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.
Buy to cover refers to when an investor purchases a stock or other security to close out a short position.
A short sale is when a trader borrows shares, betting the price will drop. A buy to cover order is a way to “cover” the short positions, so they can be returned to the lender.
Taking a short position requires a margin account, and buy to cover helps to prevent a margin call (when the broker requires that funds be deposited in the margin account).
Key Points
• Buy to cover involves purchasing shares to close a short position.
• Taking a short position requires a margin account, because the shares are borrowed, with the expectation the price will drop, and the shares can be bought at the lower price.
• A short sale strategy aims to profit from the difference between the higher selling price and the lower buying price.
• If the stock price rises, a margin call may occur, requiring additional funds or liquidation. A buy to cover order “covers” the shares needed to close out the short position.
Buy to Cover Meaning
Traditionally, you buy a stock with a bullish outlook, and sell to close out your position. In an ideal situation, you buy low and sell high, securing the difference between the purchase price and the sale price as your profit.
What Is a Short Position?
A short position is different. If you think a stock is currently overpriced, you might sell the stock before you have actually purchased it, via a short sale. Within the world of options trading, this requires temporarily borrowing the shares, usually from your broker or dealer.
Then, once the stock (hopefully) goes down, you purchase the shares at the lower price and return them to the lenderclosing out your position and pocketing the difference between the higher and lower price.
Buying to cover is the after-the-fact purchase of shares that you previously shorted, to cover the trade and avoid a margin call. When you do a short sale by selling first, you will eventually need to repay your short sale by purchasing shares.
What Is a Buy to Cover Limit?
When placing a buy to cover order, there are two ways that you can close your position. The first is a market order, in which you simply close the position at the first available market price.
The other method involves using a buy to cover limit order, in which you set a maximum price at which you’re willing to purchase the share.
One advantage of the latter approach is that you know exactly the price that you’ll get for your shares. This can help you when planning your overall strategy. A drawback, however, is that if the market moves against you, your order may not get filled.
How Does Buy to Cover Work?
A buy to cover order works much in the same way as a traditional buy order. The main difference is the order in which you make your buy and sell transactions.
In a traditional buy order, you purchase shares that you intend to later sell. With a buy to cover order, you’re buying shares to cover a sale that you previously made.
Also, a traditional buy order can be executed using cash; a short sale requires a margin account.
Example of a Buy to Cover Stock
Here’s a buy to cover stock example to help illustrate how the process works:
• You believe that stock ABC is overpriced at $50.
• After a few days, stock ABC’s price has dropped to $45.
• You issue a buy to cover order for 100 shares of ABC, paying $4,500.
• Your profit is $500 — the difference between the amount you receive from the short sale and the amount you pay to close the position, less any fees.
Sell Short vs Buy to Cover
“Selling short” and “buying to cover” are complementary actions within a short-selling strategy. If you think that a particular stock or investment is likely to go down in price, you can use a short sale to first sell shares that you’ve borrowed on margin, generally from your broker or dealer.
When you’re ready to close out your short sale transaction, you can place a buy- o cover order. This will purchase the shares that you sold originally, either at the market price or with a buy to cover limit order at a particular price.
If the stock declines in price as you expected, this strategy may yield a profit from selling high and then buying low.
Buy to Cover and Margin Trades
Using a buy to cover order is intricately tied in with both short selling and margin trading. When you sell short, you are using margin trading to borrow shares to sell that you don’t yet own.
When you are ready to close out your position, you issue a buy-to-cover order, purchasing the shares you need to correspond to the shares that you earlier sold on margin. If the stock price rises instead of falling, you may face a margin call, requiring additional funds or the liquidation of your position.
The Takeaway
A buy to cover is a purchase order executed to close out a short sale position in options trading. In a traditional sale, you purchase a stock first and then later sell the shares. When you sell short, you place a buy-to-cover order to close your position.
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%*
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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.
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.
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.
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.
When it comes to investing, there are certain rules of thumb that investors are often encouraged to follow. One of the most-repeated adages in investing is to try and “buy low, sell high.”
Buying low and selling high simply means purchasing securities at one price, then selling them later at a higher price. This bit of investing wisdom offers a relatively straightforward take on how to realize profits in the market. But figuring out how to buy low and sell high — and make this strategy work — is a bit more complicated. Timing the market is not a perfect science, and understanding that implementing a buy low, sell high strategy is more complicated than it sounds is critical to investor success.
Key Points
• Buy low, sell high is an investment strategy that involves purchasing securities at a lower price and selling them later at a higher price.
• Timing the market and implementing this strategy can be challenging, as market movements are unpredictable.
• Understanding stock market cycles and trends can help determine when to buy low and sell high.
• Technical indicators and moving averages can assist in identifying pricing trends and points of resistance.
• Investor biases and herd mentality can impact decision-making, so it’s important to make rational choices based on research and analysis.
What Does It Mean to “Buy Low, Sell High”?
“Buy low, sell high” is an investment philosophy that advocates buying stocks or other securities at one price, and then selling them later when they’ve (hopefully) gained value. This is the opposite of buying high and selling low, which effectively results in investors selling stocks at a loss.
When investors buy low and sell high, they may do so to maximize profits. For example, a day trader may purchase shares of XYZ stock at $10 in the morning, then turn around and sell them for $30 per share in the afternoon if the stock’s price increases. The result is a $20 profit per share, less trading fees or commissions. Of course, a price increase of that magnitude within a single day is highly unlikely.
Likewise, a buy and hold investor may purchase stocks, exchange-traded funds (ETFs), or mutual funds and hold onto them for years or even decades. The payoff comes if they sell those securities later for more than what they paid for them.
The following tips may help investors develop a buy low, sell high strategy (or avoid the buy high, sell low trap).
1. Investing with the Business Cycle
Understanding stock market cycles and their correlation to the business cycle can help when determining how to buy low and sell high.
The business cycle is the rise and fall in economic activity that an economy experiences over time. If the business cycle is in an expansion phase and the economy is growing, for instance, then stock prices may be on the upswing as well. On the other hand, if it’s become apparent that economic growth has peaked, that could be a signal for stock price drops to come as an economy slows or enters into a recession.
It’s also important to remember that security prices typically don’t move in a straight line up or down in lockstep with a specific phase of the business cycle. Instead, most securities experience a level of volatility, where prices move up or down (or both) in the short term before reverting to the mean.
2. Look at Stock Pricing Trends
Investors who want to buy low may find it helpful to pay attention to pricing trends or technical indicators. Tracking trends for individual securities, for a particular stock market sector, or the market as a whole can help investors get a sense of what kind of momentum is driving prices.
For instance, an investor wondering how low a stock price can go can look at technical indicator trends to identify significant pricing dips or rises in the stock’s history. This could, potentially, help determine when a stock or security has reached its bottom, opening the door for buying opportunities. Conversely, investors may also use trends to evaluate when a stock has likely reached its high point, indicating that it’s prime time to sell.
3. Use Moving Averages
Moving averages are a commonly used indicator for technical analysis. A moving average represents the average price of a security over a set time period. So to find a simple moving average, for example, an investor would choose a time period to measure. Then they’d add up the stock’s closing price each day for that time period and divide it by the number of days.
The moving average formula can help compare stock pricing and determine points of resistance. In other words, they can tell investors where stock prices have topped out or bottomed out over time. Moving averages can smooth out occasional pricing blips that temporarily push stock prices up or down.
Comparing one moving average to another, such as the 50-day moving average to the 200-day moving average, can also help investors to spot sustainable up or down pricing trends. All this can help when deciding when to buy low or sell high.
4. Beware of Investor Bias
An investor bias is a pattern of behavior that influences reactions to a changing market. For example, noise trading happens when an investor makes a trade without considering the state of the market or timing. The investor may follow pricing trends but make trades without considering whether the time is right to buy or sell.
Investors who give in to biases may find themselves following a herd mentality when it comes to making trades. If news of a pending interest rate hike sparks fear in the markets, investors may start panic selling in droves. This can, in turn, cause stock prices to drop. On the other hand, irrational exuberance for a specific stock or type of security can push prices up, causing an unsustainable market bubble.
Investors who can refrain from being influenced by the crowd stand a better chance of making rational decisions about when to buy or when to sell to either maximize profits or minimize losses.
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Pros and Cons of Buy Low, Sell High
A buy low, sell high strategy can work for investors, but while it’s a worthy goal, the implementation can be difficult. Investors who are too focused on timing the stock market can run into difficulties.
Benefits of Buy Low, Sell High
Buying low and selling high can yield these advantages to investors.
• Potential bargain-buying opportunities. If investor sentiment is causing fear and panic to take over the market and push stock prices down, that could open a door for buy low, sell high investors as they buy the dip. Individuals who ignore market panic could purchase stocks and other securities at a discount, only to benefit later once the market rebounds and prices begin to rise again.
• Potential for high returns. An investor skilled at spotting trendings and reading the market cycle could reap sizable profits using a buy low, sell high strategy. The wider the gap between a stock’s purchase and sale price, the higher the profit margin.
• Beat the market. A buy low, sell high approach could also help investors to beat the market if their portfolio performs better than expected. This might be preferable for active traders who forgo a passive or indexing approach to investing.
Disadvantages of Buy Low, Sell High
Attempting to buy low and sell high also holds some risks for investors.
• Timing the market is imperfect. There’s no way to time the market and which way stock prices will go at any given moment with 100% accuracy. So there’s still some risk for investors who jump the gun on when to buy or sell if stocks have yet to reach their respective lowest or highest points.
• Being left out of the market. Investors who want to buy low and sell high would not want to buy securities when the market is up. That practice, however, could lead to substantial time out of the market entirely, especially during bull markets.
• Biases can influence decision-making. Investment biases and herd mentality can wreak havoc in a portfolio if an investor allows it. Instead of buying low and selling at a profit later, investors may find themselves in a buy high, sell low cycle where they lose money on investments.
• Pricing doesn’t tell the whole story. While tracking stock pricing trends and moving averages can be useful, they don’t offer a complete picture of what drives pricing changes. For that reason, it’s important for investors also to consider other factors, such as consumer sentiment, the possibility of a merger, or geopolitical events, influencing stock prices.
Alternatives to Buy Low, Sell High
Buying low and selling high is not a foolproof way to match or beat the market’s performance. It’s easy to make mistakes and lose money when attempting to time the market unless, of course, you possess a crystal ball or psychic abilities.
There are, however, other ways to invest without trying to time the market. Take dollar-cost averaging, for example. This strategy involves staying invested in the market continuously through its changing cycles. Instead of trying to time when to buy or sell, investors continue making new investments. Over time, the highs and lows in stock pricing tend to average out.
A dividend reinvestment plan (DRIP) is another option. Investors who own dividend-paying stocks may have the opportunity to enroll in a DRIP. Instead of receiving dividend payouts as cash, they’re reinvesting into additional shares of the same stock. Similar to dollar-cost averaging, this approach could make it easier to ride out the ups and downs of the market over time and eliminate the stress of deciding when to buy or sell.
Investing with SoFi
A buy low, sell high investment strategy is fairly simple, in that it involves buying a security at one price, and selling it after, or if, it appreciates. Obviously, there’s no guarantee that any asset will appreciate, so it’s possible investors could lose money – but they could also see positive returns, too.
Further, the strategy can be challenging to implement. Executing a buy low, sell high plan successfully means researching and doing due diligence to understand how the market works.
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.
Opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.¹
FAQ
Is buying low and selling high a good strategy?
Buying low and selling high can generally be a good strategy as it allows you to take advantage of price movements in the market. However, there is no guarantee that this strategy will always be successful, and you may end up losing money if the market conditions are not favorable.
Is it illegal to buy low and sell high?
There is no law against buying low and selling high. Most investors make money by buying a security at a low price and then selling it later at a higher price.
Why do you sell high and buy low?
Many investors sell high and buy low because they want to take advantage of market conditions to realize a positive return. When the market is high, investors may sell an investment they purchased at a lower price to make a profit.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
Photo credit: iStock/katleho Seisa
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.
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.
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.
A security can refer to a number of different types of assets, including stocks, bonds, Treasury notes, derivatives, and more. Securities are fungible and can be traded via public as well as private markets.
The three main types of securities, broadly speaking, include: equity securities, where the investor owns a share in an organization; debt securities, where the investor loans capital and earns interest, and derivatives, which are contracts based on the value of an underlying asset.
Securities trading is regulated by the Securities and Exchange Commission, or SEC.
Key Points
• Securities is a broad term that refers to tradable financial instruments, including stocks, bonds, and derivatives.
• Equity securities represent ownership in a company, while debt securities (bonds) function as loans, where borrowers pay interest to lenders.
• Derivatives, such as futures and options, are higher-risk investments linked to underlying assets. These appeal mainly to experienced investors due to their complexity.
• Trading securities typically occurs on regulated exchanges, with investors using brokerage or retirement accounts to engage in buying and selling activities.
What is a Security?
A security is a tradable type of investment that traders can buy and sell on financial exchanges or other platforms, whether investing online or through a traditional brokerage. Securities have monetary value; buyers and sellers determine their value when trading them.
Securities include different types of asset classes. In general, investors earn money by buying securities at a low price and selling them at a higher one, but there are a range of investing strategies that can include profiting when the price of a security drops, as well as other means.
Here are some common security categories.
Equity Securities
These include stocks and stock mutual funds. Typically traded on exchanges, the price of equity securities rise or fall depending on the economy, the performance of the underlying company that offers the stock (or the companies in the fund), and the sector in which that company or fund operates.
This group includes bonds and other fixed-income vehicles, where lenders borrow money from investors and pay interest via periodic payments on the investment principal (also called the yield).
Investors can buy bonds from a variety of bond issuers, including: states, local and municipal governments, companies, and banks and other financial institutions. Typically, debt securities pay investors a specific interest rate paid usually twice per year until a maturity date, when the bond expires.
Some common debt securities include:
• Treasury bills. Issued by the U.S. government, T-Bills are considered among the safest securities.
• Corporate bonds. These are bonds issued by companies to raise money without going to the equity markets.
• Bond funds. These types of mutual funds allow investors to get exposure to the bond market without buying individual bonds.
Derivatives
This group of securities includes higher-risk investments like options trading and futures which offer investors a higher rate of return but at a higher level of risk.
Derivatives are based on underlying assets, and it’s the performance of those assets that drive derivative security investment returns.
For example, an investor can buy a call option based on 100 shares of ABC stock, at a specific price and at a specific time before the option contract expires. If ABC stock declines during that contract period, the call option buyer has the right to buy the stock at a reduced rate, thus locking in gains when the stock price rises again.
Derivatives allow investors to place higher-risk bets on stocks, bonds, and commodities like oil or gold, and currencies. Typically, institutional investors, such as pension funds or hedge funds, are more active in the derivative market than individual investors.
Hybrid Securities
A hybrid security combines two or more distinct investment securities into one security. For example, a convertible bond is a debt security, due to its fixed income component, but also has characteristics of a stock, since it’s convertible.
Hybrid securities sometimes act like debt securities, as when they provide investors with a floating or fixed rate of return, as bonds normally do. Hybrid securities, however, may also pay dividends like stocks and offer unique tax advantages of both stocks and bonds.
How Security Trading Works
Securities often trade on public exchanges where investors can buy or sell securities with the goal of making a financial profit.
Stocks, for example, are listed on global stock exchanges and investors can purchase them during market trading hours. Exchanges are highly regulated and expected to comply with strict fair-trading mandates. For example, U.S.-based stock exchanges like the New York Stock Exchange (NYSE) or Nasdaq must adhere to the rules and regulations laid out by Congress and enforced by the U.S. Securities and Exchange Commission (SEC).
Each country has their own rules and regulations for fair and compliant securities trading, including oversight of stocks, bonds, derivatives, and other investment vehicles. Debt instruments, like bonds, usually trade on secondary markets while stocks and derivatives are traded on stock exchanges.
There are many ways for investors to engage in security trading. A few of the most common ones include:
Brokerage Accounts
Once an investor opens a brokerage account with a credentialed investment firm, they can start trading securities.
All a stock or bond investor has to do is fill out the required forms and deposit money to fund their investments. Investors looking to invest in higher-risk derivatives like options, futures, or currencies may have to fill out additional documentation proving their credentials as educated, experienced investors. They may also have to make larger cash deposits, as trading in derivatives is more complex and has more potential for risk.
Some qualified investors with a certain type of brokerage account can engage in margin trading, meaning that they trade securities using money borrowed from the broker. This is a high-risk strategy suitable only for experienced investors; most brokerages have strict rules about who can trade on margin.
Retirement Accounts
By opening a retirement account, through work or a bank or brokerage account, investors can invest in a range of securities, including stocks, mutual and index funds, bonds and bond funds, and annuities.
The type of securities you have access to will depend on the type of retirement account that you have. Workplace plans such as 401(k)s typically have fewer investment choices (but higher limits for tax-advantaged contributions) than IRAs, or Individual Retirement Accounts.
Risks and Considerations
There is always the risk of loss when investing in securities. That said, some securities are riskier than others.
Risk vs. Reward
• Equities, or stocks, tend to be higher risk investments. Stock markets are known to be volatile and unpredictable. That said, stocks offer the potential for returns; the average historic return of the stock market is about 9% or 10% (or 6% to 7% after inflation).
• Bonds, by contrast, are lower risk, and provide lower but steady returns versus stocks.
• Derivatives, like options and futures trading, can be very high risk and these strategies are meant for experienced investors.
When choosing securities for an investment portfolio, it’s important to take into account the risk/reward profile of your investments, as well as whether your asset allocation reflects your risk tolerance. For example, if your portfolio is heavily weighted to stocks, that is likely to increase your risk exposure.
Types of Investments
Because many investors are less experienced at managing a portfolio for the long term, there are certain types of investments that can help investors to manage risk. This is especially true for those who are investing for retirement, and want to protect their savings while maximizing any potential growth. For example:
• Target-date funds are a type of mutual fund that are geared to be long-term investments, held until a target retirement date is reached. So a 2045 fund is designed to provide a balanced portfolio of securities for investors with a target retirement date in roughly 20 years.
The fund’s allocation of securities starts out more aggressive (tilted toward stocks), and automatically adjusts over time to become more conservative (tilted toward fixed income) to protect investors’ savings as they near retirement.
• Robo-advisors are automated portfolios that investors can select based on their personal goals, time horizon, and risk tolerance — the difference being that investors don’t select the securities in these portfolios. A robo portfolio is generally a pre-set mix of ETFs, and the allocation (or mix of securities) is determined by a sophisticated algorithm.
Because investors can’t change the securities themselves, this helps to prevent impulsive choices, and may mitigate risk over time.
Get Started With Securities Trading
To start trading securities, investors can set up a brokerage account or retirement account, and begin investing as they see fit.
Again, it’s best to start with the end in mind: Decide your investment goals, choose the amount you want to invest, do your due diligence in terms of researching various investment choices (bearing in mind risk levels and fees).
Once the account is funded, the investor can purchase a wide variety of securities in order to create an investment portfolio. Sometimes retirement account investment options can be more limited than a full-service brokerage account.
The Takeaway
There are many different types of securities that investors can purchase as part of their portfolio. Choosing which securities to invest in will depend on several factors, including your financial goals, current financial picture, and risk tolerance.
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 are the four main types of securities?
The four types of securities are: equity securities (such as stocks), debt securities (bonds and Treasuries), derivatives (higher-risk investments like options), and hybrid securities (such as convertible bonds).
What is a securities investment?
A securities investment is an investment in a security such as stocks, bonds, or derivatives. A security is a tradable type of investment that investors can buy and sell.
What’s the difference between securities and shares?
Stocks, also known as equity shares, are a type of security. The term “securities” refers to a range of different investments, one of which is stocks, or shares in a company.
Are securities an asset?
Yes, securities are a type of financial asset because they hold monetary value.
What are Treasury securities?
Treasuries are debt securities — e.g., bills, bonds, and notes — issued by the U.S. government. Treasuries are considered low risk because the U.S. has never defaulted on its debts.
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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.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.
Mutual Funds (MFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
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.
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.
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.
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.
Bollinger Bands are a popular technical analysis tool that helps traders assess price trends and market volatility. By measuring how far a security’s price moves above or below its average, Bollinger Bands provide insights into whether the price is relatively high or low compared to recent trading activity, indicating whether the security is overbought or oversold.
These bands can be applied to various assets, including options and stocks, making them versatile for different trading strategies. Although Bollinger Bands are often used to spot potential opportunities, they often work best when combined with other indicators to confirm trends and reduce the risk of false signals.
Key Points
• Bollinger Bands are technical analysis tools that measure a security’s price relative to its moving average and volatility.
• The bands consist of three lines: a simple moving average and two standard deviation lines.
• Bollinger Bands help identify overbought or oversold conditions and potential price reversals.
• This tool is more effective when used with other indicators like RSI and MACD.
• Bollinger Bands can be useful for day trading but are not predictive on their own.
What Are Bollinger Bands?
Bollinger Bands are a popular tool used in the technical analysis of securities. They are a set of three bands that measure a security’s relative price in comparison to its moving average and recent price volatility.
The center line is typically the 20-day simple moving average (SMA) of a security’s price, plus plotted lines two standard deviations away from the SMA. The bands are plotted positively and negatively from the SMA, which is what measures the volatility of a security, and the trader can adjust them based on their particular use case. These bands expand during periods of volatility and contract during periods of lower volatility, visually demonstrating market conditions.
Bollinger Bands were created to help investors understand whether a security is currently oversold or overbought, which may help determine whether it is likely to increase or decrease in value over time. When the upper band is close to the SMA, traders may see this as an overbought security. When the lower band is close to the SMA, they may consider the security to be oversold.
The bands, and a set of 22 rules about using them for trading, were developed in the 1980s by John Bollinger, a well-known technical trader.
How Do Bollinger Bands Work?
Bollinger Bands are plotted using two parameters: period and standard deviation.
Period is found by calculating the simple moving average of the security a trader is interested in. The calculation generally uses a 20-day SMA, an average of a security’s closing prices over a 20-day period — or roughly a month of trading days.
The first data point on the graph would be the average of the first 20 days being tracked. The second data point would be the next 20 days, and so on.
That line shows the SMA over time, and the Bollinger Bands are then placed above and below it by calculating the standard deviation of the security’s price along each data point. The standard deviation measures how much a security’s price deviates from its average, reflecting price volatility against its SMA, representing price volatility.
The standard deviation is calculated by first finding the square root of the variance, which is the average of the squared differences of the mean. The standard deviation is typically multiplied by two to create the bands, but traders can adjust this multiplier based on their strategy. The resulting value is then added and subtracted from each SMA data point to form the upper and lower Bollinger Bands.
Key Things to Know About Bollinger Bands
Bollinger Bands adjust dynamically to market conditions, expanding and contracting based on volatility. Here are a few things to keep in mind when using them:
• When volatility is low, the bands get closer together. This contraction reflects a lower volatility period, which may precede future price movements.
• When volatility is high, the bands get farther apart. This indicates that an existing price trend could be coming to a close in the future.
• Generally the security’s price movements stay within the two bands. And once they touch one band they start moving towards the other band. But the price can also bounce off the band multiple times or it can cross over the band. If the price touches one band and crosses the SMA, traders may watch to see if it moves toward the opposite band.
When the price crosses to the outside of the bands, this is a strong indicator of a trend in that direction.
Formula for Bollinger Bands
Below is the formula to plot Bollinger Bands:
BOLU=MA(TP,n)+m∗σ[TP,n]
BOLD=MA(TP,n)−m∗σ[TP,n]
where:
BOLU=Upper Bollinger Band
BOLD=Lower Bollinger Band
MA=Moving average
TP (typical price)=(High+Low+Close)÷3
n = Number of days in smoothing period (typically 20)
m = Number of standard deviations (typically 2)
σ[TP,n]=Standard Deviation over last n periods of TP
Bollinger Bands help traders understand whether a security’s price is relatively high or low so that they might make trades based on trends. Bollinger Bands can indicate uptrends and downtrends as well as possible upcoming price reversals.
Trends with Bollinger Bands can vary based on the asset and trading strategy, lasting anywhere from minutes to years. Traders should understand how to set up the bands based on their timeline. Here are some patterns and indicators traders might want to learn.
Uptrends
Traders can use Bollinger Bands to see whether there is a bullish trend in a security’s market price. If the center line hits the upper band multiple times, this may suggest an uptrend. If the price hits the upper band, decreases but stays above the center line, then hits the upper band again, that is a strong indicator of an uptrend. If the price then hits the lower band, it may indicate a reversal or a loss of strength in the uptrend.
Downtrends
The lower band can indicate a downtrend or an upcoming reversal towards an uptrend. If the price hits the lower band continuously and stays below the center line, this indicates a downtrend. Traders typically avoid making trades during downtrends, but if there is an indicator of a reversal, they might choose to buy.
The Squeeze
When the bands are close together, this is known as a squeeze. The squeeze happens when the security has low volatility, but it indicates that the security will probably have increased volatility in the future. Traders look for high volatility periods to find trading opportunities, so the squeeze reflects decreased volatility and often precedes periods of higher volatility, though it does not predict price direction.
Traders typically like to exit trades during periods of lower volatility, so they look for far-apart bands as a clue that volatility may soon decrease. The squeeze is not used as a trading signal, and doesn’t show whether a security will increase or decrease in value. However, it may help traders figure out the potential timing of upcoming trades.
Breakouts
The SMA line doesn’t always stay between the Bollinger Bands — it can also move above or below the bands. Around 90% of price changes do happen between the bands, so if the price has a breakout above or below the bands it’s a significant event. Breakouts can signal significant price movement outside the bands, however, but they are not reliable predictors of future trends on their own.
Bollinger Band Trading Strategies
Financial analyst Arthur Merrill identified a set of 16 trend patterns, including M patterns and W patterns, that traders can use to recognize potential price reversals. Here are two key patterns.
M Top
The M top pattern indicates that the security price may decrease to a new low. It forms an M pattern at the upper band, where the price nearly hits or hits the upper band but doesn’t cross over it, then decreases to below the low in the center of the M pattern.
W Bottoms
W patterns can be used to identify W bottoms, which is when the second low is lower than the first low but neither low goes below the lower band. If the security rises above the high in the center of the W, this is an indicator that the price will likely reach a new high.
John Bollinger recommended that traders use Bollinger Bands in conjunction with other non-correlated indicators, such as the relative strength indicator (RSI) and the Stochastic Oscillator, in order to gain a comprehensive understanding of the security being assessed.
Although Bollinger Bands help traders understand price volatility and can show opportunities for upcoming trades, they aren’t strong indicators of potential upcoming price movements.
Drawbacks of Bollinger Bands
There are a number of caveats to consider with Bollinger Bands. In particular, they are best used with other stock indicators, to form a fuller picture.
• They show old security price data with equal importance to new data, so data that is outdated may be counted with too much importance.
• They are more of a reactive indicator than a predictive indicator, so they show current market conditions and can indicate trends, but are not strong indicators of what will happen to a security’s price in the future.
• The standard settings of 20-day SMA and two standard deviations is an arbitrary measurement that doesn’t convey relevant information for every security and trading situation, so it’s important that traders understand how to adjust the band calculations for their particular situation.
Using Bollinger Bands for Crypto Trading
Bollinger Bands have become a popular tool for crypto traders to track volatility and trends. They can be used for trading crypto in a similar way to stocks, but some traders choose to use a 28 or 30 SMA instead of 20, to better represent a month of trading days, since the crypto markets are open 24/7.
The Takeaway
Bollinger Bands are a useful tool for technical analysis in options trading, which measure the relative high or low of a security’s price in relation to previous trades over, typically, the past 20 trading days.
Options traders may use Bollinger Bands to help inform their strategies, whether they’re trying to benefit from stock movements or manage risk.
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.
Bollinger Bands show how a security’s price moves over time, and whether it’s relatively high or low compared to its recent average. They also help gauge volatility: when the bands are far apart, the price is more volatile. When they’re close together, it’s less volatile.
Are Bollinger Bands good for day trading?
Yes, Bollinger Bands can be helpful for day trading because they show short-term price trends and volatility, helping traders spot potential opportunities for quick trades.
How reliable are Bollinger Bands?
Bollinger Bands are useful for identifying trends and volatility, but they’re not foolproof. They work best when combined with other indicators to confirm signals and reduce false predictions.
What indicator pairs well with Bollinger Bands?
The Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD) pair well with Bollinger Bands to confirm trends and spot potential reversals.
Photo credit: iStock/blackCAT
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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.
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The difference between the terms stock and shares is a simple one. An investor buys shares of stock in a company. The stock represents the company, and is sold in units called shares.
Thus, an investor can own a certain number of shares of a company’s stock: e.g., they might own 100 shares of Company A. But it’s incorrect to say an investor owns 100 stocks in Company A. If an investor owns 100 stocks, that would mean they own shares of stock in 100 different companies.
Key Points
• The terms “shares” and “stock” are often used in tandem, but they refer to different aspects of an equity investment.
• A stock is a broad term for the asset, while a share is the unit of ownership.
• Owning 100 shares implies you have 100 units of one company’s stock, while owning 100 stocks means you have stakes in 100 different companies.
• Ordinary shares are the same as common stock, and preference shares are the same as preferred stock.
• Common stockholders have voting rights and may receive dividends; preferred stockholders usually don’t have voting rights, but they often receive dividends before common stockholders.
Stock vs Share: Comparison
A stock is the actual asset you purchase, while a share is the unit of measurement for that asset.
So, investing in a certain stock means you’re investing in that company. A share tells you how much of that stock you own.
Differences Between Stocks and Shares
Stocks
Shares
A stock refers to the publicly-traded company that issues shares
A share is the unit of measurement of ownership in a company
Stocks can refer to the ownership of many different companies
Shares usually refer to the specific ownership stake in a company
Stock is a more general term
Share is a more precise term
For example, if you are interested in investing in Company A, you will buy 100 shares of Company A stock. Owning 100 shares of Company A would give you a specific ownership stake in the company.
In contrast, if you said you wanted to buy 100 stocks, that would generally mean you wanted to buy shares of 100 different companies.
You could buy 10 shares of one company’s stock, 50 shares of another, 1,000 shares of another, and so on. Shares represent the percentage of ownership you have in that company.
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What Are Stocks?
Stocks, also called equities, are a type of security that gives investors a stake in a publicly traded company. A publicly traded company trades on a stock exchange, like the New York Stock Exchange or Nasdaq.
When you buy stock, you buy a share or fractional shares of a publicly traded company. You essentially own a small piece of the company, hoping to get a return on your investment.
Companies typically issue stock to raise capital. Usually, the goal is to grow the business or launch a new product, but the company could also use the money to pay off debts or for another purpose.
Why Should I Buy Stocks?
Generally, people buy stocks with the hope that the company they invest in will earn money, and as a result, the investor will see a return or growth. There are two ways to earn money through stock ownership: dividends and capital appreciation.
Dividends are payouts a company makes to its shareholders. When a company is profitable, it can choose to share some of its profits with its shareholders through dividend payments. Typically, companies pay dividends on a specified schedule, often quarterly, although they can pay them at any time.
The second way to earn money is through capital appreciation, which is when a stock’s price increases above the purchase price. However, capital appreciation doesn’t lock in your gains; you don’t realize your profits until you sell your stock. And there is no guarantee that a stock will appreciate. Sometimes, owing to a range of factors, a stock’s price may drop, and investors may incur a loss.
If you sell stock and realize a profit, you must pay capital gains taxes on the earnings. The amount of tax you owe on your earnings depends on the type of asset, and how long you held it before selling.
Types of Stocks
There are two main types of stocks that investors can buy and sell.
• Common stock: The type of stock most people invest in, common stockholders have voting rights and may receive dividends.
• Preferred stock: Investors of this type of stock usually don’t have voting rights, but they often receive dividends before common stockholders. Preferred stock also gives investors a higher claim to assets than common stockholders if the company is liquidated.
Beyond common and preferred stocks, investors can buy and sell many different types of stocks. Usually, investors break down the various categories of stocks based on investing styles and company size, among other factors.
By Different Styles of Investing
Investors may divide up stocks of different companies into value and growth stocks.
Growth stocks have the potential for high earnings that may outpace the market. Growth stocks don’t usually pay dividends, so investors looking at these stocks hope to make money through capital gains when they sell their shares after the price increases.
Growth stocks are often tech, biotech, and some consumer discretionary companies. As the name suggests, consumer discretionary companies sell goods or services that consumers don’t consider essential.
Value stocks, in contrast, are stocks that investors consider to be trading below a price that accurately reflects the company’s strength. Value stocks usually have a lower price-to-earnings ratio.
Value investors are hoping to buy a stock when its price is low relative to its earnings, holding it until the market corrects and the stock price goes up to the point that better reflects the company’s underlying value.
Market capitalization, often referred to as market cap, is a common way to categorize stocks. Market cap is a measure of a company’s value. Below is a breakdown of market cap categories:
• Micro-Cap: $50 million to $300 million
• Small-Cap: $300 million to $2 billion
• Mid-Cap: $2 billion to $10 billion
• Large-Cap: $10 billion or higher
• Mega-Cap: $200 billion or higher
Generally speaking, companies with larger market capitalizations are older, more established, and have greater international exposure. Meanwhile, smaller-cap stocks tend to be newer, less established, and more domestically oriented. Smaller-cap companies can be riskier but also offer more growth potential.
What Are Shares?
A share is a piece of the company an investor can own. A share is a unit of ownership (e.g., you own 10 shares), whereas stock is a measurement of equity (e.g., you own 10% of the company).
Think of shares as a small portion of a company. So, if a company were a pie, a share would be a slice of said pie: the more slices, the more shares.
Shares play a role when calculating a company’s market cap. To find the market cap of a publicly traded company, you multiply the stock’s price by the number of outstanding shares, which is the number of shares currently owned by shareholders. This can also be referred to as shares outstanding, and the exact number can fluctuate over time.
Changes in the number of shares available can occur for various reasons. For example, if a company decides to release more shares to the public, the number of shares would increase.
Additionally you can own shares in a variety of assets other than stocks, like mutual funds, exchange-traded funds (ETFs), limited partnerships (LPs), and real estate investment trusts (REIT).
Types of Shares
Like with stock, investors may own different types of shares.
• Ordinary shares are the same as common stock. Holders of ordinary shares are entitled to vote on corporate matters and may receive dividends.
• Preference shares are the same as preferred shares. Holders of preferred shares usually receive dividends before common stock dividends are issued. If the company enters bankruptcy, shareholders of preference shares may be paid from company assets before common stockholders.
• Deferred shares are shares usually issued to company founders and executives where they are the last in line to be paid in bankruptcy proceedings, following preferred and common stockholders.
• Non-voting shares, as the name suggests, do not confer voting rights to the shareholder. Non-voting shares may have different dividend rights and rights to company assets in the event of liquidation compared to holders of voting shares.
Stock Splits Definition
A stock split is a decision made by the board of directors of a company to adjust the price of their stock without changing the company’s overall value. It is one of the ways how the number of a company’s outstanding shares can change.
A company usually initiates a stock split when its stock price gets too high. For example, if a company’s stock is trading at over $1,000, it can be difficult for some investors to purchase and limits the availability of buyers.
To remedy this problem, a company will issue new shares through a stock split, lowering the price of each share but maintaining its market cap. A 10-for-1 stock split, for instance, would exchange 1 share worth $1,000 into 10 shares, each worth $100. Your total investment value remains the same, but the number of shares you own increases.
Other Ways to Own Stock
Trading company stocks or shares isn’t the only way to own equities. One alternative is to invest in shares of a mutual fund, a managed investment fund that pools money from several different investors. The money is then invested in various securities, including stocks and bonds.
Another option for investors is exchange-traded funds (ETFs). Like mutual funds, ETFs are baskets of securities packaged into a single investment vehicle. But unlike mutual funds, investors can trade shares of ETFs all day in the stock market.
One significant benefit that mutual funds and ETFs offer is portfolio diversification. A mutual fund and ETF can either be actively managed by a financial professional or passively managed, which means the fund tracks an index like the S&P 500.
Another way besides stocks or shares to get exposure in the market is through options trading. Options are contracts giving the purchaser the right — but not always the obligation — to buy or sell a security, like stock or (ETF), at a fixed price within a specific period of time.
Test your understanding of what you just read.
The Takeaway
The difference between stocks and shares is that a share represents a unit of ownership in a company, while stocks refer to the ownership of one or more companies. It’s common to use both terms when discussing equity investments. But knowing the distinction between the two terms can help you better understand the stock market and investing.
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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.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.
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.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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.
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.
