps investors understand how market conditions can impact their portfolio based on the investment they select. Since yields rise when prices drop (and vice versa) as seen on a yield curve, investors can forecast how their investment will perform.

Additionally, YTM can help investors understand how likely they are to be affected by interest rate risk — the danger that the value of a bond may be adversely affected due to the changes in interest rate. Current YTM is inversely proportional to interest rate risk. That means, the higher the YTM, the less bond prices will be affected should interest rates change, in theory.

Yield to Maturity vs Yield to Call

With a callable, or redeemable bond, issuers can choose to repay the principal amount before the maturity date, halting interest payments early. This throws a bit of a wrench into the YTM calculation. Instead, investors may want to use a yield to call (YTC) calculation. To do so, they can use the YTM calculation, substituting the maturity date for the soonest possible call date.

Typically a bond issuer will call a bond only if it will result in a financial gain. For example, if the interest rate drops below a coupon rate, the issuer may decide to recall the bond to borrow funds at a lower rate. This situation is similar to when interest rates drop and homeowners refinance their home loans.

For investors that use callable bonds for income, yield to call is significant. Suppose the issuer decides to call the bond when the interest rates are lower than when the investor purchases it. If an investor decides to reinvest their payout, they may have a tough time finding a comparable bond that offers the yield they need to support their lifestyle. They may feel it necessary to take on more risk, looking to high-yield bonds.

💡 Quick Tip: It’s smart to invest in a range of assets so that you’re not overly reliant on any one company or market to do well. For example, by investing in different sectors you can add diversification to your portfolio, which may help mitigate some risk factors over time.

Yield to Maturity vs Coupon Rate

While a bond’s coupon rate is another important piece of information that investors need to keep in mind, it’s not the same as yield to maturity. The coupon rate tells investors the annual amount of interest that a bond’s owner is set to receive — the two may be the same when a bond is initially purchased, but will likely diverge over time due to changing economic and market conditions.

Limitations of Yield to Maturity

The yield to maturity calculation does have limitations.

Taxes

It’s important to note that YTM calculations exclude taxes. While some bonds, like municipal bonds and U.S. Treasury bonds, may be tax exempt on a federal and state level, most other bonds are taxable. In some cases, a tax-exempt bond may have a lower interest rate but ultimately offer a higher yield once taxes are factored in.

As an investor, it can be especially helpful to consider the after-tax yield rate of return. For example, suppose an investor in the 35% federal tax bracket who doesn’t pay state income taxes is considering investing in either Bond X or Bond Y. Bond X is a tax-exempt bond and pays a 4% interest rate, while Bond Y is taxable and pays 6% interest.

While the 4% yield for Bond X remains the same, the after-tax yield for Bond Y is 3.8%. While it seemed like the less lucrative of the two options up front, Bond X should ultimately yield a higher return after taxes.

Presuppositions

Another YTM limitation is that it makes assumptions about the future that may not necessarily come to fruition. Specifically, it assumes that a bondholder will hang on to the bond until its maturity date, which may or may not actually happen. It also assumes that profits from the investment will be reinvested in a uniform manner — again, that may or may not be the case.

The Takeaway

Using the yield to maturity formula can help investors compare bond options with different coupon and maturity rates, market and par values, and determine which one offers the potential for a higher yield. But calculating the YTM is not an exact science, especially when you’re gauging the return on a callable bond, say, or adding the impact of taxes to the mix.

YTM is just one tool investors can use to determine which bond may best serve their financial needs and goals. One alternative to choosing individual bonds is to invest in bond mutual funds or bond exchange-traded funds (ETFs). Investors can also speak with a financial professional for guidance.

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 is a bond’s yield to maturity (YTM)?

A bond’s yield to maturity is the total return an investor can anticipate receiving if the bond is held to its maturity date. YTM calculations assume that all interest payments will be made by the issuer and reinvested by the bondholder at a constant rate of interest.

What is the difference between a bond’s coupon rate and its YTM?

A bond’s coupon, or interest, rate is fixed from the moment an investor buys it. However, the same bond’s YTM can fluctuate over time depending on the price paid for it and other interest prices available on the market. If YTM is lower than the coupon rate, it may indicate that the bond is being sold at a premium to its face value. If it’s lower, it may be that the bond is priced at a discount to face value.

What is yield to maturity and how is it calculated?

Yield to maturity refers to the total return an investor can expect or anticipate from a bond if they hold it to maturity. It’s calculated using variables including the time to maturity, a bond’s face value, its current price, and its coupon rate.

Why is yield to maturity important?

The yield to maturity formula can give investors an idea of what they can expect in terms of returns from their bond holdings. But again, there are some assumptions the calculation takes into account, so an investor’s mileage may vary.

Is a higher YTM better?

A higher YTM may be better under certain circumstances. For example, since a higher YTM may indicate a bond is being sold for less than its face value, it may represent a valuable opportunity to invest. However, if the bond is discounted because the company that offered it is in trouble or interest rates offered by other investments are more appealing, then a high YTM might not be such a good thing. Investors must research investments carefully and understand the full story before they buy.


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.

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 $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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