What are ratios to analyse any banking stocksHAPPY REPUBLIC DAY 🇮🇳
Today we will study ratios for analysing any banking/ non- banking stock.
Key Ratios are -
1. Net Interest Margin (NIM)
2. Provision Non Performing Assets (PNPA)
3. Loan to Assets Ratio
4. Return on Assets Ratio (ROA)
5. Capital Adequacy Ratio
6. Gross NPA
7. Net NPA
8. CASA Ratio
9. Cost to Income ratio
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1. Net Interest Margin (NIM)
1. Net Interest Margin = ( Investment Income –
Interest Expenses ) / Average Earning Assets.
2. Positive Net Interest Margin shows that bank is earning more money in the form of interest than its cost of funding investments.
3. There are several factors that affect bank NIM. One of the most significant is interest rates. When interest rates are high, banks are able to earn more from loans and investments, which increases their NIM. When interest rates low, banks earning will loans and investments decrease, which lead lower NIM.
4. In summary, Net Interest Margin is important measure of bank's profitability and its ability to generate income from its existing assets. NIM is affected by interest rates and competition. Banks with a high NIM are generally considered strong financial position and better to grow and invest in new opportunities.
Let's look at example
Bank in India has total assets of ₹1,00,000 crore consist of loans and investments. The bank has total deposits of ₹80,000 crore and it pays interest rate of 4% on savings accounts and 6% on Fix Deposit The bank total interest income for the period is ₹2,400 crore which is earned by loans and investments. The bank total interest expense for period is ₹1,600 crore, which is paid to depositors.
To check the NIM we take the bank net interest income (NII) of ₹800 crore (₹2,400 crore in interest income - ₹1,600 crore interest expense) and divide by the bank average earning assets of ₹90,000 crore (average of total assets and total deposits).
NIM = NII / Average Earning Assets
NIM = ₹800 crore / ₹90,000 crore
NIM = 0.89%
Bank NIM is 0.89% every ₹100 of assets the bank is earning ₹0.89 of net interest income. This NIM is a measure of the bank efficiency in generating income from assets and can be used to compare it with other banks and over time.
NIM in India will be lower than developed countries due to lower lending rates and high competition among bank.
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2. Provision Non Performing Assets (PNPA)
1. An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank.
2. Provision for Non Performing Assets (NPA). The amount keep aside by bank, to cover it's potential losses from loans and other credit related assets that have been non performing.These provisions are made when a bank expects that some of its borrowers will default on their loans, and the bank needs to set aside funds to cover the potential loss.
3. In summary, Provision for Non Performing Assets (NPA) Banks are required to make provisions for NPA on a regular basis, quarterly basis, amount of provisions is disclosed in the financial statements. Provision for NPA is an important measure of a bank's financial health, Help bank to absorb the impact of loan defaults and manage credit risk.
Provisions for NPA is closely watched by investors, analysts, and regulators, it helps them to assess the bank's credit risk.
Let's look at example
Bank total loans of ₹50,000 crore. ₹2,000 crore classified Non performing Assets (NPA) borrowers defaulted their payments more than 90 days. Bank required to set aside certain percentage of the NPA loans as PNPA as per the Reserve Bank of India's guidelines. The current PNPA provisioning ratio is 15%.
To get PNPA we multiply the NPA loans of ₹2,000 crore with the PNPA provisioning ratio of 15%.
PNPA = NPA loans x PNPA provisioning ratio
PNPA = INR 2,000 crore x 15%
PNPA = INR 300 crore
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3. Loan to Assets Ratio
1. Loan to Assets ratio can help investors obtain complete analysis of bank's operations. Banks that have relatively higher Loan to Assets ratio banks with lower levels of Loan to Assets ratios derive a relatively larger portion of their total incomes from more diversified, noninterest earning sources, such as asset management or trading. Banks with lower Loan to Assets ratios may fare better when interest rates are low or credit is tight.
2. In summary, Loan to Asset ratio is financial metric compares bank total loans to total assets. It's used to measure bank leverage assess the level of risk associated with lending activities. Higher Loan to Assets ratio indicates that a bank is more heavily reliant on lending and is more leveraged and risky, while a lower ratio indicates that the bank is less risky.
Let's look at example
Bank has total assets ₹1,00,000 crore, total loans ₹70,000 crore. to get Loan to Assets Ratio we divide the total loans by the total assets.
Loan to Asset Ratio = Total Loans / Total Assets
Loan to Asset Ratio = ₹70,000 crore / ₹1,00,000 crore. Loan to Asset Ratio = 0.7.
Bank's Loan to Assets Ratio is 0.7 / 70% (0.7*100) bank assets in form of loans. A higher Ratio indicates that bank is heavily invested in lending activities, which can be sign of more aggressive lending strategy. it's also increases the risk of default. Than higher risk of NPA. Banks required to maintain minimum level of Capital Adequacy Ratio as per the Reserve Bank of India's (RBI) guidelines.
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4. Return on Assets Ratio (ROA)
1. Return on Assets = Net Income / Total Assets
2. The higher ratio means assets are well managed and low ratio means resources didn't used effectively compared to the industry and competitors.
3. In summary, ROA is financial ratio measures profitability of company in relation to total assets. It is calculated by dividing the company's
net income by its total assets. This ratio is useful to compare the performance of company with its peers in the same industry. It is an important metric used to evaluate a company's overall efficiency and performance but it's important to keep in mind that high ROA not necessarily mean that company have strong financial position.
Let's look at example
Bank has total assets of ₹100 billion and net income of ₹5 billion. To get ROA we divide the net income by total assets.
ROA = Net Income / Total Assets
ROA = ₹5 billion / ₹100 billion
ROA = 0.05 or 5%.
Bank ROA is 5% For every ₹100 billion of assets, the bank generates ₹5 billion of net income. Higher ROA show that bank is profitable and efficient in utilizing assets. It's important to note this ratio is sensitive to the size of the bank It's better to compare the ROA of a bank with other banks of similar size.
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5. Capital Adequacy Ratio
1. The Capital Adequacy Ratio helps make sure banks have enough capital to protect depositors money.
2. Banks are required to maintain a certain level of Capital Adequacy Ratio as per the regulations set by central bank to ensure that they have sufficient capital to meet the potential losses and continue their operations even in adverse situations.
3. It helps maintain the stability of the financial system by ensuring that banks can withstand in unexpected situation.
Let's look at example
In India, the Reserve Bank of India (RBI) sets the minimum Capital Adequacy Ratio for banks at 9%. which means that they must hold capital worth at least 9% of their total risk-weighted assets.
Bank in India with total assets of ₹100 billion and risk-weighted assets of ₹80 billion must maintain minimum capital of ₹7.2 billion (9% of ₹80 billion) to meet the Capital Adequacy Ratio requirement set by the RBI.
It's important to note that, the Banks with a higher Capital Adequacy Ratio are considered to have a better ability to absorb unexpected losses.
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6. Gross NPA
1. Gross Non Performing Assets (GNPA) is refer to the total value of loans or advances that have been classified as Non Performing Assets. These are loans or advances the borrower has defaulted on repayment or interest for certain time. loan is classified as an NPA if the borrower has not made any payment for period of 90 days or more.
2. A high ratio of GNPA to total loans indicates a higher level of credit risk and potentially weaker financial condition for the bank.
Let's look at example
Bank has total loans of ₹100 billion and ₹20 billion are classified Non Performing Assets (NPA). The bank Gross Non Performing Assets (GNPA) would be INR 20 billion.
we see the ratio of GNPA to total loans we get 0.2 (₹20 billion / ₹100 billion). This ratio of 20% indicates that 20% of the bank loans are classified as NPA. This high ratio may indicate the bank is facing high level of credit risk it could be cause for concern.
It's important to note that Gross NPA ratio is used in conjunction with other financial indicators to understand overall financial health of bank and single indicator may not enough to make a conclusion.
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7. Net NPA
1. Any financial security owned by a bank is considered an asset. The interest we pay on loans is the primary source of income for banks these loans are classified as assets for bank's.
when borrowers can't repay the amount these assets are classified as Non Performing Assets (NPA) because they are not generating any income for the bank's.
2.If loan provided by bank is overdue more than 90 days from the borrower end comes under NPA. If loan amount is unpaid more than 1 year from due date then it's a doubtful debt and if it’s unpaid more than 3 years then loss of an asset or default account.
Net Non-Performing Asset = Gross NPA – Provisions.
Gross NPA = Total Gross NPA/Total Loans given.
Impact of NPA
Due to higher NPA rates, banks will suffer significant revenue losses that will potentially affect their brand image. insufficient funds, banks will have to increase the interest rates on loans to maintain their profit margin.
Let's look at example
Bank has total loans of ₹100 billion and ₹20 billion are classified as Non Performing Assets (NPA). The bank is required to make provisions for ₹10 billion against these NPA. The bank Gross Non-Performing Assets (GNPA) would be ₹20 billion and Net Non Performing Assets (Net NPA) would be ₹10 billion (₹20 billion - ₹10 billion).
If we see the ratio of Net NPA to total loans we get 0.1 (INR 10 billion / INR 100 billion). This ratio of 10% indicates that 10% of the bank's loans classified as NPA after making necessary provisioning. This ratio gives a clearer picture of bank's financial health than just Gross NPA ratio as it takes into account the provisions made against NPA.
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8. CASA Ratio
1. CASA (Current Account and Saving Account) it is measure the proportion of bank deposits that are in the form of current and savings accounts.
2. The ratio is calculated by dividing the total value of current and savings account deposits by the total deposits. It is typically expressed as percentage. Higher CASA ratio indicates that bank have larger proportion of stable deposits. This is because banks can use these deposits to fund their lending activities at a lower cost which improves bank's net interest margin.
Let's look at example
Bank has total deposits of ₹200 billion and ₹150 billion in form of current and savings accounts. The bank CASA ratio would be 75%.
This ratio indicates that three fourth of the bank deposits are in the form of current and savings accounts which are considered the stable form of deposits. This high ratio is considered positive sign. Stable deposits can used to fund lending activities lower cost.
High CASA ratio the bank will have access to cheaper funding which will improve it's net interest margin. This means that the bank will be able to offer loans at a lower rate of interest. which will make it more competitive in the market and attract more customers. And bank will also have more stable funding which will make it less vulnerable to market fluctuations and interest rate changes.
Asset quality, capital adequacy play important roles in assessing a bank's overall financial condition.
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9. Cost to Income ratio
1. Cost to Income Ratio (CIR) measure company efficiency by comparing it's operating expenses to it's revenue. calculated by dividing the total operating expenses by the total revenue and expressed in percentage.
2. Lower (CIR) indicates that company more efficient in managing expenses and able to generate more income for every unit of expenses. while higher (CIR) indicates that company less efficient in managing it's expenses and is generating less income for every unit of expenses.
Let's look at example
Bank A with a high CIR.
Bank has total operating expenses of ₹10 billion and total revenue of ₹15 billion. The bank's CIR is 67% (₹10 billion / ₹15 billion). High CIR indicates that the bank is not very efficient in managing its expenses and is generating less income for every unit of expenses. The bank may need to review its cost structure and implement measures to reduce expenses in order to increase its efficiency and profitability.
Bank B with a low CIR:
A bank has total operating expenses of ₹5 billion and total revenue of ₹15 billion. The bank CIR is 33% (₹5 billion / ₹15 billion). This low CIR indicates that the bank is efficient in managing its expenses and is able to generate more income for every unit of expenses. The bank able to invest in growth opportunities and increase profitability.
I hope you found this helpful.
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Thank you for reading!
Fundamental Analysis
A sense of debtIn the previous two posts, we explored how assets are grouped in a company's balance sheet.
Part 1: Balance sheet: taking the first steps
Part 2: Assets I prioritize
Now let's deal with Liabilities and Stockholders' equity. Let me remind you that these are the sources of funds that give a company assets. And indeed, with what funds can a company have assets? Either with its own funds (stockholders' equity), or with funds borrowed (liabilities). For simplicity, we will call them Debts and Equity.
Debts can vary in maturity, so we've divided them into two categories in the balance sheet: Current liabilities and Non-current liabilities .
Current liabilities include:
- Current debts are debts that need to be paid back within a year after they are incurred. Do you remember our master took a loan from the bank to make a large batch of boots? That loan will be recorded in this item (assuming the loan is up to one year in repayment).
- Accounts payable (debts to suppliers of goods and services). You can borrow money not only from the bank, but also from your suppliers, for example. In other words he is giving you raw materials now, but is ready to accept payment later. Such debts are reflected in this item.
- Accrued liabilities (Provisions for future expenses on unpaid bills in the form of wages, rent, taxes). The word "debt" is in many ways synonymous with the word "liability." A company may have many such liabilities: payment of wages, rent and taxes. In essence, these are also debts to be paid during the year. For convenience, cash reserves are set aside for them. They are spent at the moment when the payment is due. Such reserves are recorded in this item.
- Other current liabilities . Debts or liabilities with a maturity of up to one year that are not included in the categories above are shown here.
Non-current liabilities include:
- Long term debt - these are debts that need to be paid back more than one year after they are incurred. If our master had borrowed from the bank for two years, such a loan would fall into this category.
- Deferred taxes liabilities (Provision for taxes to be paid in a future period). Tax rates are subject to change, and new taxes may come into effect in a year or more. But even now, the company can set aside money for future taxes.
- Other long term liabilities . Here are debts or liabilities with a maturity of more than one year that are not included in the categories above.
In short, debts are loans taken by the company, provisions for tax liabilities, and debts to suppliers.
The amount of debt is a very important indicator in the fundamental analysis of a company. On the one hand, the mere presence of debt is not scary, because it demonstrates that banks trust the company and give it loans for development. On the other hand, a substantial amount of debt can cause serious problems and losses in the period of weak sales of goods or services. Banks are unlikely to suspend interest charges on loans if a company is doing poorly. This means the company will incur expenses in the form of interest on loans that are not offset by revenue. Also a reminder that if a company goes bankrupt, the owners of the stock get the assets of that company only after all debts have been settled . If the debts are so large that they exceed the value of all the property, the shareholders get nothing. For these reasons, I select companies with small debt loads.
What liabilities do I focus on?
- Current debt;
- Accounts payable;
- Long term debt.
For me, these are the items that most clearly reflect the company's debt situation.
In the next post, we will conclude our study of the balance sheet and look at the basic source of assets, which is Equity. See you soon!
Assets I prioritizeIn the previous post Balance sheet: taking the first steps , we began parsing the balance sheet of the imaginary workshop and focused on assets. Today, I suggest looking at what types of tangible and intangible property are classified as current assets and what types are classified as non-current assets.
Current assets contain the following items:
- Cash and cash equivalents - in our case we can include a safe with money, which, in general, corresponds to the company's cash in its current bank accounts.
- Net receivables - here we would include the IOU from a friend. That is everything that clients owe the company for goods or services.
- Inventory - this includes a bag with leather, rubber and thread. That is all raw materials, from which goods are made, as well as stocks of finished goods in warehouses.
- Other current assets - this can include other current assets that do not belong to the previous items.
Non-current assets include the following items:
- Net property, plant and equipment - we include a garage, table, chair, sewing machine and tools. Depreciation is deducted from the original cost of the property when reporting it. Depreciation is the cost to repair and renew the property.
- Equity and other investments - in our example, this would include oil company stocks (and in general, any company investment in stocks or bonds of other companies).
- Goodwill - let's say our company wants to buy another company and is willing to pay $11 million for it. The assets of the other company are $10 million, and the debts that our company will have to pay for the other company are $2 million. So the assets net of debt are $8 million. After the purchase, the assets and debts of that company will become the assets and debts of our company. So, the difference between the purchase amount of $11 million and the net assets of $8 million is a goodwill equal to $3 million. For our workshop, this item is not relevant, as it didn't buy any company. Nevertheless, remember that goodwill is the difference between the purchase price of another company and its net assets.
- Intangible assets - this can include the value of the customer base in the master's phone book, as well as any other assets that have no tangible basis (such as purchased trademarks).
- Other long term assets - this item includes other non-current assets that don't belong to the previous items.
Once we understand which asset belongs to which item, its value (or rather, the sum of the values of all assets belonging to this item) is written in the balance sheet. For example, let's say we've determined that the Inventory item includes leather, rubber, and thread. The accountant adds up the value of the leather, rubber, and thread and writes the total amount in monetary terms against the Inventory item. This is how the numbers appear in the balance sheet.
Now let's discuss which balance sheet items we should pay attention to during the fundamental analysis of assets. I have formulated the following rule for myself: pay attention to the assets that are directly related to the sale of the company's goods or services .
If a company does not sell its goods or services well, its bank account balance will shrink, huge inventories of unsold goods and raw materials will accumulate in its warehouses, and accounts receivable (customers debt) will grow. The fact is that when sales are bad, the company is ready to lend out goods as debt.
If sales are going well, then, on the contrary, the money in the account will grow, and accounts receivable and inventory will start to shrink. All other assets can influence sales only indirectly, so I don't consider them.
Thus, I have identified my priority assets :
- Cash and cash equivalents;
- Net receivables;
- Inventory.
As you can see, they are all quick current assets. Non-current assets only indirectly affect sales, so they are not a priority benchmark for me.
In the next post, we'll start looking at the right side of our disclosed book, called the Balance sheet. That's where the company's liabilities and equity belong. See you next time!
Balance sheet: taking the first stepsToday we are going to start learning about fundamental analysis of companies. In my opinion, this is the basic skill you should have when picking stocks to invest in.
Once again, the main principle of the strategy I follow is to pick outstanding companies and buy their stocks at a discounted price.
You may have noticed that first-class products are occasionally discounted in stores, but not for long, because such products are quickly swept off the shelves, and almost the next day the price is again without a discount. Exactly the same strategy is applicable to the stock market. Now, fundamental analysis is a method for picking outstanding companies (that is, companies with strong fundamentals).
How can we tell if a company has a strong foundation or not? There is only one way - by analyzing its financial statements. Every listed company has to disclose this information publicly on its website. In other words, we don't have to extract that information - it is publicly available. You can also find it on TradingView and see the data in dynamics.
What is the content of this information? The company publishes three reports : balance sheet, income statement and cash flow statement.
The balance sheet, like the order book , can be presented as an open book. The left side of the book lists the company's assets and their valuation in monetary terms, and the right side lists the company's liabilities and equity , and their valuation in monetary terms.
What are company assets? These are everything that belongs to the company: buildings, equipment, trademark, shares of other companies, cash in the cash register. In general, all tangible and intangible property of a company are assets.
What are liabilities and equity of a company? These are the sources of funds that gave rise to the assets. For example, if you bought a computer for $1000 with your savings, then the computer is an asset, and your own savings are equity. If a friend lent you $100, and you put the money in your pocket, the money in your pocket is an asset, and the debt to your friend is a liability. Based on these examples, you can make an imaginary balance sheet:
As you can see, the entry in the balance sheet is the name of the asset, liability or equity and their monetary value. Assets, liabilities and equity are inextricably linked, so the sum of assets is always equal to the sum of liabilities and equity .
If we were to write every asset in this way on the balance sheet of a large company, it would turn into an endless book of hundreds of pages. However, if we look at the balance sheets of huge corporations, they can fit on a single sheet of paper. This is due to the fact that over time invented to group the same type of balance sheet items. Let's look at how the company's balance sheet items are grouped:
Don't be frightened. Now we will try to digest this table with the help of an example we are already familiar with. Let's think back to our master cobbler , specifically to the period when he was just starting out.
Let's assume what exactly he had at that time: a garage, a table, a chair, a sewing machine, tools, a bag with leather and rubber, thread, a safe with money, a phone book with clients' contact information, a IOU from his friend, and oil company stocks.
I have now listed the assets of our master, or should I say, of his workshop. I should note that what is listed here is exactly what is directly related to his business. Even the money in the safe, the debt from his friend, and the oil company shares came about because of the existence of the business. Let's say the master's apartment or the bicycle he rides in the park are not assets, because they don't belong to the workshop. They belong to the master, but not to his business.
Let's categorize the workshop's assets into groups. There are two big groups: Current assets and Non-current assets .
How should you distinguish them? The general rule is this: Current assets are what a company's product is made of, and what can turn into money in the near future, so they can be called quick assets . Non-current assets are where and with what we create the product, and what can turn into money not so soon (so they can be called long-term assets ).
So, here we go:
- A garage, a table, a chair are where we create a product, so a long-term (non-current) asset.
- A sewing machine, tools - this is what we use to create a product - a long-term (non-current) asset.
- A bag with leather and rubber and thread is what a product is made from - a quick (current) asset.
- A safe with money is already real money - a quick (current) asset.
- A phone book with customer numbers - it's hard to sell it to someone quickly, such assets are also called intangible assets and are placed in long-term (non-current) assets.
- IOU from a friend, i.e. a friend bought boots from a master, but can pay only after receiving his salary - a quick (current) asset.
- Shares of an oil company - let's assume that a customer once paid for the boots with them - a long-term (non-current) asset.
So, we've just categorized the master's assets into two groups: current assets (quick assets) and non-current assets (long-term assets). In the next post, we'll break down the components of these two large groups. See you then!
Man on the shoulders of giantsIsaac Newton, who turned people's view of the world upside down, once said: "If I have seen further than others, it is by standing on the shoulders of giants". And indeed, each of us has a chance to discover something new for ourselves and others by drawing on the wisdom of our predecessors. I want to say a big thank you to Benjamin Graham, David Dodd, Warren Buffett and Peter Lynch, who openly shared their ideas with the world and inspired more than one private investor in their first investments.
I'm sure Mohnish Pabrai will join me in saying the same. Born in Mumbai, an engineer by training, he had no interest in the subject of stock investing until he was 30 years old. But by chance, after reading a book by Peter Lynch, he began to study the subject more deeply. Centimeter by centimeter he climbed the shoulders of the giants of value investing to see hitherto unknown horizons. He is now known as a successful investor, author of books on investing, and creator of incredibly kind philanthropic initiatives.
Listening to Mohnish Pabrai's lectures, I noted his ideas, which in many ways coincide with my own. I am happy to share them with you:
1. The market is always concerned about what will happen to the company in the future, so it cannot be 100% efficient (*).
(*) Let me remind you that according to "efficient market" theory, a company's current price reflects its "fair value" because any publicly known information instantly affects the price. Thus, an investor is unlikely to make a profit on any information, such as a company's strong financial statements, because the market has already reflected the event. However, this theory does not take into account the future, which we all think about every day and act in the present, including the market, based on those thoughts. For example, someone may think that a company's future is murky because of the news that has come out. This concern will be picked up by the crowd, and the stock will go down. Or on the contrary, the success of the company may be perceived as over-optimistic, and a real stir will start around the stock. No one knows the future, but thinking about it affects the present. For this reason, the current price of the company may not reflect its fair value, contrary to the "efficient market" theory.
2. Continuing with the first thought, the waves of pessimism and optimism will always be present in the market. They distort a company's value so much that they give us private investors a chance to buy and sell a company's stock profitably.
3. The more time you spend analyzing a company, the more you "fall in love" with it. Try to grasp this idea. After all, by spending a lot of time studying something, such as a company's excellent financial statements, we set ourselves up for what it must pay off as a profitable investment. Remember: the market doesn't owe you anything.
4. Often the decision to invest in a company can be made based on just a few surprising figures. For example, if the value of a company is equal to 50% of the amount of cash in its checking account. Mohnish Pabrai said that Warren Buffett used a reference book with the statements of thousands of companies, not to spend months studying each of them, but to find something that would really surprise him.
5. Mohnish Pabrai admitted that he has never once played the short and has no intention of doing so for the rest of his life. His math is really simple. If you play the short by selling a stock at $100, your maximum earnings are capped at $100 (which will happen when the stock drops to zero). Whereas a buyer of a $100 stock has a chance to sell it at both $1,000 and $2,000. There is no upside restriction by its very nature.
6. And the thought I want to conclude this post with is don't look for people to hand you a treasure on a platter. Looking for treasure is much more interesting! It's about not trying to replicate someone else's trades or portfolio positions. Try to make your own decisions. Try to see your horizon.
The unwavering shoulders of giants will help you in all of this.
POWER OF COMPUNDING IN TRADING AND INVESTMENT Hello guys here I am sharing a very interesting topic for which we heard and discuss many times and that is Compounding my dear friends so I am trying to share few things about it below-:
WHAT IS COMPOUNDING-: Compounding is the concept of continually reinvesting the earnings from an investment to generate more earnings, which are also reinvested to earn more, thereby growing the value of the investment over time. To put it differently, compounding is the process of generating earnings from both the initial capital and the earlier earnings on the capital. The term compound gains refers to the sum of the accumulated earnings over the specified period. That is, the gains earned on the principal amount is reinvested, and it earns an additional gains — the accumulation of both the interest on the principal and the gains on the earlier gains is called compounding gains.
So, compounding is basically a process of earning compound returns on an investment. Compounding is a simple concept but very powerful because it has a multiplier effect on the initial capital — the ability of the investment to generate earnings from not only the initial principal invested but also the subsequent returns earned over the coming period. No wonder Albert Einstein referred to it as the 8th wonder of the world: “The magic of compounding lies in the fact that it can help investors multiply their returns over the long-term”.
WHAT COMPOUNDING REQUIRES AND HOW IT WORKS-: Compounding requires three things:
1- The original investment remains invested
2- The reinvestment of earnings
3- Time
The more time you give your investments, the more your earnings would accumulate. So, to take full advantage of the power of compounding, you have to start investing early so that your investment will have enough time to accumulate and compound earnings. However, what you earn depends on the rate of returns, as that is what accelerates the income potential of your original investment.
To understand how compounding works, let’s take a look at this example. Assuming you invest $100 at a 10% return, you’ll have $110 at year’s end. If you don’t reinvest the 10 you earned, your return at the end of year 2 will still be just $10 (10% of the initial 100), and you will have only $120. But if you reinvest that $10 you earn the first year, you will also make a 10% return on it in year 2, so your total return on year 2 will be $11 instead of just another $10, and you will have $121 instead of $120 as you would if you weren’t compounding your earnings. See the two tables below for non-compounding investment and compounding one for a 10-year duration.
HOW TO GROW TRADING ACCOUNT BY COUMPOUNDING-: The same way the power of compounding is used to grow investments, you can use it to grow your trading account because your trading capital is an investment on its own. But since trading is an active process and with no consistent rate of returns, you need to know how to actively make compounding work for you.
Before we go into details, let’s examine some important trading concepts you should know, which are necessary for implementing a growth plan. These are the three key ones below
Account risk percent: This refers to the percentage of your trading account you risk per trade. This can be 1%, 2%, 5%, or even 10% if you are an aggressive trader. Most experts advise traders to risk only 1% or 2% of their account capital in each trade to reduce the possibility of blowing their accounts in no time. Once you have chosen the right percentage to risk in each trade, you may want to keep it constant.
Position size: This is the quantity of the instrument you carry in each trade. For stocks, it is the number of shares you buy, while for futures, it is the number of contracts you want to trade. In forex trading, it is called lot size. Whichever the market, your position size is a function of how much you want to risk in that trade. To get your position size, you need to convert your account risk percent to the dollar amount. For example, if you have a $10,000 account and decides to risk only 1% of it in each trade, it would translate to risking only $100 in each trade. With this, you can calculate your position size if you have decided where to place your stop-loss order. Here’s the formula in the case of stock trading: Position size = account risk (in dollars)/ (stop lose size x the share price). Assuming the account risk is $100, the share price is $5 per share, and the stop loss is 10%, the position size (number shares to buy) is 200 shares (100/ ). Thus, as your account balance grows, your position size increases without increasing your account risk percent.
Reward/risk: This is the ratio of what you stand to make for any risk you take. It depends on your trading strategy. You can have a trading strategy that allows you to have your profit target at 2 times your stop loss size. For instance, if your stop loss is a 10% drop in share price, your profit target can be a 20% gain in the share price. So, if your strategy has a fixed stop loss and profit target, you can only increase your earning by increasing your position size, which you can do only when your account balance increases so that you don’t increase your account risk percent.
So that is it friends mates and respected seniors I have to bind up this article already it has been lengthy so going to share one last point and that is the difference between compounded or non compounded returns-;
NON COMPOUNDED INVESTEMENT
COUMPOUNDED INVESTMENT
A pill for missed opportunitiesPrevious parts of the post:
Part 1: My Three Comrades: the Chart, the Screener, and the Watchlist
Part 2: Two captains of the same ship
The market is an element we take for granted. It can't stop when we're busy doing other things, and it can't work if the stock market is off and you personally have work days.
The small investor's impact on the market is close to zero. Some may not like it, but I see it as a big plus. I'm not the only one. Even Peter Lynch wrote about this . It is because of our size that we small investors have the ability to get the best buy and sell prices on stocks. Just imagine an elephant and a mouse trying to drink water from a coffee mug. Who has a better chance?
Like the best sales, attractive stock prices don't last long. This also applies to the period of increased stock prices that are interesting to sell. To make sure you don't miss this time, TradingView has an alert service.
Why do we need an alert system? For our convenience. Once we have selected fundamentally strong companies, our next step is to keep an eye on their stock price so we can buy them at a price we can benefit from.
You remember our strategy, right? Buy rooms in a great hotel, and even during a sale period.
How do you monitor these "sales"? You have two options: to monitor the price chart yourself during the trading period, or set up alerts so that if the stock price reaches a certain level, you will receive an SMS message to your phone or email, or a push-notification in the TradingView app (depending on your settings). Agree, this is very convenient.
So how do you set up the alerts?
1. First of all, you must open the chart of the stock you are going to configure the alerts for.
2. Then click on the "Alert" button at the top toolbar of the chart.
3. Set the alert parameters in the settings menu.
How do I read the settings in this picture?
If the Apple stock price is less than $130 per share, I will receive an alert every minute, all the time the stock is trading below $130.
The alert I will receive will contain the following message:
AAPL Less Than 130.00
If you don't want to get an alert every minute, set the trigger to "Only Once".
4. In the "Notifications" tab, you can configure where the alerts and the sound will go. The system of customized alerts will allow you to use your time effectively. You will not be chained to the monitor and you can calmly wait for the cherished message.
In the picture you can see that alerts can come as:
- push notification to your phone (if you have the TradingView app installed);
- a pop-up window on your monitor;
- a letter to your email address;
- a message to a web address (advanced feature for developers);
- SMS to your phone, but via email (i.e. your email service must have the ability to send copies of emails via SMS).
As for my investment strategy, it's quiet enough to work on it even without alerts. Mr. Market doesn't often come with insanely interesting prices, so it takes time to get to the target values. It's like waiting for an astronaut from the Moon: he can't return to Earth in a day, you have to wait patiently, with the occasional peek at the situation.
So, I'm concluding my series of posts dedicated to the basic functions of TradingView. I advise you to "play" with the platform for a while to get used to it as quickly as possible. In fact, it has a lot of features that you will discover over time. For now, that's it.
In the following posts, we will begin to examine perhaps the most important aspect of an investment strategy, which is fundamental analysis. Get ready, here comes the part that will require the most concentration. But then you will be able to navigate this topic with ease.
See you next time!
Two captains of the same shipPrevious part of the post: My Three Comrades: the Chart, the Screener, and the Watchlist
Now let's move on to the fundamental analysis. Remember in this post I gave the example that a joint stock company can be thought of as a hotel, and owning shares can be thought of as owning one or more rooms in that hotel. So, imagine now that our hotel has a terrible foundation with lots of holes in it. What would happen to such a hotel? Of course, it could collapse, dragging everything down with it. It would also affect the value of the stock, and in our case, the value of the rooms. Because no one will want to buy rooms in such a hotel, on the contrary, they will try to sell them at any price, and then the value of rooms (stocks) will go down.
The purpose of fundamental analysis is to understand how financially stable and profitable the chosen company is. Sometimes they say that a company has a strong or weak foundation - a generalized conclusion based on analysis of its financial statements. So, our task will be to find stocks of companies with strong foundations.
Let's go to "Chart+" and select "Indicators" in the upper toolbar. A menu will open for you, where on the left we will select "Financials". Here we can select data from company reports: Balance Sheet, Income Statement and Cash Flow. They are issued quarterly and annually. Accordingly, you can select any indicator from the statements, such as revenue, select the period - quarter or year, and add it to the chart. In this way, you can study the dynamics of this indicator over time.
In addition to the reporting data, you can add so-called multipliers to the chart. They are placed in the same menu after the "Cash Flow" > subsection called "Statistics". What is a multiplier and how to analyze the statements, we will discuss in our separate posts on the fundamental analysis, and now let's move on to the technical analysis.
Technical analysis is a search for recurring patterns on a price chart in order to predict its future behavior.
Let's go back to the time when candlesticks were invented. These charts appealed to traders so much that they began to look for repeating combinations of candlesticks, which served as signals of future price movement.
For example, there is a combination called "bearish engulfing" . When the market has a clear upward trend, and in one day, a massive bearish candle appears, the body of which closes the body and shadows of the previous candle - it can herald the reversal of the uptrend.
Or, if the market for three days in a row is drawn three black candles with massive bodies - they are called "three crows" . Traders interpret this as a sign that the downtrend is continuing.
Doesn't that sound like an omen to you? In fact, people have made up dozens of similar patterns and many more that, like weather forecasts, don't always come true.
You must have sensed that I cover this topic rather cursorily? This is due to the fact that I do not use technical analysis at all. That is, I do not make predictions based on recurring situations from the past.
I do, however, use one of the tools of technical analysis, which is the average value of the stock price over the year. Not to make predictions, but to have a guideline: when to buy and when to sell stocks of companies with strong fundamentals.
I will surely elaborate on this in my next posts, but for now, wrapping up the topic of technical analysis, I want to give one analogy.
Stock price movements can be compared to the sea: sometimes it is calm and sometimes it is subject to strong waves. An investor can be compared to the captain of a ship who has to decide whether to put to sea now or not (i.e. whether to buy stocks or not).
A captain who looks at the official weather reports and gauges is like an investor who uses fundamental analysis. And a captain who is only guided by omens and his gut is like an investor making a decision based on technical analysis.
You can be captain number two without me, but how to become captain number one is the subject of my blog.
My Three Comrades: the Chart, the Screener, and the WatchlistToday we will continue to explore the fascinating world of stock investing. And TradingView will help us with that. I sincerely recommend making friends with this platform, as I haven't found anything more convenient to implement my strategy yet.
After you have registered on the site, move to the main menu "Products" > "Chart+" . This is where you'll spend most of your time with the platform.
What opportunities are in front of you:
- Find companies to invest in;
- Make a fundamental analysis of the companies;
- Make a technical analysis of stock charts;
- Receive alerts on the buy or sell price of a stock that is right for you.
So, let's break down each item. How to search for stocks on TradingView?
Hopefully, you've already entered the "Chart+" section. In the upper left corner is a line to enter the ticker of the stock. If you don't know the ticker, just enter the first letters of the company name: the system will find the ticker that corresponds to that company on its own. However, keep in mind that stocks of the same company may be traded on different exchanges from different countries, so sometimes one company may have several tickers.
As an example, let's enter the name "Tesla" in the search bar to open a chart of their stock. As we can see, the system tells us that Tesla is traded on NASDAQ and some exchanges in other countries.
To the right of the search bar is a button with a choice of time frame. You can try different time frames, but for me the most important is the time frame of 1 day (i.e. one candle shows the price change for 1 day).
So, the way of selecting a company via the search bar is convenient when you know at least its name. But there are thousands of companies listed on the stock exchange, and it is impossible to know the name of every company. In this case, the "Stock Screener" will help us. It is located in the lower left corner. Clicking on the Screener will open a list of stocks, filtered according to the parameters you set (you can customize the parameters by clicking on the bright blue button "Filters" on the right).
Let's go to filters and configure the parameters we need. First of all, let's select the country - (for example), the USA . In the second turn, on the tab with general parameters, let's choose the instrument type - common stocks , and let's choose the exchanges - NYSE , NASDAQ , and one more American exchange - NYSE ARCA . Now we have a list of all stocks, which are traded on the exchanges that we have chosen.
What we are interested in, we can add to the "Watchlist" . This is the first (top) button in the menu on the right. Just right-click on the ticker from the screener and select "Add to Watchlist". The same can be done by right-clicking on a chart. Switching between the tickers in the Watchlist you will consequently switch between the charts.
So, we have figured out how to find the shares of a company. In the next post, let's see what we have in terms of fundamental analysis of companies.
A little bit about volumes and the master of all averagesSo, let's refresh our knowledge from the previous posts (read part 1 and part 2 at the links):
- The chart is based on the data from the tape;
- The X-axis is the time scale, and the Y-axis is the price scale;
- To avoid having to analyze a huge number of trades, interval charts were invented for convenience;
- The most popular chart type is the Candlestick chart;
- The candlestick consists of a body and shadows (upper and lower). The body is drawn at the open and close prices of the interval. The shadows are built by the maximum price (high), and the minimum price (low);
- The time interval for one candle is called a time frame. The smaller the time frame, the more detailed information we get about the price changes.
In addition to information about the price dynamics, from the stock chart, we can get information about the dynamics of trading volume. These are bars that we see below the candlesticks. They are also drawn on the basis of information from the tape. Let's return to our example:
FB $110 20 lots 12/03/21 12-34-59
FB $115 25 lots 12/03/21 12-56-01
FB $100 10 lots 12/03/21 12-59-12
FB $105 30 lots 12/03/21 12-59-48
If you add up all the lots of trades in the interval from 12-00-00 to 12-59-59, we get 85 lots. Then the lots need to be multiplied by the number of stocks in one lot, for example, 100. It turns out that 8500 shares changed their owners in 1 hour. This information is displayed as a bar below each candlestick.
My strategy does not use a trading volume analysis, but it is important to understand that increasing trading volumes are a sign of increasing attention to the stock. However, this attention does not always translate into higher prices. If there is negative news about a company, we will see both a drop in the stock price and an increase in volume.
What is constantly used in my investment strategy is the moving average . What is it? This is the average of the close prices of a selected number of candles, starting with the last one.
I use the average of the close values of the last 252 candlesticks. Why this number? The number 252 corresponds to the average number of trading days per year on the NYSE and the NASDAQ. That is, in fact, the average annual moving price .
Why is it moving? Because every day there is a new candlestick with a new close value, and it begins a new calculation of the average value of the last 252 daily candlesticks.
You can plot the moving average chart on a candlestick chart and see how far the current price has "run away" from the annual average price. I will tell you exactly how to apply this in investing in the next posts, and that's all for today.
Finally, I will ask you to reflect on one thought:
One who is true to the golden mean will always find something that someone else missed and give it to someone who is afraid to miss it.
See you in future posts.
Japanese Candlesticks: Game of Body and ShadowsSo, in the last post we learned how to build a simple line chart based on the tape. Each point on the chart is defined by coordinates from the time (X scale) and price (Y scale) of a trade. But some stocks are traded at a frequency of hundreds of trades per second, at different prices. The question arises: which trade price to choose from this set?
Interval charts were invented to solve this question. The most popular is the Candlestick Chart . They appeared in Japan three hundred years ago, when the Japanese exchanges were trading rice. They were invented by a trader named Homma. Apparently, being tired of drawing a lot of points on charts, he decided that it would be more convenient to show the price change over the time interval. So, what he came up with.
Let's take a time frame equal to one hour and plot a 1-hour candle on the basis of the following tape:
FB $110 20 lots 12/12/22 12-34-59
FB $115 25 lots 12/12/22 12-56-01
FB $100 10 lots 12/12/22 12-59-12
FB $105 30 lots 12/12/22 12-59-48
A candle consists of a body and upper and lower shadows. Like a float. The body is formed from the open and close prices of a certain time frame. In our case the hour interval is from 12-00-00 till 12-59-59. Only 4 deals were concluded in this time interval. The price of the first deal is $110, which is the opening price of the period or the so-called " open ". The price of the last deal was $105, which is the period closing price or " close ". These two prices are enough to form the body of the candle.
Now let us move on to the shadows . The upper shadow is drawn at the maximum price of the interval (115$) and is called " high ". The lower shadow is drawn at the minimum price of the interval ($100) and is called " low ".
The shape of our candle is ready. However, it should also have a content, namely the color. What is it for? Let's take a look at another candle.
Here we can see where is the high and where is the low. But how do we know which is the open or the close? After all, the open is not always at the bottom of the candlestick body, as in the previous example, it can be at the top.
To understand where is the open and where is the close, Homma has invented to paint the body of a candlestick in black, if close is lower than the open, i.e. if the price in the interval is falling (falling candle or bearish candle ).
But if close is higher than open, the body of the candle remains white, it will indicate the growth of price during the interval (rising candle or bullish candle ).
Sometimes a candlestick has shadows, and the close price is equal to the open price. Then it will look like a cross. This candlestick is called a doji .
White and black are the classic colors for the bodies of Japanese candles. However, you can come up with your own colors. If you want the rising candles, for example, to be blue, and the falling orange - you're welcome. The main thing is to make it convenient and understandable for you.
So, one candlestick allows us to understand where we had the first trade, the last trade, the price maximum and minimum in a given time frame. But it does not allow us to understand how the price changed within the interval: when the maximum or minimum was reached and what was happening within this price range.
But the problem can be easily solved if we switch to a smaller time frame. If we look at the daily candlesticks (this is when the time frame of one candle is equal to one day), and we want to see what was during the day - we switch to the hourly time frame. If we want to see even more details - we switch to 15-minute candles and so on down to the seconds. But you and I will most often use daily timeframes, so as not to be distracted by the fluctuations that occur during the day.
To be continued :)
The birth of the chart. The evolution of the tapeLast time we studied how the exchange price is formed, and we found out that it is important to learn how to read charts correctly in order to analyze price changes correctly. Let's see how a chart is made and what it can tell us.
Everyone who went to school probably remembers: to draw a function, we need the X and Y axes. In stock charts, the X-axis is responsible for the time scale, and the Y-axis is responsible for the price scale. As we already know, a chart is built on the basis of data from a tape. At the previous post , we have produced the following tape:
FB $110 20 lots
FB $115 5 lots
FB $100 10 lots
Actually, in addition to ticker, price and volume the tape also fixes time of trade. Let's add this parameter to our tape:
FB $110 20 lots 12/08/22 12-34-59
FB $115 5 lots 12/08/22 12-56-01
FB $100 10 lots 12/08/22 12-59-02
That's it. Now this data is enough to put points on the chart. We draw three points, connect them with straight lines and get a chart.
At one time, this was enough, because trades on the exchange were not frequent. But now some popular stocks, such as Apple or Google, have hundreds of trades per second with different prices.
If the minimum division on the X scale is one second, what price point should we put if there were many trades at different prices in one second? Or let's place all the points at once?
We will discuss that in the next post. And now, as a postscript, I want to show you some pictures describing how the tape was born and evolved.
Here is a picture of a stock player, looking through a tape with quotations, which is given by a special telegraph machine.
Each telegraph machine is connected by wires which, like a spider's web, entangle New York City.
1930's broker's office with several telegraph machines and a quotation board.
An employee of the exchange looking through a tape of quotes. It won't be long before all this is replaced by the first computers.
We'll continue today's theme soon.
Price Action Trading Plan - BeginnersPrice Action Trading Plan - Beginners
Step 1 :Before you trade, consider your strategy for the day and how much risk you are willing to take.
Step 2 : Determine whether the market trend is bullish, bearish, or sideways.
Step 3 : Plan for proper entry and exit once trends have been identified.
Step 4 : Avoid trading under duress. Be committed to your plans before engaging in the trade.
Step 5 : Take pleasure in the
Three important parameters that every beginner should be aware of
Human Psychology
System Development
Money Management
Happy Trading ! Support Trading Community
History of Stock Market Crashes In IndiaHistory of Stock Market Crashes In India
In this post we'll go back in time and examine various known and unknown stock market crashes in India.
When is it said that the stock market crashed?
Every participant in the stock market has heard the term "stock market crash." But how many people understand what it really means?
When the Nifty falls by more than 10% in 20 days.
When the difference between a day's high and the next trading day's low is greater than 10%.
When NIfty falls by more than 5% in a 9-day period.
Crash of 1865
In India, the first recorded stock market crash occurred in 1865.At the time, India had no formal stock exchange.Some Gujarati and Parsi traders would mutually trade stocks of Indian companies at the corner of Meadows Street and Rampart Row.
The American Civil War, which began in 1861, increased demand for cotton, which was a major export commodity for Indian companies at the time.The earnings from this boom were invested in the stock market, causing a buying and selling madness as well as an increase in speculation transactions.
The Civil War ended in April 1865, resulting in a decrease in cotton demand and a stock market crash.
Crash of 1992
The 1992 stock market crash may be the most well-known of all time. This was the first time that a major scam that include Rs. 5,000 crores or more had hit the Indian stock market. Mr. Harshad Mehta's planned security scam made contributions to the 1992 stock market crash. BSE fell by roughly 12%. The eventual bear market in the face of the scam lasted two years. It wiped out crores of rupees in the banking sector and is regarded as one of the worst time frames in Indian stock markets.
Crash of 2004
The 2004 stock market crash was caused by the sudden fall of the NDA government, which resulted in a 15.52% drop in the Sensex. In terms of percentage, it is the largest fall in Indian stock market history. The fall of the government stimulated UBS, an institutional investor, to sell the shares, fearing political instability.
Crash of 2008
The Sensex fell by around 1408 points on January 21, 2008, eroding investor wealth. This day is known as Black Monday, and analysts attribute the drop to a variety of factors.
Factors such as a drop in interest rates, a lack of investor confidence, the sale of shares, and the exit of FIIs and Foreign Hedge Funds from risky emerging markets The stock markets encountered a continuous crash throughout the year, and it took approximately two years for the market to recover and return to pre-crash levels in September 2010.
Crash of 2015
After a good run since the fall of 2008, the markets crashed again in 2015 against the backdrop of a falling Chinese economy. The Shanghai stock exchange fell by an unbelievable 8.5%, having caused the Indian stock market to fall well as. Other factors that led to this drop included poor income by major Indian companies.
Crash of 2016
By the beginning of 2016, the Indian stock markets had fallen by approximately 26% over an 11-month period.The increase in bank NPAs, the decline in crude oil prices, the slowing of the Chinese economy, and general global weakness and lack of investor confidence all contributed to this drop.
Crash of 2020
The rapid spread of COVID-19, that also resulted in a pandemic and globally lockdowns, caused a massive market crash in the global and Indian markets.The stock markets fell continuously for five days, marking the worst drop since the 2009 crash.This coincided with the Yes Bank crisis, which caused the strong BFSI sector to lose ground as well.
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Market order or the hunger games of stock tradingThe previous parts of the post can be found at the links:
Part 1 - How is the share price formed on the stock exchange? We do it
Part 2 - Bid/Offer: The Yin and Yang of Stock Prices
So, let's continue. So why don't we ever see some orders in the order book?
Because such orders don't have a price, which means they can't be arranged in a book where all orders are sorted by price. This type of order is used by buyers or sellers who don't want to wait for a counter offer with a suitable price.
"But how can you buy or sell something without specifying a price?" - you ask. It turns out it's possible. When you put out an order without specifying a price, the order simply "eats up" the number of lots you need at the prices currently on the books. Such an order is called a " market order ". We can say that the most "hungry" investors who want to satisfy their "hunger" right now use the market order. Remember yourself: when you really want, for example, a cake, you won't stand at the counter and wait for the seller to set the price you want, you'll just buy the cake at the price that's valid at the moment.
So, let's imagine that someone sent the following order to the exchange: " to sell FB stocks in the volume of 20 lots". Such an order will not appear in the book, but it will "eat" all bids within 20 lots, starting with the most expensive ones.
In our example, there were a total of 15 lots left in the book, so the following concluded trades will be printed in the tape:
FB $115 5 lots
FB $100 10 lots
What will happen to the remaining market order of 5 lots (20-15) that couldn't be filled? The exchange will cancel the order for this remainder, as there are no counter offers in the book.
So, let's review what we learned in the current series of posts:
- For each company, the exchange maintains its own order book for buying and selling stocks;
- A buy order is called a "bid";
- A sell order is called an "offer";
- The order must contain the ticker (abbreviated name of the stock), the direction of the transaction (buy or sell), the price per share and the volume in lots;
- The lot size is set by the exchange. It may be equal to 1 share, 100 shares or some other quantity;
- All orders in the book are called "limit orders";
- There is a special type of orders, which are called "market orders". They have the following parameters: ticker, trade direction, volume in lots, and have no "price" parameter.
- The intersection of buy and sell orders by price creates a trade;
- The volume and price of a trade depends on how much volume was "eaten" in the counter offer and at what price;
- The trade is recorded in the tape. Each company has its own tape.
By the way, our book became empty because all limit orders were filled and no new ones came in. As a result, we have a tape of three trades. The trades are recorded in the tape according to when they were made:
FB 110$ 20 lots
FB 115$ 5 lots
FB $100 10 lots
So, when you see a flashing stock price somewhere, like in the broker's app, know that it's the last trade in the tape as of the current second. Or if you hear that Tesla stock has reached $2,000 a share, that means that there's a $2,000-a-share deal imprinted in the Tesla tape.
To show how the stock price has changed over time, a chart is made based on the prices of the trades and when they were made. At its core, a chart is a demonstration of how the stock tape has changed over time.
Knowing how to read a price chart is a basic skill that you will use as you invest. I will tell you how to read charts at our next meeting.
Bid/Offer: The Yin and Yang of Stock PricesRead the first part of this post at the link: How is the share price formed on the stock exchange? We do it
So at what price and what volume will the deal eventually be made?
To understand this, let's go back to the "price" parameter of the order.
When a buyer placed an order "to buy 25 lots at $115 a share", the exchange takes it as "to buy 25 lots at a price not more than $115 a share". That is the purchase price can be less than the price stated in the order, but not more.
And when the seller earlier submitted an order "to sell 20 lots at $110 a share", the exchange takes it as "to sell 20 lots at a price not less than $110 a share". That is, it is possible to sell at a price higher than that specified in the order, but not less.
Once again: buyers always put orders "buy at no more than such-and-such a price", and sellers always put orders "sell at no less than such-and-such a price".
So, we return to the situation with the crossing of prices. When the exchange detects a crossover, it begins to execute the order that has caused this crossover. In our case, it is an order for 25 lots at $115 per share. This order kind of "eats up" all sell orders that are on the way to the price of $115 (that is, everything cheaper than $115), until it reaches 25 lots.
Which orders were "eaten up" in our case? One single order to sell is 20 lots at $110 per share.
What was "eaten" is recorded as a buy and sell trade in what's called a tape. It's similar to the way a cash register punches a check with a price. The record looks like this:
FB $110 20 lots
However, we have a remainder after the trade is 5 lots, the remainder of those 25 at a price of $115. Since at this price (or lower) nothing can be "eaten", the order remains in the left page of the book until a suitable offer.
Let's see how the FB order book looks now, after the deal is done:
Let me note again that all orders in the book are sorted in descending order from top to bottom.
The concept of "book" is very useful for understanding how the exchange price is formed. In the past, when there were no electronic trading systems, there were so-called floor brokers, who used to collect and record prices and volumes of orders in a real book. Nowadays you may encounter alternative terms like Depth of Market (DOM), Level II, but they are all identical to the notion of an "order book".
The orders to buy that we see in the order book are called "bids", and the orders to sell are called "offers". So, in our order book there are two bids and no offers. All bids and offers are called "limit orders" because they have a price limit.
But there's also a type of order that we will never see in the book. Why? I'll tell you in the next post.
How is the share price formed on the stock exchange? We do itYou already know that the stock exchange is a one-stop place to buy or sell stocks, whether you are a novice investor or a seasoned professional. But even if you don't trade stocks, you will still "come" to the stock exchange to find out stock prices.
Let's find out how the exchange price of a stock is formed. Regardless of what country the stock exchange is in, the rules for determining the price are similar for everyone. Let us understand how it works, as always, with the help of our imagination.
Imagine a large rack of books. Each book has a name on the cover: Apple, Facebook, Amazon, etc. Let's take one of the books, let's say Facebook, and open it. We will see only two pages, and they are both blank. On the left page we will record buyers' orders to buy shares, and on the right page we will record sellers' orders, respectively, to sell shares. So, every day the exchange, when it opens trading, essentially opens such a "book" and records every bid it receives.
What should be written in the order?
First of all, there must be an abbreviated name of the stock, or, in professional slang, the "ticker," to understand which book to get off the shelf. For example, Facebook shares have a ticker consisting of two letters FB, while Apple shares have four letters - AAPL.
Second, the order must indicate the direction of the transaction, i.e. "buy" or "sell". This is how the exchange understands whether to record the incoming information on the left or on the right page of the book.
Third, the order must indicate the price per share, so that the exchange can sort the orders in descending order of price from top to bottom.
Fourth, the order must specify the volume in lots, that is, how many lots of shares we want to buy or sell. To clarify: Shares on the exchange are not traded by the piece, but by the lot. The lot size is set by the exchange. One lot may be equal to one share, or a hundred, a thousand, or even ten thousand shares (depending on the specific share). This is really handy because the price of one share can be equal to, for example, the price of your computer (then 1 lot may be equal to 1 share), and sometimes 1 share may be worth as much as a box of matches (then 1 lot may be equal to a thousand shares). Why "may be"? The specific rules for determining the lot size depend on the laws of the country and the exchange itself. For example, on the New York Stock Exchange (NYSE), the usual size of 1 lot is equal to 100 shares.
So, let's return to our example. Suppose we want to buy shares of FB at a price of $100 per share in the amount of 10 lots. Then the exchange will record the following on the left side of the FB book:
100$ 10
Then there is a seller who wants to sell FB stock at $110 per share in an amount of 20 lots. Then this is what the exchange will record in the right side of the book:
110$ 20
Then there is a buyer who wants to buy FB stocks at $115 per share in an amount of 25 lots. The entry on the left side of the FB book will look like this:
115$ 25
And now comes the interesting part.
Did you notice that the $115 price in the last buy order is higher than the single sell order of $110? That means the buyer is willing to make a deal at a price even higher than what the seller is offering. So at what price and what volume will the deal end up being made?
Please wait for the next post.
Picking rules - the Lynch methodBack in 1977, the still famous investment company Fidelity Investments entrusted the management of a small fund of $18 million to this very man. The next 13 years were impressive for the Magellan fund and its manager - the famous Peter Lynch. The fund's assets grew to $14 billion, more than doubling the average annual growth of the S&P500 stock index.
When he stopped actively managing assets, Peter shared his approach with the rest of us. Some of his thoughts inspired me to create my approach and may be useful to you as well.
1. The private investor has an objective advantage over institutional investors (e.g., funds) because he is more agile. He is not burdened by the need to coordinate his actions with the management of the company, and his purchase requests are easily satisfied by the market. Agreed, it's easier to buy for $1,000 than it is to buy for $1 billion. Thus, the private investor can catch prices that the big "players" will have a hard time getting.
2. Don't spend everything you have under your belt on stock investments. The trades will not be able to close "in the plus" just by your own volition. So first provide yourself with a financial safety cushion, a stable job and a place to live, and then start investing.
3. Admit to yourself: are you a patient person who is capable of making independent decisions, diving deep into analysis and soberly reacting to plus and minus changes? If not, practice, but on small volumes.
4. Never buy a company's stock if you can't explain what it does and can't talk about its financial performance. The stock market is no place for gambling. There are slot machines, etc., for that.
5. The company works for profit and grows because of it. So keep an eye on everything that affects profits. Evaluate the company not in monetary units, but in the number of profits.
6. Watch where the company invests its profits. If it's mostly capital investments that will probably make a profit someday, in the distant future - think about it. After all, the beautiful future as conceived may not come. If, on the other hand, the company is allocating its profits to buying its own stock, it means that management thinks the current stock price is attractive enough.
7. The success of the stock may be unrelated to the company's financial success. Beware of such investments.
8. A company's financial success may not be reflected in its stock price for a long time. However, the longer the period in question, the more direct the relationship. So if you select companies based on an analysis of financial performance, be prepared to make a long-term investment.
To this day, these thoughts help me look at assets consciously and not give in to spontaneous decisions.
What do you think of this approach?
I dream of entering the stock market. The question is: What for?Read the previous part of the post here .
Having received only denials, the owner of the workshop decides the following: it would be great if shares were sold and bought not in the offices of banks, but in one single place - the stock exchange. Then those who want to vote would be able to buy as many shares as they need votes. Those who want a discount will wait until the price on the stock exchange falls to an acceptable level for them. And those who bought one share would be able to sell it at any time at the exchange price. The owner likes this idea and decides to list his shares on the stock exchange.
Another term to remember is listing. Listing is the service of the stock exchange to allow the shares to be traded on the stock exchange.
Now the shares can be bought or sold in one place, simply by connecting to the stock exchange trading through brokerage companies. The banks, which have brokerage licenses, also liked it. The main thing is that now they do not have to convince clients to buy shares for dubious rights, you can just say that the price at the exchange is constantly changing, and if you buy shares at $ 1000 now (in the bank office), then a month later at the exchange you can sell them already at a higher price. This created a real stir around the company's shares, and they were bought up from banks at the IPO price - that is, at the original price of $1,000 per share.
A significant advantage for any investor is the ability to buy or sell shares quickly and easily. That is exactly the kind of opportunity stock exchanges provide. If there were no stock exchange, the owners of shares would have to look for buyers on their own. But now they have the opportunity to connect to the exchange and make a deal at any time.
As soon as the stock exchange started trading, the share price of the workshop came to life. This attracted new investors who tried to buy cheaper shares and sell at a higher price. Such investors include you and me.
So what we know so far:
- A company needs stock to sell a share of its business and get real money.
- Shares can only be issued by a public company.
- Shares give its owner rights: to vote, to receive agreed dividends, and to receive a share from a bankrupt company.
- The initial sale of shares to the public is called an IPO (initial public offering).
- During an IPO, shares are sold not on the stock exchange, but through brokers or banks.
- The first day of stock trading on the stock exchange is the completion of the IPO process.
- In order for the shares to be traded on the stock exchange, the company has to go through the listing procedure.
- It is only possible to buy shares on the stock exchange through a licensed broker.
- The exchange price is constantly changing during trading.
The workshop story may give the impression that we small investors are only being used to get money from us in exchange for unnecessary rights. However, it is important to understand that we are more interested in the opportunity to profit from the growth of the shares than in gaining formal rights. It is this desire that unites all shareholders of a company, whether you have one share or a million.
A joint-stock company can be compared to a hotel with many identical rooms. One share is one room. If the hotel is doing great and making a profit, investors will want to buy more rooms, and sellers will want to sell more rooms at a higher price. If the hotel performs poorly and makes a loss, then room owners will get rid of them (i.e. sell even at an unprofitable price to get money and find another hotel that is more attractive for investment).
The strategy I will share will be to find, figuratively, great hotels (in fact, joint stock companies) during a room sale (i.e., a period of declining stock).
We'll figure out how stock prices are formed on the stock market soon. See you next time!
Stock Company. Selling something that no one will buy piecemealSo, here we go. Start of the story here .
What next? How will he sell something that no one will buy in pieces?
He turns his company into a joint-stock company, which is a form of company organization that allows it to be split into shares. Our owner issues 1 million shares, that is, he sort of divides the company into 1 million pieces. Then he calculates how much his whole business is worth - let's say $1 billion. And if $1 billion divided by 1 million shares, you get $1,000. That's how he calculated the value of 1 share. Recall that our owner has decided to put only 25% of his business up for sale, that is, 250,000 shares. And if we multiply 250 thousand shares by the price of $1 thousand, we get $250 million in total - this is the value of the share of the company he plans to sell.
Now he has to decide: will he sell 25% of the shares to one or more buyers, or even an unlimited number of people. First, he was approached by one large investor who has $250 million to buy all 25% shares. But the investor shared with the owner a plan to grow the company and asked him to place his managers in high positions. The owner of the company didn't like it because he didn't want to lose control of the company, so the deal didn't go through. Then he was approached by several investors who promised him they would stay out of the company's business, but were willing to buy a 25% stake not for $250 million, but for only $200 million. That option did not suit the owner either. Then he decided this way: instead of negotiating with big buyers, I will offer my shares to anyone who is willing to pay 1 thousand dollars for 1 share. This offer is called IPO (initial public offering) . Remember this term, because you'll come across it quite often.
Our owner had agreed with the banks from which he borrowed money, that for a small commission they would sell his shares at $1,000 apiece to absolutely any buyer. But the first buyer asked the bank the question, "What's in it for me to own one share?" Through this question, we come to the point where we find out what owning stock gets us.
The bank answers the prospective buyer that:
- You will be able to manage the stock company by voting on matters of the general meeting of shareholders. The weight of your vote will be one in a million votes.
- You will be able to receive dividends if a majority of the general meeting of shareholders votes "yes" to pay dividends.
- If the company goes bankrupt, you will receive one millionth of its assets left over after all of the company's debts to banks have been paid.
The buyer decided he was being mocked and rejected the offer. After all, why should he have the right to vote if 1 his vote means little in the overall background. Why does he need dividends if they may not be assigned. Why would he need property that would be impossible to sell after bankruptcy.
But more about that in the next post.
What is a stock? Let me tell you a storyNow let's talk about what a stock is, why companies issue them, and why they attract investors.
To do this, imagine a story. Imagine a small shoe workshop with a single owner. Suppose he makes boots out of crocodile leather. His product is unique to the city and in demand, because these boots are very durable and comfortable. At this point, he can only produce one pair of boots a day, and the number of orders for boots is 2 pairs a day. To meet the demand of his customers, he hires an employee and buys twice as much crocodile leather and other necessary materials for the job. With what money? With all the profits previously accumulated. The workshop now meets the demand of two pairs of boots a day.
Later, the workshop receives a corporate order for 90 pairs of boots per month. In order to meet the new order, three more pairs of boots must be produced in addition to those two. But with what money to buy so many materials and hire three more employees? After all, even all of the previously accumulated profit is not enough for such a batch. In order not to miss out on a major customer, the workshop owner goes to the bank for a loan. The bank is happy to give him a loan secured by the workshop (which means that if the owner will not repay the loan, his workshop will be taken away). But all goes well, the owner hires three more workers, buys materials, and puts out five pairs of boots a day. With the proceeds, he pays the loan and interest.
Now, let's go back to that beautiful day when the shop received an order for 90 pairs. The owner could have declined the loan and waited for the accumulated profit, but to do so he would have had to negotiate with a potential buyer for a longer lead time for the entire batch, and that could have resulted in the loss of the order.
What it turns out: he needed the credit in order to ramp up production quickly, and thus the size of the business.
Taking advantage of the credit and constant demand, our workshop owner goes nationwide and becomes the most famous manufacturer of crocodile leather boots with many workshops all over the country. And a lot of people around him want to buy the successful business.
Then he starts thinking: on the one hand, he has a huge business that is profitable, and on the other hand, he has an opportunity to get money in exchange for workshops, stock of materials, employees' labor, business connections and reputation. In short, in exchange for everything he has created with his own hands and head, which is very difficult to sell individually.
He likes the idea, but in order to keep part of his business, he decides that he will sell only a share of his company - 25%. He did the math and realized that this money is enough for the rest of his life (and even to live another life).
What next? How does he sell something that no one will buy in pieces? Let's continue next time.
The lifestyle of your savings, and why Big Mac?I've mentioned the word "risk" many times before, and it really is a very important word in the investment process.
Today I would like to focus on a risk that you should pay much attention to as a future investor: market risk, or in other words, the risk that you will have to sell the shares you bought cheaper than the price at which you bought them, and suffer a loss in doing so. You will face this risk all the time, which is absolutely normal, because at any time events can happen which will cause the value of the stock to fall.
It can be said that investing in stocks is a series of profitable and unprofitable operations. So don't get discouraged and pour ashes on your head if your first trades are unsuccessful. That's part of the process. Investing is not a one-time transaction to make a quick profit, it's a way of life for your savings.
Remember the fundamental and simple rule of investing - the expected return is roughly equal to the risk you take. So, when you place money in a bank deposit, the only risk you take is that your money will depreciate by the difference between the rise in prices and the deposit rate.
The easiest way to explain this is with Big Macs. Let's say you have the money to buy 100 Big Macs. But you don't spend it, you put it under your mattress. A year later, because of a price increase of, say, 7%, you can buy not 100, but 93 Big Macs with the money from under the mattress. Every time you put money "under the mattress," you reduce the purchasing power of your savings. To preserve it, you can put your money in a year's deposit at the bank. That way, in a year, you'll withdraw the original amount from the deposit, plus a profit in the form of interest. Even if prices go up, as in the last example, you can buy 99 Big Macs, not 93.
Why not 100? Because the interest rate on a deposit is usually less than the percentage increase in prices (that is, inflation). In our example, it was 6% versus inflation of 7%.
If you choose not to keep money "under the mattress" and not to open a deposit, but to invest in stocks, then at the end of the year you can buy, for example, 150 or only 50 Big Macs, because you are dealing with a potentially more profitable and therefore more risky instrument.
This is how the fundamental law of investing works, let me remind you again: as much risk as possible profit.
Thanks to this law we can refine our formula: investing in stocks is buying a share of a company with the goal of getting a future profit from its sale and being aware of the risk of a possible loss. Awareness of the risk of possible loss is an obligatory variable of our formula, an obligatory ingredient of our investment recipe.
Awareness of the problem is already a big step towards its solution. It's impossible to completely eliminate risks, but with proper management their impact can be minimized.
So, after studying the entire series of posts, you will get the necessary knowledge and practical skills to:
- find shares of companies interesting for investment;
- evaluate the financial condition of companies;
- determine the conditions for buying stocks;
- determine the conditions for selling stocks;
- manage risks;
- take into account the results of your operations.
You will have a ready-to-use strategy that will always help you find the answer to what to do or not to do with the stock at the current moment in time. You will not have to chain yourself to the monitor and do it all your time. You won't spend any more time doing it than you do watching the news or social media. You will learn to think like a intelligent investor, and you certainly will become one, if you are prepared to open yourself up to a very interesting and fascinating field of knowledge - stock investing. I sincerely wish you success on this path!
Raising initial capital: 4 approaches, of which one is not goodLet's break down the thought from the previous post in more detail. Obviously, to buy stocks, you have to have money, and if you are determined to become an investor, get ready to open your piggy bank. If you don't have savings, however, don't despair, there are other options.
I suggest you look at the following 4 options for acquiring the finances to buy stocks:
- Reduce your current expenses
- Sell unnecessary assets
- Increase your regular income
- And the option I don't recommend using at the start is to borrow.
I immediately stipulate that it is your, and only your responsibility how to apply the knowledge gained - to use something of the proposed or to go another way. I do not insist on anything. Rather, I am sharing information, but the decision is up to you in any case.
My opinion - always start with reducing your current costs, because the funds you save now give you a chance to increase your wealth in the future through investing. Make it a rule to plan your purchases in advance and buy only what is on your list. Don't go to the store without a list, otherwise you will buy more than you really need.
Next. Look at your possessions. Make a list of what you can sell without compromising your financial and mental well-being. Let what you don't need now serve to increase your wealth in the future.
Increasing your regular income is probably the most time-consuming but feasible way to accumulate funds for investment. Many people are often faced with the problem of choosing between a job they love where they don't earn enough and a job they hate with a higher income or, even worse, a job they hate with a paltry income. In the latter two cases, I recommend becoming an active user of services that will help you find the job you want (but don't act in haste, don't quit a job you don't like right away). Remember our goal is to keep and increase our income, not lose it altogether. In the case of a job you love and don't make much money, think about how you can increase your income in your current job. Sometimes all you have to do is make up your mind and ask your employer for it. Even a small increase will help you start saving. And if you have both a job you love and a desired level of income, I congratulate you, you are truly lucky.
Moving on. Borrowing for investments is the riskiest option. I highly do not recommend it, especially at the beginning of your investing journey. You definitely should not take a loan from a bank or other financial institutions. The credit rate will only increase your costs, and the need to repay the loan every month will break your entire investment strategy.
If family, friends or acquaintances are willing to lend you money long-term and without interest, think about whether your lender is aware of the risks and whether you are aware of the risks associated with investing in stocks, and whether this person will demand the money back before the agreed upon deadline. Even if you have agreed on everything, write down all of the terms of such a private loan on paper, so it is easier to resolve any disputes.
I always insist that the investment is conscious, that you understand and are ready to bear the responsibility and risks. So if you have even the slightest doubt about the borrowing option - don't take it! Consider another option. Ideally - work out a step-by-step plan and accumulate the necessary amount of money gradually.
