May
18
2024
A Guide to Special Margin Requirements

Guide to Special Margin Requirements

By | Growing Wealth, invest, Investing | Comments Off on Guide to Special Margin Requirements

Special margin requirements refer to higher-than-normal requirements for margin traders. That typically means requirements that are above 25%.

According to the Securities and Exchange Commission (SEC), many brokers keep even higher maintenance margin requirements, typically between 30% and 40% — and sometimes higher depending on the type of securities purchased. These special margin requirements may vary.

Key Points

•   Special margin requirements are set above the standard 25% maintenance margin rate, indicating a need for higher equity in the account.

•   These requirements are often applied to volatile stocks or concentrated positions, enhancing broker security.

•   Margin trading uses securities in your account as collateral to amplify potential returns, though it also involves paying interest on borrowed funds.

•   The SPAN system helps calculate these requirements by assessing one-day risk in futures and options markets.

•   Brokers issue margin calls when account equity falls below the required percentage, necessitating additional deposits or liquidation by the account holder.

What Are Special Margin Requirements?

Special margin requirements are higher than standard margin requirements — above a maintenance margin rate of 25%. Higher margin rate requirements mean you must maintain a higher equity amount in your account when trading on margin.

Margin trading refers to using cash and securities in your account as collateral to purchase more assets. In doing so, you can use leverage to amplify returns — but you must also pay interest on borrowed funds. For anyone interested in trading on margin, it’s important to know the rules of margin accounts and also which stocks feature special margin requirements.

When it comes to trading stocks on margin, there are plenty of blanket rules and regulations in place. For instance, the Federal Reserve requires a 50% initial margin and a 25% maintenance margin.

The Financial Industry Regulatory Authority (FINRA) and the New York Stock Exchange (NYSE) also require at least $2,000 of cash or securities to be deposited before someone can trade in a margin account.

Special margin requirements are often found on highly volatile stocks, so just a small drop in the price of these stocks can trigger a margin call. Brokers might also issue special margin requirements on concentrated positions in your account. Leveraged positions and other factors might also trigger special margin requirements.

Leverage and margin are related — but not the same.

Brokers do not just haphazardly issue special margin requirements. An analysis of historical volatility is used along with the use of SPAN margin. SPAN margin is calculated by standardized portfolio analysis of risk — a system used by exchanges around the world to control risk. SPAN margin determines margin requirements based on an assessment of one-day risk for a trader’s account. It is used primarily in options and futures markets. The SPAN system allows an exchange to know what a “worst-case” one-day move could be for any open futures position.

Special vs Standard Margin Requirements

Special Margin Requirement

Standard Margin Requirements

Brokers can determine special margin rates Initial margin set at 50%
A special margin requirement might exist for a concentrated position Some securities cannot be purchased on margin



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How Do Special Margin Requirements Work?

Special margin requirements work by enforcing stricter equity deposits in your account when trading volatile stocks. The broker wants to protect itself in the event the securities in your account rapidly drop in value. Another way a broker protects itself is by issuing margin calls when special margin requirement percentages are breached.

With a margin call, you must deposit more cash or securities into your account to meet the call. You can also liquidate your holdings to generate cash and increase your equity percentage. If you fail to meet the call on time, the broker might liquidate your positions for you.

For a broker, it’s important to have safeguards like special margin requirements in place in case financial markets turn volatile. If many investors face margin calls all at once, the broker could face credit risk if those investors are unable to repay loans used in margin trading.

Pros and Cons of Special Margin Requirements

In terms of benefits and drawbacks, the upside is that special margin requirements help to control risk when investors engage in day trading — and the downside is more restrictions on your margin trading account.

Here’s a deeper dive into positives and negatives for the broker and for the investor.

Pros and Cons for Brokers

Pros Cons
Reduces risk when markets turn volatile More restrictive trading could turn away customers
Allows for tighter margin calls on risky positions Individuals might seek looser requirements from other brokers
Historical data provides a guide as to which stocks are most volatile Uncertainty exists when trying to predict what the most volatile securities will be going forward

Pros and Cons for Investors

Pros Cons
Highly volatile stocks are easier to identify Higher equity is required to trade certain stocks
Provides a guardrail when trading stocks Margin calls can trigger more quickly
Can be a tool to identify highly volatile stocks for options trading Margin percentages can change without notice

The Takeaway

While many stocks and ETFs have initial margin amounts of 50% and maintenance margin levels at 25%, some volatile stocks have higher special margin requirements. These requirements help protect both brokers and investors in the event that the stock tanks.

Margin trading is typically riskier than trading with a cash account. Investing with borrowed funds amplifies returns — positive and negative. It is important to be aware of the risks involved with this strategy.

If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.

Get one of the most competitive margin loan rates with SoFi, from 4.75% to 9.50%*

FAQ

What is a special margin account?

A margin account is a type of brokerage account in which your broker lends you cash, using the account’s equity as collateral, to purchase securities. These securities are known as marginable securities. Margin increases your purchasing power but also exposes you to the potential for larger losses.

What are margin requirements?

Margin requirements are percentages of equity you must maintain in your margin trading account. According to Regulation T of the Federal Reserve Board, the initial margin for equities is 50% and maintenance margin is 25%. There are higher special margin requirements for highly volatile stocks. In addition, if you have a concentrated position, you might face a special higher margin requirement.

How much money do you need to open a margin account?

The NYSE and FINRA require a deposit of $2,000 or cash or securities with your broker before trading on margin. Some firms may require larger deposits.

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.


¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

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May
18
2024
Time Decay of Options: How It Works & Its Importance

Time Decay of Options: How It Works & Its Importance

By | Growing Wealth, invest, Investing | Comments Off on Time Decay of Options: How It Works & Its Importance

Editor's Note: Options are not suitable for all investors. 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. Please see the Characteristics and Risks of Standardized Options.

Time decay, as it relates to options trading, has to do with an option contract’s loss of value as it nears its expiration date. There are numerous variables in the mix when it comes to time decay, but knowing the basics of what the terms means, and how it can affect an investment strategy, can be important for investors.

Key Points

•   Time decay refers to the reduction in an option’s value as its expiration date approaches.

•   The rate of time decay is represented by theta, which accelerates as expiration nears.

•   Options lose more value in the final month before expiration due to increased time decay.

•   Intrinsic and extrinsic values are key components in options pricing, affected by time decay.

•   Understanding time decay is crucial for options traders to manage potential profits and losses effectively.

What Is Time Decay?

Time decay is the loss of an option’s value as it gets closer to expiration. An option’s time value refers to the extent to which time factors into the value — or the premium — of the option. Time decay accelerates, or declines more quickly, as the expiration date gets closer because investors have less time to exercise the contract.

For options traders, understanding the power of time decay is important whether you’re buying call options or put options. Here are the basics you need to know.

Recommended: Options Trading: A Beginner’s Guide

How Time Decay Works

The rate of change in the time value of an option is known as theta. For traders who buy options with the intention of holding them until expiration, theta usually isn’t of great concern. That’s because traders who hold contracts until the expiry date are hoping that the underlying security moves so far in their favor that the reward in terms of intrinsic value will outweigh any loss in extrinsic value.

But traders who want to close their options position prior to expiration may be more concerned about time decay. Because the security will have less time to move in their favor, the potential profit from intrinsic value is reduced, and the potential loss of extrinsic value becomes greater.

While both intrinsic and extrinsic value are important for options traders of all kinds, the type of options trading strategy a trader is using can influence which factors they put more emphasis on.

Understanding Options Pricing

Time decay isn’t a difficult concept, but it does require a quick refresher about how options are traded and priced.

Four of the main variables that impact the price of an option are:

1.    The underlying price and strike price

2.    Time left until expiration

3.    Implied volatility

4.    Time decay

The underlying price, strike price, and expiration date of the options contract are the main factors that determine its intrinsic value, while implied volatility and time decay are the factors that determine its extrinsic value.

•   Intrinsic value. An option’s intrinsic value refers to the option’s value at the time of expiration, which depends on the price of its underlying security relative to the strike price of the contract. In other words, whether the option is in the money, out of the money, or at the money.

•   Extrinsic value. Extrinsic value refers to how time can impact the option’s value, i.e. its premium. As the expiration date of the options contract approaches, there’s less time for an investor to profit from the option, so time decay or theta, accelerates and the option loses value.

Interest rates can also affect options prices, but this is more of a macro factor that doesn’t have to do with the specific contract itself.

Thus, time value represents the added value an investor has to pay for an option above the intrinsic value. Options are sometimes referred to as depreciating or wasting assets because they tend to lose value over time, since the closer the option is to expiration, the faster its time value erodes.

Recommended: Popular Options Trading Terminology to Know

Finally, user-friendly options trading is here.*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the
OCC Options Disclosure Document.

How to Calculate Time Decay

The rate of an option’s time decay is measured by theta.An option with a theta of -0.05 (theta is expressed as a negative value) would be expected to fall about $0.05 each day until expiration, but this would likely accelerate during the days and weeks leading up to the expiry date.

Greek values like theta are constantly changing, and can therefore be one of the most difficult factors to take into account when trading options.

Example of Time Decay of Options

Imagine an investor is thinking about buying a call option with a strike price of $40. The current stock price is $35, so the stock has to rise by at least $5 per share for the option to be in the money. The expiration date is two months in the future, and the contract comes with a $5 premium.

Now imagine a similar contract that also has a strike price of $40 but an expiration date that is only one week away and comes with a premium of just $0.50. This contract costs much less than the $5 contract because the stock would have to gain almost 15% in value in one week to make the trade profitable, which is unlikely.

Thus, the extrinsic value of the second option contract is lower than the first, because of time decay.

How Does Time Decay Impact Options?

Option time decay is pretty straightforward in principle. Things can be more complicated in practice, but in general, options lose value over time. The more time there is between now and the expiry date of the option, the more extrinsic value the option will have. The closer the expiry date is to the current date, the more time decay will have taken effect, reducing the option’s value.

The basic idea is that because there’s less time for a security to move one way or the other, options become less valuable the closer they get to their expiration dates. This isn’t a linear process though. The rate of time decay accelerates over time, with the majority of decay occurring in the final month before expiration.

💡 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.

The Takeaway

If you think about it, the time value of an option is similar to other things that have a value which is time dependent. A fresh loaf of bread, a new car, a newly built home — these items would have an intrinsic value, but you might also pay a premium when they’re at full value.

As time passes, though, consumers will pay less for loaf of bread that isn’t fresh — or a car or home that’s older — because time has eroded some of the value. Similarly, as an option gets closer to its expiration date, it too loses value owing to the effects of time decay or theta.

SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.

With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.

Explore SoFi’s user-friendly options trading platform.

Photo credit: iStock/Tatyana Azarova

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

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


¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

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May
18
2024
American Option vs European Options: Key Differences

American Option vs European Option: What is the Difference?

By | Growing Wealth, invest, Investing | Comments Off on American Option vs European Option: What is the Difference?

Editor's Note: Options are not suitable for all investors. 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. Please see the Characteristics and Risks of Standardized Options.

Two of the most popular types of options are American and European. American and European options have a lot in common, but there are some key differences that are important for investors to understand.

Key Points

•   American options offer the flexibility to exercise the buy or sell right on any trading day before expiration.

•   European options can only be exercised on the expiration date, limiting flexibility.

•   American options are often traded on exchanges, while European options are typically traded over-the-counter.

•   The pricing of American options usually includes higher premiums due to their increased flexibility.

•   European options are generally less expensive and settle in cash, often related to indices rather than specific stocks.

Options Basics

One of the reasons investors like options trading is that it provides the right, but not the obligation to the buyer, to buy an asset. Making the choice to buy (call) or sell (put) is known as exercising the option.

Like all derivatives, the value of options reflects the value of an underlying asset. The value of an option changes as its expiration approaches and according to the price of the underlying asset. Investors using a naked option trading strategy may not have the cash or assets set aside in their portfolio to meet the obligations of the contract.

If the value of the contract or the underlying asset doesn’t increase, the investor would choose to let it expire and they lose only the premium they paid to enter into the contract. Both put and call options contracts include a predetermined price to which the buyer and seller agree, and the contract is valid for a specified period of time.

After the contract ends on the expiration date, so does the option holder’s ability to buy or sell. There are many different options trading strategies that investors can use.

Recommended: Call vs Put Option: The Differences

What Are American Options?

America options are the most popular, with both retail investors and institutional investors using them. One of the reasons for their popularity is their flexibility. Traders can exercise their right to buy or sell the asset on any trading day during the term of the agreement.

Most often, American stock options contracts have an expiration period between three and twelve months.

American Option Example

Say an investor purchases an American call in March with a one-year expiry date. The contract states that the investor has the option to purchase stock in Company X for $25 per share. In options terminology, $25 would be known as the option’s strike price. As the price of the underlying stock asset changes, the value of the option also changes.

After the investor purchases the American call options, the value of the stock increases. Within a few months the price was $50. The investor decides to exercise their option to buy, purchasing 100 shares of the stock at the agreed upon strike price of $25/share, paying a total of $2,500. The investor then sells the shares at the current market price of $50/share, making a profit of $2,500 because their value had doubled, not including the premium paid.

Investors can also buy put options, which give them the right to sell instead of the right to buy. With put options the scenario is reversed in that the investor would exercise their right to sell if the asset decreased in value.

Finally, user-friendly options trading is here.*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the
OCC Options Disclosure Document.

What Are European Options?

European options are similar to American options, but holders can only exercise them on the expiration date (not before), making them less flexible.

European Options Example

Let’s say an investor purchases a European call option for 100 shares of Company X with a strike price of $25 and an expiration date six months from the time of purchase. Three months after the contract starts, the price of the stock increases to $50/share. The investor can’t exercise the right to buy because the contract hasn’t reached the expiration date.

When the option holder is able to exercise three months later, the stock is down to $30/share. So the investor can still exercise the option and make a profit by purchasing 100 shares at $25 and selling them for $30. The investor would also need to subtract the upfront premium they made, so this scenario wouldn’t be nearly as profitable as the American option scenario.

This is why European options are not as valuable or popular as American options. Options pricing reflects this difference. The premium, or price to enter into a European option contract is lower. However, traders can sell their European options at any point during the contract period, so in the example above the trader could have sold the option for a profit when the stock price went up to $50/share.

💡 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.

American Style Options vs European Style

American and European options are similar in that they have a set strike price and expiration date. But there are several key differences between American and European options. These include how they’re traded, associated premiums, and more.

Trading

One main difference between American and European options is traders typically buy and sell European options over-the-counter (OTC) and American options on exchanges.

Recommended: What Is the Eurex Exchange?

Premiums

American options typically have higher premiums than European options since they offer more flexibility. If the investor doesn’t exercise their right to buy or sell before the contract expires, they lose the premium.

Settlement

European options tend to relate to indices, so they settle in cash. American options, on the other hand, typically relate to individual stocks or exchange-traded funds and can settle in stock or cash.

Settlement Prices

With American options, the settlement price is the last closing trade price, while with European options the settlement price is the opening price of index components.

Volume

American options typically have a much higher trading volume than European options.

Exercising Options

Traders can only exercise European options at the expiration date, while they can exercise American options at any point during the contract period. Traders can sell either type of option before its expiration date.

Pricing Models

A popular pricing model for options is called the Black-Scholes Model. The model is less accurate for American options because it can’t consider all possible trading dates prior to the expiration date.

Underlying Assets

The underlying assets of most American options are related to equities, European options are typically pegged to indices.

Risks of Americans and European Options

American options are riskier to an options seller because the holder can choose to exercise them at any time.

For buyers, it’s easier to create a hedging strategy with European options since the holder knows when they can exercise their right to buy or sell. Day traders and others who invest in options realize that there are risks involved with all investing strategies, along with potential reward.

The Takeaway

Options are one commonly traded type of investment, and many traders use them to execute a trading strategy. However, it’s possible to build a portfolio without trading options as well. If you have questions about how options may fit into your investment strategy, it may be a good idea to speak with a financial professional.

SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.

With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.

Explore SoFi’s user-friendly options trading platform.

Photo credit: iStock/AleksandarNakic

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

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


¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

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May
18
2024

What Is a Stock Split? How Does It Affect Investors?

By | Growing Wealth, invest, Investing | No Comments

A skyrocketing share price is usually a good thing for a company; investors expect the company to continue growing in the future. However, a stock trading with a hefty price tag may frighten away smaller investors, who may perceive the stock as too rich for their blood. That means many investors might pass over the company’s stock for other stocks with a lower per share price tag.

To combat this, a company may conduct a stock split. This action brings down the price of the company’s stock so that shares look more attractive to more investors, even though the company’s value remains the same. The idea is that investors can invest, and the company gets more marketability and liquidity on the stock market.

Learn more about a stock split and how it works.

Key Points

•   A stock split is when a company increases the number of its outstanding shares on the stock market, lowering the price per share.

•   Stock splits can make shares more affordable to retail investors and increase liquidity in the market.

•   There are different types of stock splits, including forward stock splits and reverse stock splits.

•   Companies conduct stock splits to make their stock more accessible and increase marketability.

•   Stock splits can have pros such as increased accessibility and liquidity, but also cons such as potential expenses and dilution of ownership.

What Is a Stock Split?

A stock split is when a company increases the number of its outstanding shares on the stock market, which lowers the price of its shares, but its market capitalization (sometimes referred to as market cap) stays the same. This is also known as a forward stock split.

For example, if an investor owns 10 shares of a company with a stock price of $100 and the company announces a 5-to-1 stock split, the investor will then own 50 shares of the stock trading at $20 per share after the stock split. Despite the split, the shareholder still owns $1,000 worth of stock.

A stock split may also be referred to as a one-time stock dividend, since the company is giving out additional shares to stockholders.

What Is a Reverse Stock Split?

In a reverse stock split, a company swaps each outstanding share of the company’s stock for a fraction of a share. A company often conducts a reverse stock split when the share price is low and the company is looking to increase the share price.

For example, in late July 2021, General Electric (GE) completed a 1-for-8 reverse split of its shares to boost the stock’s share price. The reverse split increased its share price from less than $13 pre-split to more than $100 post-split; the company replaced every eight shares held by an investor with one share.

💡 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.

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*Customer must fund their Active Invest account with at least $50 within 45 days of opening the account. Probability of customer receiving $1,000 is 0.026%. See full terms and conditions.

Types of Stock Splits

A number of different ratios can be used to split a stock. When the bigger number comes first in the ratio (such as 2 for 1) it means that the number of outstanding shares will increase—this is a forward stock split. In other words, the stock split ratio can reveal the number of new shares that will be created.

Here are some common stock split types and what they mean.

5 for 1 (5:1)

With a 5 for 1 stock split, for every one share of stock that currently exists, four new shares will be created, for a total of five shares. The share price will adjust downward accordingly, but the company’s market capitalization will stay the same.

2 for 1 (2:1)

In a 2 for 1 stock split, one new share of stock is created for every share that already exists, for a total of two shares. Again, the price for each share will adjust accordingly. A 2 for 1 stock split is one of the most common stock splits.

3 for 1 (3:1)

With a 3 for 1 split, for every share of existing stock, two more shares of stock are created, for a total of 3 shares.

3 for 2 (3:2)

Another fairly common stock split is the 3 for 2 split. In this case, one new share of stock is created for two already-existing shares, for a total of three shares.

Why Do Companies Conduct Stock Splits?

Companies will often split their stock when the share price gets too high. By splitting the stock, a company lowers its share price and makes it more affordable to retail investors, even though the company’s value stays the same.

For example, retail investors may be more likely to buy a chunk of shares of a stock trading at $20 rather than shares trading at $100 or more. This move to reduce the individual share price helps increase the stock’s liquidity in the market.

Pros and Cons of Stock Splits

There are several potential benefits of stock splits, but there are some possible disadvantages of the practice as well.

Pros

Some advantages of a stock split include:

The stock may become more accessible to more investors.

If a stock’s price is very high, smaller investors may be less likely to buy it. Splitting the stock and making it more affordable can result in more investors purchasing the stock.

The stock may have greater liquidity.

Creating more outstanding shares of the stock can make it easier to buy and sell it. For many investors, greater liquidity means they can more readily access their money by selling the stock if they need the funds. Liquidity is typically an important consideration when building a portfolio.

The stock’s price may rise.

Companies that undergo a stock split often do so because their stock price is rising, signaling investor confidence in the company. So, the announcement of a stock split is an indication that the company is doing well. Investors may want to put money into the company, pushing the share price up even before the stock split.

Following the stock split, the stock’s share price may go up because the lower price makes it more affordable to smaller retail investors that may not be able to purchase shares at, say, a $1,000 price. There becomes an increased demand for the lower share price.

Cons

Stock splits can also have drawbacks, such as:

Expensive and complicated.

In order to conduct a stock split, a company must get legal oversight of the process and meet regulatory requirements, which can be costly. A stock split does not change the company’s market cap, so the company must determine whether a split is worth the expense involved.

May attract too many investors.

A company may prefer to keep ownership of its shares exclusive. However, with a stock split, many more investors may be able to afford to buy the stock, meaning the shares would lose their exclusive equity ownership.

Potential for the share price to drop in the future.

It’s possible that once a stock is split and its share price is reduced, the price might drop even lower in the future, which lowers the value of the stock. For instance, if a company’s performance suffers, the face value of the stock might drop more in response.

Examples of Stock Splits Throughout History

Here are some notable stock splits from the last couple of decades:

•   Apple (AAPL): The computer giant split its stock by a 4-to-1 ratio in August 2020. Prior to the split, the stock was trading at around $500. After the split, the stock traded at about $124.

•   Netflix (NFLX): The entertainment company announced a 7-to-1 stock split in July 2015. Before the split, the stock was trading at nearly $800 per share. After the split, the stock traded at about $114.

•   Nike (NKE): The sports apparel company split its stock by a 2-to-1 ratio in December 2015. Prior to the split, the stock was trading at around $128 per share. After the split the stock traded at about $64 per share.

•   Nvidia (NVDA): The technology company engaged in a 4-to-1 stock split in July 2021. Before the split, Apple’s stock was trading at around $750, and after the split, the shares were priced near $187.

•   Tesla (TSLA): The electric car manufacturer split its stock by a 5-to-1 ratio in August 2020. Before the split, the stock was trading at around $2,200. After the split, the stock traded at around $440. Tesla’s shares rallied during the next two years, so the company declared a 3-to-1 stock split in August 2022, bringing the stock price down to around $300 from nearly $900 per share.

💡 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.

What Happens When a Stock You Own Splits?

If an investor owns stock in a company that announces a split, it will not materially affect the investment. As mentioned above, if an investor owns $1,000 worth of stock and a company splits its stock, an investor will still own $1,000 worth of stock after the split.

The additional shares at the lower share price will be automatically added to an investor’s account by the broker.

A stock split does not dilute the ownership of existing shareholders like a new stock issue may do. After a stock split, an investor still owns the same percentage of the company.

Recommended: Understanding Stock Dilution

The Takeaway

When a company announces a stock split, it can be tempting for investors to buy the stock because it will be more affordable on a per share basis. However, investors should be wary of making rash decisions simply because a stock may look more affordable and attractive. After all, the value of the company is still the same.

For most investors, it’s wise to make financial decisions that line up with their long-term investment and wealth-building goals, regardless of a stock’s price tag.

Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.


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

FAQ

Are stock splits a good thing?

Generally, a stock split is considered to be a good thing. It typically happens when the price of a company’s stock is high. The high price and value of the stock tends to be a positive sign reflecting that the company is doing well. Splitting the stock may encourage more investment in it, which could then drive up the price of the stock and be beneficial.

Do stocks do better after a split?

It is possible that a stock might do better after a split, but this isn’t always the case. The stock may be bought by more investors, which could drive up its share price. But even after a stock split, the company’s market capitalization doesn’t change. And it’s possible that a stock could drop in price after a split.

Is a stock split bullish or bearish?

A forward stock split, in which more shares of stock are created, is generally considered bullish, since it typically indicates that the company is performing well. However, a reverse stock split, which reduces the total number of shares of a stock, is usually considered bearish, since it may indicate that a company has underperformed.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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

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

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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May
15
2024
15 Technical Indicators for Stock Trading

7 Technical Indicators for Stock Trading

By | Growing Wealth, invest, Investing, Tools & Calculators | Comments Off on 7 Technical Indicators for Stock Trading

One way traders seek to profit from short-term movements in security prices is by using technical analysis.

While some stock analysis tools examine company fundamentals, technical stock indicators identify patterns in price and volume data to give investors and traders insights about how a stock might move in the future.

For that reason, although technical indicators can assist with trend identification, it’s best to combine different indicators when conducting stock analysis.

How Do Stock Technical Indicators Work?

Technical analysis uses various sets of data and indicators, such as price and volume, to identify patterns and trends. This type of stock market analysis is different from fundamental analysis, which looks at company financials, industry trends, and macroeconomics.

Rather, technical analysis solely analyzes a stock’s performance. Stock technical indicators are often rendered as a pattern that can overlay a stock’s price chart to predict the market trend, and whether the stock would be considered “overbought” or “oversold.”

Two Main Types of Technical Indicators

Stock technical indicators generally come in two flavors: overlay indicators and oscillators.

Overlay Indicators

An overlay indicator typically overlays one trend onto another on a stock chart, often using different colors to distinguish between the lines.

Oscillator Indicators

An oscillator typically uses metrics such as a stock’s price or trading volume to determine momentum, or rate of change, over time. It uses this info to generate a signal, or trend line, whose fluctuations between two values in a range can indicate if a stock may be overbought or oversold.

If the trend line moves above the higher value of the range, it can indicate a stock is overbought, while dipping below the lower value can indicate it’s oversold. The movements of the trend line thus can help traders determine support and resistance in certain price trends, so they can decide whether to sell or buy (support being the price at which a downturn generally bounces back up, and resistance being the point at which rising prices generally start to fall).

Oscillator indicators can be leading or lagging:

•   A leading indicator tracks current market movements to anticipate where the trend is headed next.

•   A lagging indicator is based on recent history and seeks patterns that will indicate potential price movements.

The moving average is a common oscillator; it’s considered a lagging indicator as it measures specific intervals in the past.

Naturally, every stock indicator has its pros and cons. Various trading indicators can be used by investors to analyze supply and demand forces on stock price, to help shed light on market psychology, or to manage risk.

But while stock indicators and trading tools can help with buy and sell points, false signals can also occur.

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Reasons to Use Stock Market Indicators

Knowing some of the most popular trading tools might benefit your investing strategy by providing you with easier-to-spot buy and sell signals. You don’t have to know every single technical indicator, and there are many ways to analyze stocks, but using multiple stock indicators may help you improve trading results.

You can also use these stock indicators to help you manage risk when you are actively trading.

Price trend indicators are some of the most important technical trading tools since identifying a security price’s trend is often a first step to forming a trading strategy. Long positions are often initiated during uptrends, while short sale opportunities can occur when prices are in a downtrend.

Volume trend indicators are also helpful to gauge the power or conviction of an asset’s price move. Some believe that the higher the stock volume on a bullish breakout or bearish breakdown, the more confident the move is. Higher volume could signal a lengthier trend continuation.

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

7 Stock Indicators for Technical Analysis

It’s important to remember that these trading tools were developed based on the belief that mathematically derived patterns may be valuable as predictors of stock movements. Past performance, however, is not a guarantee of future results. So while it can be useful to employ stock technical indicators, they are best used in combination before deciding on a potential trade.

Also, many of these trading tools are lagging indicators, which can lead to an inaccurate reflection of current and future market conditions.

Following are seven of the most common technical stock indicators, along with their advantages and disadvantages.

1. Moving Averages (MA)

A moving average (MA) is the average value of a security over a specific time. The MA can be:

•   Simple Moving Average (SMA)

•   Exponential Moving Average (EMA)

•   Weighted Moving Average (WMA).

A moving average smooths stock price volatility, and is taken as an indicator of the direction a price may be headed. If the price is above the moving average, it’s considered an uptrend versus when the price moves below the MA, which can signal a downtrend.

Moving averages are typically used in combination with each other, or other stock indicators, to identify trends.

Pros

•   Using moving averages can filter out the noise that comes from price fluctuations and focus on the overall trend.

•   Moving average crossovers are commonly used to pinpoint trend changes.

•   You can customize moving average periods: common time frames include 20-day, 30-day, 50-day, 100-day, 200-day.

Cons

•   A simple moving average may not help some traders as much as an exponential moving average (EMA), which puts more weight on recent price changes.

•   Market turbulence can make the MA less informative.

•   Moving averages can be simple, exponential, or weighted, which might be confusing to new traders.

2. Moving Average Convergence Divergence (MACD)

The Moving Average Convergence Divergence (MACD) helps investors gauge whether a security’s movement is bullish or bearish, and helps gauge the momentum of the trend. The MACD uses two different exponential moving averages (EMAs) to do so.

A 26-period EMA is subtracted from a short-term 12-period EMA to generate the MACD line. Then a signal line, based on a nine-day EMA, is plotted on top of the MACD to help reveal buy and sell entry points.

If the MACD line crosses above the signal line, that can signal a buy opportunity. If it crosses below the signal line, that could signal a price decline and an opportunity to sell or take a short position.

Pros

•   The MACD, used in combination with the relative strength index (below) can help identify overbought or oversold conditions.

•   It can be used to indicate a trend and also momentum.

•   Can help spot reversals.

Cons

•   The MACD might provide false reversal signals.

•   It responds mainly to the speed of price movements; less accurate in gauging the direction of a trend.

3. Relative Strength Index (RSI)

The relative strength index or RSI is an oscillator tool that looks at price fluctuations in a given period and calculates average price losses and gains. It ranges from 0 to 100. Generally, above 70 is considered overbought and under 30 is thought to be oversold.

Traders often use the RSI in conjunction with the MACD to confirm a price trend. The RSI can sometimes identify a divergence, when the indicator moves in opposition to the price; this can show the price trend is weakening.

Pros

•   An RSI can help investors spot buy or sell signals.

•   It may also help detect bull market or bear market trends.

•   It can be combined with moving average indicators to spot breakout trends or reversals.

Cons

•   The RSI can move without exhibiting a clear trend.

•   The RSI can remain at an overbought or oversold level for a long time, making this tool less useful.

•   It does not give clues as to volume trends.

Recommended: 5 Bullish Indicators for a Stock

4. Stochastic Oscillator

Traders will often use the stochastic oscillator, which is a momentum indicator, to determine whether a given security is overbought or oversold. The stochastic oscillator allows traders to compare a specific closing price of a security to a range of its prices over a certain time frame.

By using a stochastic chart, traders can gauge the momentum of a security’s price with the aim of anticipating trends and reversals. A stochastic oscillator uses a range of 0 to 100 to determine if an asset is overbought (when the measurements are above 80) or oversold (when the measurement is below 20).

Pros

•   Clearer entry/exit signals: The oscillator has a basic design and generates visual signals when it reaches the outer bounds of a price range. This can help a trader determine when it may be time to buy or to sell stocks.

•   Frequent signals: For more active traders who trade on intraday charts such as the 5-, 10-, or 15-minute time frames, the stochastic oscillator generates signals more often as price action oscillates in smaller ranges.

•   Easy to understand: The oscillator’s fluctuating lines are fairly clear for investors who know how to use them.

Cons

•   Possible false signals: Depending on the time settings chosen, traders may misperceive a sharp oscillation as a buy or sell signal, especially if it goes against the trend. This is more common during periods of market volatility.

•   Doesn’t measure the trend or direction: It calculates the strength or weakness of price action in a market, not the overall trend or direction.

💡 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.

5. On-Balance Volume (OBV)

OBV is a little different from the other indicators mentioned. It primarily uses volume flow to gauge future price action on a security or market. When there’s a new OBV peak, it generally indicates that buyers are strong, sellers are weak, and the price of the security may increase.

Similarly, a new OBV low is taken to mean that sellers are strong and buyers are weak, and the price is trending down.

The numerical value of the OBV isn’t important — it’s the direction that matters. In that respect it can be used as a trend confirmation tool. It can also signal divergences, when the price and the volume move in opposite directions.

Pros

•   Volume-based indicator gauges market sentiment to predict a bullish or bearish outcome.

•   OBV can be used to confirm price action and identify divergences.

Cons

•   It can be hard to find definitive buy and sell price levels.

•   False signals can happen when divergences and confirmations fail.

•   Volume surges can distort the indicator for short-term traders.

Recommended: How to Find Portfolio Beta

6. Accumulation / Distribution Line (ADL)

The accumulation/distribution line (ADL) looks at the trading range for a certain stock, and uses price and volume data to gauge whether shares are being accumulated or distributed. Like OBV it also looks for divergences, so that if a price trend isn’t supported by volume flow it could indicate the trend is about to reverse.

Although this sounds similar to OBV, they are calculated differently, and the ADL gives more attention to price and volume data within a specified range.

Pros

•   Traders can use the ADL to spot divergences in price compared with volume that can confirm price trends or signal reversals.

•   The ADL can be used as an indicator of the flow of cash in the market.

Cons

•   It doesn’t capture trading gaps or factor in their impact.

•   Smaller changes in volume are hard to detect.

7. Standard Deviation

Standard deviation measures the extent to which a data point deviates from an expected value, i.e. the mean return. When used as a technical indicator, standard deviation is a common stock volatility measure; it refers to how far a stock’s performance varies from its average.

Investors often measure an investment’s volatility by the standard deviation of returns compared with a broader market index or past returns.

Pros

•   Standard deviation mathematically captures the volatility of a stock’s movements, i.e. how far the price moves from the mean.

•   It provides technicians with an estimate for expected price movements.

•   It can be used to measure expected risk and return.

Cons

•   It does not provide precise buy and sell signals.

•   It must be used in conjunction with other indicators.

The Takeaway

Technical analysis tools use past price and volume data to help traders identify price trends and make buy and sell decisions. It’s important to know that technical analysis does not use fundamentals to assess the underlying companies, their industries, or any macroeconomic trends that might drive their success or failure. Rather, technical analysis solely analyzes the movement and volume inherent in a stock’s performance.

Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.

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

FAQ

What is the most popular technical indicator for stocks?

Traders typically combine technical indicators, so it’s difficult to point to one as being a top choice. That said, many traders use the moving average indicators in combination with others to gauge price trends.

What is the most accurate indicator of the stock market?

There is no single indicator that can anticipate overall stock market performance. In fact, it’s an important factor to keep in mind when using technical indicators: For every successful price prediction or winning trade, there are countless others that don’t pan out. There are no crystal balls.

Which indicator gives buy and sell signals?

Different traders favor different indicators when looking for signals about how to place a trade. That said, the stochastic oscillator is relatively clear-cut in that it can help traders identify buy and sell opportunities based on price closes and trends within a certain range.

Photo credit: iStock/staticnak1983

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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