Understanding the Different Stock Order Types

Understanding the Different Stock Order Types

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.


💡 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.

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.


💡 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).

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.

Recommended: Buy Low, Sell High Strategy: Investor’s Guide

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.

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 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.

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 $10 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 Are Cyclical Stocks?

What Are Cyclical Stocks?

Cyclical stocks are stocks that tend to follow trends in the broader economic cycle, with returns fluctuating as the market moves through upturns and downturns. A cyclical stock is the opposite of a defensive stock, which tends to offer more consistent returns regardless of macroeconomic trends.

Investing in cyclical stocks could be rewarding during periods of economic prosperity. During a recession, however, certain types of cyclical stocks may suffer if consumers are spending less.

What Is a Cyclical Stock?

The stock market is not static; it moves in cycles that often mirror the broader economy. To understand cyclical stocks, it helps to understand how the market changes over time, with the understanding that this has a different impact on different types of stocks.

A single stock market cycle involves four phases:

Accumulation (trough)

After reaching a bottom, the accumulation phase signals the start of a bull market and increased buying activity among investors.

Markup (expansion)

During the markup phase more investors may begin pouring money into the market, pushing stock valuations up.

Distribution (peak)

During this phase, investors begin to sell the securities they’ve accumulated, and market sentiment may begin to turn neutral or bearish.

Markdown (contraction)

The final phase of the cycle stock is a market downturn, when prices begin to significantly decline until reaching a bottom, at which point a new market cycle begins.


💡 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.

Cyclical Stocks Examples

The cyclicality of a stock depends on how they react to economic changes. The more sensitive a stock is to shifting economic trends, the more likely investors would consider it cyclical. Some of the most common cyclical stock examples include companies representing these industries:

•   Travel and tourism, including airlines

•   Hotels and hospitality

•   Restaurants and food service

•   Manufacturing (i.e. vehicles, appliances, furniture, etc.)

•   Retail

•   Entertainment

•   Construction

Generally, consumer cyclical stocks represent “wants” versus “needs” when it comes to how everyday people spend. That’s because when the economy is going strong, consumers may spend more freely on discretionary purchases. When the economy struggles, consumers may begin to cut back on spending in those areas.

Cyclical Stocks vs Noncyclical Stocks

Cyclical stocks are the opposite of non cyclical or defensive stocks. Noncyclical stocks don’t necessarily follow the movements of the market. While economic upturns or downturns can impact them, they may be more insulated against negative impacts, such as steep price drops.

Non Cyclical stocks examples may include companies from these sectors or industries:

•   Utilities, such as electric, gas and water

•   Consumer staples

•   Healthcare

Defensive or non cyclical stocks represent things consumers are likely to spend money on, regardless of whether the economy is up or down. So that includes essential purchases like groceries, personal hygiene items, doctor visits, utility bills, and gas. Real estate investment trusts that invest in rental properties may also fall into this category, as recessions generally don’t diminish demand for housing.

Cyclical stocks may see returns shrink during periods of reduced consumer spending. Defensive stocks, on the other hand, may continue to post the same, stable returns or even experience a temporary increase in returns as consumers focus more of their spending dollars on essential purchases.

Dive deeper: Cyclical vs Non-Cyclical Stocks: Investing Around Economic Cycles

Pros and Cons of Investing in Cyclical Stocks

There are several reasons to consider investing in cyclical stocks, though whether it makes sense to do so depends on your broader investment strategy. Cyclical stocks are often value stocks, rather than growth stocks. Value stocks are undervalued by the market and have the potential for significant appreciation over time. Growth stocks, on the other hand, grow at a rate that outpaces the market average.

If you’re a buy-and-hold investor with a longer time horizon, you may consider value cyclical stocks. But it’s important to consider how comfortable you are with investment risk and riding out market ups and downs to see eventual price appreciation in your investment. When considering cyclical stocks, here are some of the most important advantages and disadvantages to keep in mind.

Recommended: Value Stocks vs. Growth Stocks: Key Differences for Investors

Pros of Cyclical Stocks

•   Return potential. When a cyclical stock experiences a boom cycle in the economy, that can lead to higher returns. The more money consumers pour into discretionary purchases, the more cyclical stock prices may rise.

•   Predictability. Cyclical stocks often follow market trends, making it easier to forecast how they may react under different economic conditions. This could be helpful in deciding when to buy or sell cyclical stocks in a portfolio.

•   Value. Cyclical stocks may be value stocks, which can create long-term opportunities for appreciation. This assumes, of course, that you’re comfortable holding cyclical stocks for longer periods of time.

Cons of Cyclical Stocks

•   Volatility. Cyclical stocks are by nature more volatile than defensive stocks. That means they could post greater losses if an unexpected market downturn occurs.

•   Difficult to time. While cyclical stocks may establish their own pricing patterns based on market movements, it can still be difficult to determine how long to hold stocks. If you trade cyclical stocks too early or too late in the market cycle, you could risk losing money or missing out on gains.

•   Uneven returns. Since cyclical stocks move in tandem with market cycles, your return history may look more like a rollercoaster than a straight line. If you’re looking for more stable returns, defensive stocks could be a better fit.


💡 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.

How to Invest in Cyclical Stocks

When considering cyclical stocks, it’s important to do the research before deciding which ones to buy. Having a basic understanding of fundamental analysis and technical analysis can help.

Fundamental analysis means taking a look under a company’s hood, so to speak, to measure its financial health. That can include looking at things like:

•   Assets

•   Liabilities

•   Price to earnings (P/E) ratio

•   Earnings per share (EPS)

•   Price to earnings growth (PEG)

•   Book to value ratio

•   Cash flows

Fundamental analysis looks at how financially stable a company is and how likely it is to remain so during a changing economic environment.

Technical analysis, on the other hand, is more concerned with how things like momentum can affect a stock’s prices day to day or even hour to hour. This type of analysis considers how likely a particular trend is to continue.

Considering both can help you decide which cyclical stocks may be beneficial for achieving your short- or long-term investment goals.

The Takeaway

Cyclical stocks are stocks that tend to follow trends in the broader economic cycle, with returns fluctuating as the market moves. Cyclical stocks could be a good addition to your portfolio if you’re interested in value stocks, or you want to diversify with companies that may offer higher returns in a strong economy.

Investing in cyclical stocks does have its pros and cons, however, like investing in just about any other type or subset of securities. Investors should make sure they know the risks, and consider talking to a financial professional before making a decision.

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.

Claw Promotion: Customer must fund their Active Invest account with at least $10 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.

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What Is Spoofing In Financial Markets?

What Is Spoofing in Trading?

In the financial space, the term “spoofing” refers to an illegal form of stock market and exchange trickery that is often used to change asset prices. Given that the stock markets are a wild place, and everyone is trying to gain an advantage, spoofing is one way in which some traders bend the rules to try and gain an advantage.

Spoofing is also something that traders and investors should be aware of. This tactic is sometimes used to change asset prices — whether stocks, bonds, or cryptocurrencies.

What Is Spoofing?

Spoofing is when traders place market orders — either buying or selling securities — and then cancel them before the order is ever fulfilled. In a sense, it’s the practice of initiating fake orders, with no intention of ever seeing them executed.

Spoofing means that someone or something is effectively spamming the markets with orders, in an attempt to move security prices.

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

What’s the Point of Spoofing?

Because stock market prices are determined by supply and demand — for instance, the more demand there is for Stock A, the higher Stock A’s price is likely to go, and vice versa — they can be manipulated to gain an advantage. That’s where spoofing comes in.

By using bots or an algorithm to make a high number of trades and then cancel them before they go through, it’s possible for spoofers to manipulate security prices. For a trader looking to buy or sell a certain security, those valuations may be moved enough to increase the profitability of a trade.

Spamming the markets with orders creates the illusion that demand for a security is either up or down, which is then reflected in the security’s price. Because it would require an awful lot of “spoofed” orders to move valuations, spoofers might rely on an algorithm to place and cancel orders for them, rather than handle it manually. For that reason, spoofing is typically associated with high-frequency trading (HFT).

Is Spoofing Illegal?

If it sounds like spoofing is essentially cheating the system, that’s because it is. In the United States, spoofing is illegal, and is a criminal offense. Spoofing was made illegal as a part of the Dodd-Frank Act, which was signed into law in 2010. Specifically, spoofing is described as a “disruptive practice” in the legislation, straight from the U.S. Commodity Futures Trading Commission (CFTC), which is the independent agency responsible for overseeing and policing spoofing on the markets:

Dodd-Frank section 747 amends section 4c(a) of the CEA to make it unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that —

(A) violates bids or offers;

(B) demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; or

(C) is, is of the character of, or is commonly known to the trade as ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).

Additionally, there are laws and rules related to spoofing under rules from the Securities and Exchange Commission (SEC), and the Financial Industry Regulatory Authority (FINRA), too.

Example of Spoofing

A hypothetical spoofing scenario isn’t too difficult to dream up. For instance, let’s say Mike, a trader, has 100,000 shares of Firm Y stock, and he wants to sell it. Mike uses an algorithm to place hundreds of “buy” orders for Firm Y shares — an algorithm that will also cancel those orders before they’re executed, so that no money is actually spent.

The influx of orders is read by the market as an increase in demand for Firm Y stock, and the price starts to increase. Mike then sells his 100,000 shares at an inflated price — an artificially inflated price, since Mike effectively manipulated the market to increase his profits.

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

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


*Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

Consequences of Spoofing

Because spoofing is a relatively easy way to manipulate markets and potentially increase profits, it’s also a fairly common practice for some traders and firms, despite being against the law. That transgression can cost spoofers if and when they’re caught.

For example, one financial institution was fined nearly $1 billion by the SEC during the fall of 2020 after the company was caught conducting spoofing activity in the precious metals market.

But it’s not just the big players that can be on the receiving end of a smack down by the authorities. During August of 2020, an individual day trader was caught manipulating the markets through spoofing activity — actions that netted the trader roughly $140,000 in profits. The trader was ultimately ordered by the CFTC to pay a fine of more than $200,000.

Despite the cases that make headlines, it’s generally hard to identify and catch spoofers. With so many orders being placed and executed at once (especially with algorithmic or computer aid) it’s difficult to identify fake market orders in real time.

How to Protect Against Spoofing

There are a number of parties that are constantly and consistently trying to gain an edge in the markets, be it through spoofing or other means. For investors, it’s worth keeping that in mind while sticking to an investing strategy that works for you, rather than investing with your emotions or getting caught up in the news cycle.

In a time when a single social media post or errant comment on TV can send stock prices soaring or into the gutter, it’s critical for investors to understand what’s driving market activity.

The Takeaway

Spoofing is meant to gain advantage in the markets, but as such it’s illegal and penalties can be steep. Beyond the spoofers trying to manipulate the market, spoofing has the potential to affect all investors.

If spoofers are manipulating prices for their own gain, that can cause traders and investors to react, not realizing what is going on behind the scenes. While this is more of an issue for active investors or day traders, it’s something to be aware of.

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.


Photo credit: iStock/visualspace

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 $10 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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A Guide To Derivatives Trading

A Guide To Derivatives Trading

“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.

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.


Photo credit: iStock/solidcolours

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

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 $10 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 Meme Stock Investing in 2021

What Are Meme Stocks? Guide to Meme Stock Investing

Meme stocks have gotten a lot of attention in recent years, especially during the pandemic. Meme stocks are stocks that go viral on social media platforms and quickly increase in price.

What is a meme stock exactly? Read on to find out more about meme stock investing.

What Is a Meme Stock?

The meme stock meaning is that meme stocks are company shares that have gone viral due to popularity among retail investors on social-media platforms.

In a traditional buy-and-hold strategy, investors seek stocks whose shares appear undervalued relative to the company’s fundamental worth or growth potential. In contrast, prices of meme stocks are closely tied to sentiment and chatter among day traders on the Internet, rather than the value of the underlying business. Meme stocks can be extremely volatile and risky.

Common Meme Stock Terminology

Meme stocks have a specific terminology that those who invest in them use. These are a few of the common terms:

Apes: These are members of the meme stock community

Diamond hands: This refers to hanging onto a stock, even if it suffers losses, because the investor thinks the price will go back up.

Hold the line: This is about standing your ground with meme stocks and holding onto them, despite volatility.

Tendies: Profits made in meme stock. The word is a play on chicken tenders.

To the moon: The belief that the stock will rise sky high.


💡 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.

Background on Meme Stocks

In the past, before the pandemic, when it came to institutional investors vs. retail ones, the former were thought to hold clout in markets. After all, the top 10 largest institutional investors at that time made up 43% of the average public company’s ownership, according to data from the Organisation for Economic Cooperation and Development.

But in 2021, small investors showed they could be a force to be reckoned with, coordinating trades on Internet platforms like Reddit, Twitter, YouTube, or Discord to fuel big price swings. These investors also helped drive moves in different types of cryptocurrencies as well as SPACs, or special purpose acquisition companies.

In January 2021, Investors on the Reddit forum “r/wallstreetbets” banded together and triggered a short squeeze in GameStop Corp., a popular short among hedge funds. When an investor or trader is shorting a stock, it means they’re wagering that the price of the shares will fall. A short squeeze refers to rapid price gains in a stock, as traders exit their bearish positions en masse.

Recommended: A Guide to Wallstreetbets Terminology

Retail investors succeeded in triggering a short squeeze and losses for hedge funds, who then turned to trying to monitor social-media forums in order to spot the next meme stock.

However, controversy ensued when some brokerage firms halted trading in some meme stocks, citing an inability to post collateral at clearinghouses. Such moves led to angry retail investors and day traders and congressional hearings that looked into brokerage practices such as payment for order flow.

How Does a Stock Become a Meme?

A stock becomes a meme when it goes viral. It may become popular on online platforms like Reddit, Twitter, and YouTube. A meme stock can gain a following in discussion groups in these platforms, and the online communities can fuel price swings in the stock.

Examples of Meme Stocks

The first major meme stock example was GameStop Corp., as mentioned above. Investors on the Reddit forum “r/wallstreetbets” banded together. They triggered a short squeeze, which rove up the price of the stock.

Other meme stocks have included AMC Entertainment Holdings, Inc., a movie theater chain; Blackberry Limited, the smartphone maker; and Bed, Bath and Beyond, Inc.

Pros and Cons of Trading Meme Stocks

Benefits of Trading Meme Stocks

1.    Rise of Retail Trader: Retail investors have shown they need to be taken more seriously by the rest of the market.

2.    Younger Investors: Given the hyper-online ways in which meme stocks come about, younger investors have learned more about investing and trading through these social-media fads. Still, it’s unclear whether meme stocks will help engender healthy long-term financial planning habits for beginner investors in their 20s.

Risks of Trading Meme Stocks

1.    Lack of Fundamentals: Meme stocks tend to go viral not because of the performance or potential of the underlying business, but because of the sometimes irrational enthusiasm of retail investors and day traders. That puts meme-stock investors at greater risk of downward share performance, if the fundamentals of the business disappoint when the economy or markets dip.

2.    High Volatility: Studies have shown that passive, diversified investments tend to outperform active trading over the long term. The volatility of meme stocks means that investors are at greater risk of locking in losses or seeing their portfolios underperform in the near term. Take for instance, when trading was halted on GameStop, investors potentially couldn’t execute sell orders.

3.    Potential Stock Dilution: In some cases, meme-stock companies have tried to take advantage of higher valuations by issuing new shares. In such examples, it’s important that investors understand stock dilution, which occurs when the number of outstanding shares increases and every shareholder ends up owning a less significant piece.


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

How to Trade Meme Stocks

Single-name stocks are also not the only ways investors can get exposure to meme stocks. Options trading in meme stocks tend to be liquid, often allowing investors to buy and sell calls and puts easily.

If an investor doesn’t want to research or follow specific meme stocks, another way to get exposure to the phenomenon is by buying an exchange-traded fund (ETF) that holds companies popular on brokerage platforms.

In addition, here are some precautions that investors can take when trading meme stocks:

1.    Diversify Your Portfolio: Rather than just holding meme stocks in their portfolios, investors may benefit from also getting exposure to more broad-based ETFs, blue-chip stocks, or dividend-paying companies. Such stocks tend to post more muted price moves, which may help offset the volatility of meme stocks.

2.    Set Stop-Loss Orders: Investors can pre-set orders so that a meme stock automatically gets sold if it hits a certain price. A stop-loss order can be used to lock-in profits, so if the shares rise, or to limit losses, if the stock’s price falls.

The Takeaway

The proliferation of zero-commission brokerage accounts, and stay-at-home orders due to Covid-19, led to an individual-investor surge.

Sometimes such traders target companies with high short interest to turn into meme stocks. Certain meme stocks like GameStop and AMC captured news headlines by posting colossal gains rapidly, but once the trading frenzy subsided, many meme stocks also plummeted. Investors may want to consider other, less risky investments for their portfolio.

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


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

FAQ

What is a meme stock rally?

A meme stock rally is when a meme stock that became popular through social media skyrockets in price.

What is a meme stock ETF?

Meme stock ETFs are exchange-traded funds based around meme stocks. ETF meme holdings are made up of primarily meme stocks.

What investment strategy should you use for meme stocks?

Investing in meme stocks can be extremely risky. If you do decide to invest in them, you may benefit from also having other assets, such as ETFs or blue-chip stocks, in your portfolio to help diversify it. That may may help offset the volatility of meme stocks.


Photo credit: iStock/RgStudio

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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