Investing Archives - Hanover Mortgages

May 6, 2021

From Bitcoin to GameStop to SPACs: 8 Tips for Mania Investing

Market speculation is seemingly everywhere. From new SPACs being issued, to the prevalence of Reddit stocks such as GameStop to the popularity of electric vehicle stocks and the rise of cryptocurrency – speculation is alive and well in the markets today.

“Mania” is a good word to describe the energy surrounding these types of investments. Dramatic daily swings are the new normal in these holdings. Hollywood elites and business moguls are attaching their names to crypto and the latest SPAC investments.

The top mania investment areas are electric vehicles, cryptocurrency, Reddit stocks, space, SPACs, precious metals and pot stocks. The dictionary definition of mania describes “excessive or unreasonable enthusiasm.” That seems about right. The result has been a meteoric rise in value not tied to business fundamentals but tied to hype, expectations or projections.

Investors looking to boost performance often wonder how much exposure to these types of investments should they have. With strong appreciation in some of the holdings, it is tempting to get into the game. Here are our top eight tips for mania investing.

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1. Admit that it is a mania

A woman is swept away on waves of water.

Have some honest reflection about the investment environment you are in. Mania investing can be fun, it can be thrilling and, ultimately, it can be painful. But mania investing is not your conventional long-term investing strategy. Admit you are being swept up in a mania and acknowledge what that might mean regarding your tactics. It’s impossible to explain to yourself or your friends the fundamentals of a company with no earnings, so stop trying to make sense of it. It is a mania, not an investment based on fundamentals.

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2. Have an exit strategy & set a price target

How far are you willing to watch your investment drop before you pull out? Set a price target and stick to it. Some of the biggest mistakes happen with investors who fall in love with a company or a product and hold it while closing their eyes. Mania investments are not typically long-term plays, and you must plan for how much risk you are willing to take. Set a target to get out and limit your downside exposure.

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3. Limit your overall portfolio exposure

If you are going to be a mania investor, maybe you limit your exposure to 3%, 5% or 10% of your total portfolio. Understand it is the high-risk portion of your portfolio and do not allocate more than you are willing to lose. The older you are and the closer to retirement, the less you can afford to lose. The younger you are, the more you might be willing to allocate to more aggressive strategies.

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4. Diversify your manias

A woman balances a bitcoin on a red tightrope.

Maybe you like cryptocurrency — go ahead and invest in it, but buy into three different types, instead of just one, to diversify. Maybe you like electric vehicles. If so, consider adding some exposure to space or precious metals as well. Even in your mania investing, you do not want to concentrate all that allocation to just one mania strategy. Diversification can help reduce risk even in a risky space. Although, be careful of too much diversification. In a world like electric vehicles, there is a possibility of there being few winners and many losers.

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5. Understand performance in context

Woman standing under an orange umbrella in the rain

The S&P 500 10-year average over the past 100 years is around a 10% return per year. Warren Buffett has averaged about 15% per year. If your mania investments have made 100% in a year, understand how rare that is and that the odds of duplicating that performance year after year are incredibly remote. Part of good investment performance is not just making money in good times, but also weathering losses during challenging times.

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5. Know the difference between investing and speculating

Investing for the long term carries its own set of disciplines and rules and expectations. Mania investing is more akin to speculating or even gambling. It often has dramatic movements in price over a short period of time. It might include hype in the media, memes on social networks and inexperienced people giving investment advice. Be careful and realize speculating is a high-risk game — it is not the same as sound investment on fundamentals.

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6. Take some winnings off the table

Maybe you own one of the stock names that have doubled or tripled in value over the past year. Consider selling some of the holdings and locking in your gains. Maybe reduce your exposure by 50%. Keep some of the holdings a bit longer, but diversify into something more stable or consistent. Setting a price target on the upside can be just as important as setting one on the downside.

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7. Do not gamble the farm

The sun sets over the red barn of a farm.

A smart gambler, if they go to Vegas, will set their own personal limit on what they are willing to lose. Whether that is $100, or $10,000 — set a limit when it comes to mania investing. Also, do not raid all your retirement money on a whim to chase manias. While a portion could make sense, the lion’s share of your retirement should be focused on fundamental investment strategies that are consistent. Pulling all your retirement money to buy into different manias would likely be a crazy idea, just like putting your house keys in the pot of a poker table would be ill advised.

Investing in some of these sexy stocks and industries has appeal, and there is money to be made. But there is also money to be lost, and it is important to have a rule set for investing even if you are investing in mania stocks. Finally, know how risk taking can fit in your overall financial plan and realize that the risk you are willing to tolerate is likely to be different from someone else.

Investing carries an inherent element of risk, and it is possible to lose principal and interest when investing in securities. Strategies are used to assist in the management of your account. Even with these strategies applied to the account, it is possible to lose money. No strategy can guarantee a profit or prevent against a loss. There may be times when the strategy switches between equities or fixed income at an inopportune time, causing the account to forfeit potential gains.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

CEO – Senior Wealth Adviser, Sterling Wealth Partners

Scot Landborg has over 17 years of experience advising clients on retirement planning strategies. Scot is CEO and Senior Wealth Adviser for Sterling Wealth Partners. He is host of the retirement planning podcast Retire Eyes Wide Open. Scot is a regular contributor to Kiplinger.com and has been quoted in “U.S. News & World Report,” Market Watch, Yahoo Finance, Nasdaq and Investopedia. He also formally hosted the nationally syndicated radio show “Smart Money Talk Radio.”

Investment Adviser Representative of USA Financial Securities. Member FINRA/SIPC A Registered Investment Advisor. CA license # 0G89727 https://brokercheck.finra.org/

Source: kiplinger.com

May 5, 2021

Investing in Food Stocks

You may not know what the future holds, but you know there’ll be a meal involved. A good meal or grocery trip is not only a necessity for survival, it can also be part of an investment strategy.

While restaurants and grocery stores may come to mind, the world of food stocks is larger than one might think, encompassing everything from a grain of wheat to the latest on-demand app.

Food stocks and the industries surrounding them have long been a part of investors’ portfolios. The most recent figures show that Americans dedicate close to 10% of their disposable income on food, a level that’s been consistent for about two decades. Roughly half that is spent for food at home, and the other half is on dining out.

But some types of food stocks can hold more risk than others. Read on to learn the history of food stocks in the market, the types of food stocks, and the overall risk profile of these investments.

Are Food Companies Consumer Staples or Discretionary Stocks?

Looking at the market as a whole, food stocks are part of the “consumer staples” industry, which is considered to be a “defensive” sector in investing. Defensive sectors are those less closely tied to the economy. That means even if the economy is in a recession, consumer staples are seen as less risky and more stable than other industries.

However, no stock is recession-proof. And not all food stocks are actually consumer staples. For instance, restaurant companies typically fall into the consumer discretionary category, which consist of “cyclical stocks,” or those tied to how well the economy is doing. That’s because of how people tend to dine out when they have more income to spend in their pockets.

Recommended: Investing With the Business Cycle

When deciding whether to invest in a food stock, beginner investors might want to research which industry the company falls under: consumer staples or consumer discretionary.

Different Types of Food Stocks

Food stocks include more than just memorable brands. It’s more encompassing than just consumer-facing brands or restaurants. Anything that helps food get to your plate can be considered part of the food supply chain.

Food stocks generally fall under these seven sub-industries:

Farming

Food stock investing can start at the granular level–investing in raw agricultural commodities like soy, rice, wheat, and corn. Farming stocks can also include the ancillary companies that foster that growth–companies that create and distribute insecticide and herbicide or build the industrial-size farm equipment to help harvest goods.

While one might think investing in farming stock would be actual farms, the reality is the opposite. About 98% of farms in the U.S. are family-owned and therefore, not publicly traded. So investing in farming stock primarily means the chemicals and machinery that help harvest the raw product.

Farming stocks can waver based on things like the weather and current events. It can be challenging to predict the next rainy season or drought, sometimes making it hard to track and predict value. In addition, tariffs and trade agreements can influence the performance of these stocks, making them more volatile.

Recommended: Understanding Stock Volatility

Food-Processing Stocks

Companies that work in food processing buy raw ingredients that are combined to make items in the grocery store aisles or on restaurant menus.

Some names and brands in the food processing sector might not be familiar to the casual investor. More often than not, these companies are behind the scenes, operating at a large scale to provide the world oils and sweeteners.

Food processing stocks have their own quirks when it comes to investing. Unlike farming, they’re less influenced by the whims of weather or season, but they still have an associated set of risks. The costs associated with this industry vertical are vast, and price competition across brands can lead to drops or jumps in the market.

Stocks of Food Producers

Further up the supply chain comes food producers, where novice investors are more likely to know these brands and companies from daily life and dietary habits. Food producers take the raw ingredients provided by processors and create the items found on store shelves.

Break this vertical down further to find “diversified” and “specialized” producers.

As the name suggests, diversified food producers are companies that create a ton of different products under the same name umbrella, like Nestlé, which makes everything from baby food to ice cream.

Then there are specialized producers. They make consumer products as well, but these companies often cater to a narrower audience, producing only a few items, often within the same vertical.

In times of recession, luxury or expensive food processing stocks might take a dip. Additionally, consumer trends can influence the market. Take the alternative meat craze–a popular investment trend in recent years. Investors saw larger-than-average returns for the industry due to interest in the trend.

Food-Distribution Stocks

Distribution companies have little to do with consumption or production and focus more on logistics and transport. These companies send products across the country and world.

Distribution companies range from very large, reaching national distribution, to fairly small, where they connect specialty retailers. The distribution market might have its long-term players, but investing in it comes with its own risks.

Grocery-Store Stocks

Grocery stores have become big business in the investment game. The next link in the chain, grocery stores are where the products end up once a distributor drops them off.

Grocery store investments are hardly recession-proof, but the necessity of groceries as a staple for consumers suggests these investments take a lesser hit in a market downturn.

Recommended: Investing During a Recession

Restaurant Stocks

Restaurants are an additional resting place for food distributors. In economic downturns, discretionary restaurant spending is usually the first to go, making this industry within food investing slightly less stable than the others. Additionally, this arena might be most susceptible to trends.

Food-Delivery Service Stocks

The newest addition in food stocks is more about tech than good eats. Online delivery services have burst onto the scene, and with a limited history of performance, are considered to be riskier than the traditional food stocks outlined above.

Right now, delivery service companies are still duking it out across the country, expanding to new cities and slashing the price of services to entice customers.

Pros and Cons of Investing in Food Stocks

With all the ingredients in order, it’s time to highlight a few of the basic pros and cons of investing in food stocks.

• Pro: Food stocks, particularly those that are consumer staples, can perform consistently. Food stocks can be a relatively safe, recession-resistant investment (but remember all stocks have inherent risk).
• Con: Food stocks perform consistently. For an investor looking for a higher-risk investment, the steady year-over-year earnings might not be as enticing for someone trying to build a high-return portfolio.
• Pro: Familiarity with brands. Many food stocks are also commonly found in investors’ pantries and refrigerators. For someone new to investing, buying stocks in the brands they trust and use could be a great way to dip their toes in the market.
• Con: Not all food stocks are immune to ups and downs in the economy. Some companies, particularly restaurant groups or those that produce higher-priced products, may be hurt if discretionary spending by consumers pulls back.

The Takeaway

Investing in food companies can actually lead to investing in a wide range of different companies–those that are defensive and more immune to economic shifts, those that are cyclical and rise when the economy is hot.

It can also involve wagering on stocks that have long been a part of the food supply chain, as well as startup unicorn companies that are using innovative mobile technology to deliver meals to consumers.

For individuals who want to try their hand at picking food stocks, SoFi’s Active Investing platform may be a good option. Investors can buy traditional stocks, exchange-traded funds (ETFs), or even fractional shares of some companies. For those who need help, the Automated Investing service builds portfolios for SoFi Members and Certified Financial Planners can answer questions on investing.

Get started with SoFi Invest today.

Source: sofi.com

May 5, 2021

Managing Your Money, Together

To learn more about how our Minters are achieving their financial goals, we reached out to everyday Mint users, just like you, to hear their stories. Whether it’s paying off student loans, or working toward buying a home, we’re so inspired by the dedication this community has shown in working toward your goals and dreams.

One of the Minters we connected with is Jordan. He shared with us how he’s used Mint to reach a number of his financial goals. Check out his #EmpowerMint story:

My wife and I have been interested in getting out of debt ever since the day we took on student loans. With the desire to pay those loans off, we strived to learn more about budgeting and personal finance.

As we grew in our journey, there were many financial things we questioned that felt ‘normal.’ We heard so many messages that emphasized the need to have the newest toys to be happy, that having debt is normal, and that most people live paycheck to paycheck. We realized that we didn’t feel comfortable with any of that, and that we found satisfaction in being content with what we have.

Knowing that money issues were often a problem area for couples, my wife and I started using Mint shortly after we got married in 2010 to ensure transparency and partnership from the beginning. We found Mint to be a terrific tool for us to have a complete picture of our financial situation. During this time, I was working full-time and my wife was finishing up her last year in nursing school. Mint was an immediate help in keeping track of where our money was going and in starting budget discussions that have proved to be invaluable in our marriage. It also helped initiate discussions on both near-term and long-term goals, which have been so key in helping us plan both strategically and aspirationally.

As time went on, Mint was instrumental in helping us achieve so many of our goals including:

Paying off student loans

Paying for grad school with cash

Preparing for kids

Starting a 529

Saving for a down payment

Buying a home

Our current goal is to complete our 15-year mortgage in under 5 years. A combination of Mint, aggressive savings, overtime shifts, and side hustles have helped put us in a position to achieve this goal within the next 12 months. Once that goal is complete, we’re excited to have a little fun and celebrate this accomplishment, and then prepare for the next chapter in our financial journey.

In addition to this goal, we also have various net worth milestones we would like to achieve in the next 1-, 5-, and 10-year periods. We are very excited about the concept of financial independence, and would like to be in a position where we have the opportunity to focus our attention on things outside of work, such as further investing in our family and causes that are important to us. With Mint, we can see how the choices we’re making are helping move us closer to achieving these goals.

Today, we check Mint on a daily basis in order to stay on top of our expenses and monitor for any fraudulent activity. Years ago, Mint helped me identify a fraudulent charge almost immediately, enabling me to notify our bank and get the issue resolved. Reviewing our expenses enables us to stay within our budget, catch fraudulent activity, and follow the ‘every dollar’ budgeting rules that have been so helpful for us. In addition, linking our accounts has automated what would otherwise be a very manual and time-intensive process.

I have also loved using the trends feature to have full visibility into exactly how our money is being spent and to help ensure we’re always partnering as we work towards our financial goals, rather than feeling like one person is pulling the other along. We can budget with transparency and not feel any need to hide transactions for personal expenses and rewards or small splurges.

The trends feature has also allowed us to get a sense of what our typical spending has been in different categories. We periodically review our budget, and being able to easily see our historical spending in different categories has helped us set realistic targets, as well as track our progress when we are attempting to change habits. Lastly, being able to see changes in our net worth over the years has been inspiring, as we have been able to see in real-time how decisions to save or forego immediate gratification can have long-term benefits.

Beyond that, we have found a great deal of joy in doing things ourselves, whether it is cooking meals for the week, doing our own car maintenance, or trying to fix something ourselves before calling someone. Additionally, the satisfaction has compounded as we’ve seen that making these choices has helped us not only learn new things, but also in achieving our goals.

Knowing what we know now, we’re really excited to pass these values on to our kids, and we’re happy to discuss them with anyone who asks. Additionally, I can see a ‘life’ after work that involves volunteering in some form in the personal finance field, whether that is teaching folks about budgeting or just encouraging them in their financial journey.

Learn more about security

Source: mint.intuit.com

May 4, 2021

Bitcoin Gold (BTG): Creation, Controversy, and How it Stacks up to BCH

Any conversation about cryptocurrency has to start with Bitcoin. It was the first crypto (it’s been around since 2009), it is the most valuable (worth over $1 trillion), and it’s the most traded (over $60 billion in daily volume). It also has the most spinoffs, or “forks,” that have become widely-used cryptos in their own right.

Perhaps the most well-known forks are Bitcoin Cash (BCH), which came out in 2017, and Bitcoin Gold(BCG), which was the product of a fork from Bitcoin a few months later.

What is Bitcoin Gold?

Bitcoin Gold was a hard fork from Bitcoin with the intent of further decentralizing Bitcoin. The idea was to use a new algorithm for the mining process that would not prioritize major mining operations, as some believed Bitcoin did.

Bitcoin Gold was an implicit criticism of Bitcoin, essentially arguing that it had betrayed or at least strayed from its initial roots as a decentralized currency with its increasingly centralized mining operations. Even if anyone can buy Bitcoin, it’s much harder (or at least not profitable) for anyone to create it.

Developers wanted to make it easier for normal computer users to mine on their own machines, a contrast to the massive Bitcoin mining industry, which is mostly done on specialized computer equipment purchased and operated by big-time operators in places like Iceland, where electricity is cheap. With Bitcoin Gold, however, the humble graphics card could carry the load.

Bitcoin Gold Controversy

Bitcoin Gold has been controversial almost since its inception. Typically with hard forks, owners of the initial cryptocurrency also receive units of the new one. For example, when Bitcoin Cash forked from Bitcoin, all Bitcoin owners got Bitcoin Cash.

When the Bitcoin Gold fork occurred, on the other hand, Bitcoin owners did not immediately get their new cryptocurrency. Instead, developers kept the Bitcoin Gold blockchain private for a few weeks so that they could mine BTG without competition—which they described as a “premine”. Critics opposed this practice, as it left fewer coins available for others to mine and also amounted to “free money” for the BTG developers.

As a result, cryptocurrency exchange and service provider Coinbase said it would not support BitcoinGold, explaining that because developers hadn’t made the code available for review by the public, it posed a security risk.

BTG Security Issues

Bitcoin Gold was worth over $8 billion when it launched, but fell dramatically in value as security issues emerged.

BTG has experienced multiple “51% attacks,” where an entity or individual or hacker is able to do the one thing that cryptocurrency is supposed to prevent: take control of transactions and “double spend” them, essentially stealing money. After one of the attacks, Bitcoin Gold was delisted from some exchanges.

In 2020, the developers behind Bitcoin Gold were able to fend off another attempt on the cryptocurrency’s network.
In early March 2021, the Bitcoin Gold team posted on its blog that its “hibernation has come to an end”—the 51% attacks that plagued the coin last year were ultimately defeated by the BTG miners and community.

What is Bitcoin Gold Worth Now?

Bitcoin Gold is ranked 73rd among cryptos according to CoinMarketCap (as of late April 2021) and has a total value of around $1.6 billion and a value per coin of around $90. Bitcoin Gold’s value was over $470 per coin at least twice in 2017, but has been under $100 since early 2018.

Bitcoin Gold vs. Bitcoin Cash Value

When comparing Bitcoin Gold vs Bitcoin Cash, the numbers speak for themselves: the original fork has a total value of almost $11 trillion, volume of almost $3 billion, and a value per coin of over $500. Bitcoin Cash is about 87 percent from its absolute peak value but is still substantially more valuable than its forked cousin on a “per coin” basis, at least so far, when it comes to Bitcoin Cash vs Bitcoin Gold, Bitcoin Cash is winning.

How to Invest in Bitcoin Gold

Bitcoin Gold is not available to buy and sell on mainstream exchanges like Coinbase, but, according to its organizers, it is available to trade on exchanges like Binance and Bitfinex.

The Takeaway

Bitcoin Gold is yet another hard fork of Bitcoin, like Bitcoin Cash. What distinguishes Bitcoin Gold is its intent: To further decentralize and democrative mining, making it more accessible to individual miners, rather than large groups with massive computing power.

For investors interested in building a crypto portfolio, buying crypto on SoFi Invest® can be a great way to start trading crypto. You can get started with just $10, we keep your crypto secure and protected from fraud, and you can manage your account in the SoFi app.

Find out how to invest in crypto with SoFi Invest.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).

2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.

3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.

For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.

SOIN21136

Source: sofi.com

May 3, 2021

The Risks and Rewards of Naked Options

Naked options are a type of option strategy where the investor does not hold a position in the underlying asset. This options strategy can be a way to make money for nothing, or—as recent history has shown with the Gamestop frenzy of early 2021—a way to suffer incredible trading losses.

What is a Naked Option?

A naked, or “uncovered,” option is an option that is issued and sold without the seller setting aside any shares or cash to meet the obligation of the option when it reaches expiration.

When an investor buys an option, they’re buying the right to buy or sell a security at a specific price either on or before the option contract’s expiration. An option to buy is known as a “call” option, while an option to sell is known as a “put” option.

Investors who buy options pay a premium for the privilege. To collect those premiums, there are investors who write options. Some hold the stock or the cash equivalent of the stock they have to deliver at the option’s expiration. The ones who don’t are sometimes called naked writers, because their options have no cover.

Naked writers are willing to take that risk because the terms of the options factor in the expected volatility of the underlying security. This differs from options based on the price of the security at the time the option is written. As a result, the underlying security will have to not only move in the direction the holder anticipated, but do so past a certain point for the holder to make money on the option.

Recommended: A Guide to Options Trading

The Pros and Cons of Naked Options

There are risks and rewards associated with naked options. It’s important to understand both sides.

Naked Writers Often Profit

The terms of naked options have given them a track record in which the naked writer tends to come out on top, walking away with the entire premium. That’s made writing these options a popular strategy.

Those premiums vary widely, depending on the risks that the writer takes. The more likely the broader market believes the option will expire “in the money” (with the shares of the underlying stock higher than the strike price), the higher the premium the writer can demand.

But Sometimes the Options Holder Wins

When an option writer sells an option, they’re obligated to deliver the underlying securities (in the case of a call option) or cash (in the case of a put) to the option holder at expiration. But because a naked writer doesn’t hold the securities or cash, they need to buy it or find it if the option they wrote is in the money, meaning that the investor exercises the option for a profit.

In cases where the naked writer has to provide stock to the option holder at a fixed price, the strategy of writing naked call options can be disastrous. That’s because there’s no limit to how high a stock can go between when a call option is written and when it expires.

Naked Options in Recent Headlines

The high-profile trading drama surrounding the stock of video game retailer GameStop showcased some of the danger of naked options. As the stock soared to a peak of $483 per share in late January of 2021, there were naked call options in the hands of investors that entitled them to buy the stock for $87 per share.

While that sounds like great news for the options holders, it had the potential to be catastrophic for the naked writer—because they’d have to find the money to buy the stock to cover those options. And because they weren’t holding the stock during its runup, they would have to either go into their cash reserves or sell other investments to buy the stock they were required to deliver.

But during that period of wild trading in GameStop, naked writers were still at work. With the stock trading at nearly $200, naked options writers sold 33,000 put options betting the stock would close at under fifty cents in the near future. Those writers potentially stood to pocket the entire premium.

How to Use Naked Options

While there are some large institutions whose business focuses on writing options, some individual investors can also write options.

Because naked call writing comes with almost limitless risks, brokerage firms only allow high-net-worth investors with hefty account balances to do it. Some will also limit the practice to wealthy investors with a high degree of sophistication. To get a better sense of what a given brokerage allows in terms of writing options, these stipulations are usually detailed in the brokerage’s options agreement. The high risks of writing naked options are why many brokerages apply very high margin requirements for option-writing traders.

Generally, to sell a naked call option, for example, an investor would tell their broker to “sell to open” a call position. This means that the investor would write the naked call option. An investor would do this if they expected the stock to go down, or at least not go any higher than the volatility written into the option contract.

If the investor who writes a naked call is right, and the option stays “out of the money” (meaning the security’s price is below a call option’s strike price) then the investor will pocket a premium. But if they’re wrong, the losses can be profound.

This is why some investors, when they think a stock is likely to drop, are more likely to purchase a put option, and pay the premium. In that case, the worst-case scenario is that they lose the amount of the premium and no more.

How to Manage Naked Option Risk

Because writing naked options comes with potentially unlimited risk, most investors who employ the strategy will also use risk-control strategies. Perhaps the simplest way to hedge the risk of writing the option is to either buy the underlying security, or to buy an offsetting option. The other risk-mitigation strategies can involve derivative instruments and computer models, and may be too time consuming for most investors.

Another important way that options writers try to manage their risk is by being conservative in setting the strike prices of the options. Consider the sellers of fifty-cent GameStop put options when the stock was trading in the $190 range. By setting the strike prices so far from where the current market was trading, they limited their risk. That’s because the market would have to do something quite dramatic for those options to be in the money at expiration.

The Takeaway

With naked options, the investor does not hold a position in the underlying asset. Because this is a risky move, brokerage firms may allow their high-net-worth investors to write naked options.

Investors looking to take an active role in their investments might consider opening an account with SoFi Invest®. With SoFi Invest, members can trade stocks, ETFs, crypto, and may participate in upcoming IPOs.

Find out how to get started with SoFi Invest.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).

2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.

3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.

For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments.
IPOs: Investing early in IPO stock involves substantial risk of loss. The decision to invest should always be made as part of a comprehensive financial plan taking individual circumstances and risk appetites into account.
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 email customer service at [email protected] Please read the prospectus carefully prior to investing. Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

SOIN21112

Source: sofi.com

May 2, 2021

How Are IPO Prices Set?

Prior to listing a stock for sale on a public exchange, companies go through a rigorous process of preparation and compliance.

In addition to providing the SEC and the public a detailed prospectus about their team, background, and finances, they must come up with a suggested starting price for each share they plan to sell in their IPO. This price then creates an IPO valuation for the company.

There are a variety of factors and steps that are used to determine the IPO price. Here’s a closer look at the IPO valuation process.

What Is an IPO?

When privately-owned companies, such as unicorn companies, begin to sell shares of stock to the public, they hold an initial public offering, or IPO. This is called “going public.” Prior to an IPO, companies are owned by the founders, employees, and early investors such as venture-capital firms and angel investors.

An IPO can help a company bring in significant funds for expansion. They can also be a source for publicity. However, the IPO process is also time consuming and expensive, and once a company has gone public, it faces new challenges such as increased scrutiny and the need to please shareholders.

Recommended: Guide to Tech IPOs

Why Do Companies Go Public?

The number of publicly traded, exchange-listed companies in the U.S. has gone down from the peak in the mid-to-late 1990s, when it reached about 8,000. In late 2020, the figure was closer to 6,000 companies, which traded on different stocks exchanges, such as the New York Stock Exchange and Nasdaq.

Holding an IPO is a huge and risky undertaking, but can create significant value for a company. The main reason companies choose to go public is to raise money. In many cases, IPOs raise millions and even billions of dollars.

Other reasons companies go public are to gain media attention, grow a broad base of financial supporters, and please venture-capital firms that helped fund the company in its early stages.

Bringing in public investment benefits the business, but it also benefits early investors and employees. Those who have invested time and money in a company can sell their shares following an IPO.

That’s because when an individual joins a company, sometimes they are granted employee stock options. The options are often given over a number of months or years–a process called vesting. Usually employees must wait to sell their vested stock until the end of a “lock up period”–a span of time after an IPO during which employees have to wait before selling their shares.

Steps in IPO Valuation

How Underwriting Works in IPOs

When a company decides to hold an IPO, they work with an investment bank to come up with the price. The process of investment bankers handling an IPO is called underwriting. Each underwriting process can be slightly different, but the factors that investment bankers consider in order to determine IPO prices are essentially the same. Some questions include:

• Why has the company decided to go public?
• What is the current status of the market?
• Who are the company’s competitors?
• What are the company’s assets?
• How much has been invested in the company and by whom?
• What is the history of the company and its team?
• What are the company’s prospects for growth?

Process of Determining IPO Prices

The rules of supply and demand which apply to most products also apply to stocks. As an investor, what are you willing to pay for each share of a company when it decides to go public? The process of IPO pricing goes like this:
Prior to an IPO, the ownership of Company X is divided into equal shares. The existing owners each own a certain number of these shares. These owners include the founders, early employees, and any venture capitalist and angel investors who already own a stake in Company X.

When Company X decides to go public, the existing owners are selling off a portion of the company to investors in order to raise capital. The money raised in the IPO goes into the company’s bank account, and the percentage of ownership of each of the initial owners goes down.

To create a balance in this tradeoff that makes both existing and new owners of the company happy, the company must decide how many new shares to issue, and the price they plan to sell each share for in the IPO. The company’s executives and their investment bank come up with the number of new shares by determining how much money they hope to raise and are willing to give up.

Institutional Investors in IPO Process

Once executives and bankers decide on the number of new shares, they reach out to institutional investors to start asking them how many shares they are interested in buying. Institutional investors include hedge funds, mutual funds, high net worth individuals, and pension funds in good standing with the investment bank.

Recommended: Institutional vs Retail Investors

These investors come up with estimates about the price based on their own analyses, and rumours begin to circulate about the IPO price.

Days before the IPO, the institutional investors place requests for how many shares they actually want to purchase. Company X then sets the price for the IPO, and they know exactly how much money they will raise.

The underwriting investment bank goes through the complex process of figuring out the allocation of all the shares to the institutional investors. They want to create a balance of different types of investors, and they have knowledge about each of the investors which factors into the allocations.

Retail Investors in IPO Process

When the public IPO market opens, the institutional investors hold the shares, and orders start coming in from retail investors. Unfortunately for the at home retail investor such as yourself, it can be nearly impossible to buy a stock at its IPO price. Some brokerage platforms like SoFi have started to offer IPO Investing services that allow individuals to buy closer to the IPO price.

But retail investors often buy at a markup, even though some companies have been known to trade below their IPO price on the first day. The investment bank for Company X takes a look at all the incoming orders, which may be either buy or sell orders, and reports the predominant price.

They then go through a process of price discovery to determine what the opening price will be. The goal is to have the maximum number of trades be executed from all the placed orders. At Nasdaq this is done electronically, while at the NYSE, human traders are involved.

When they set the price they input all the existing orders, the opening IPO price is now set, and the trading day continues.

Post-IPO Trading

In an ideal situation for the company and the underwriters, the closing price of the stock on opening day is fairly close to the opening price. This means the shares are priced accurately for what investors are willing to pay for them.

Win up to $1,000 in free
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However, the IPO price isn’t necessarily a good indicator of the value of a stock. Broader market interest in the stock is impossible to plan for, and IPO conditions differ from the long term presence of the company in the market.

You can determine the value of shares sold using the IPO price formula of the number of shares sold divided by the total amount of capital paid in. These numbers can be found in the company’s prospectus document.

One of the goals of an IPO is to gain positive media and investor attention, so companies hope to see immediate increases when their stock debuts. IPOs are generally priced with a goal of going up or “popping” on opening day. This ‘discount’ also acts as a cushion to protect the stock from falling. Ideally, the stock holds its value until the company reports its first-quarter earnings.

Do IPO Stocks Always Rise?

Highly talked about IPOs have disappointed in their opening weeks at the markets. This may be because investors feel these companies are overvalued and don’t want to risk putting money into them when they haven’t yet shown a profit.

It also isn’t uncommon in the world of tech IPOs. Data from Dealogic shows that since 2010, around ¼ of IPOS in the U.S. have seen losses after their first day. This is both costly and disappointing, since so many months of planning go into holding an IPO.

It can take time for a stock to increase following an IPO, so the initial sale isn’t necessarily an indicator of long term success or failure. The frenzy of the sale doesn’t always result in an immediate rise, but the influx of new capital allows the company to grow.

New hires and expanded resources bring results a number of months, or even years, later. Many stocks experienced tumultuous action for months before seeing a steadier climb. As an investor, looking for companies which have a solid team and business plan, rather than just hype and a high valuation, can result in long term portfolio growth.

Recommended: Understanding Stock Volatility

How to Invest in IPOs

As you can see, IPOs can be very volatile. Knowing when to buy IPO stocks is a crucial part of building a strong portfolio, as is keeping a long-term perspective.

Although there is potential for significant returns, investors can also see severe losses in the weeks and months after a company goes public. Aside from researching a company before deciding to invest in it, there are other ways to mitigate risk.

Rather than investing right away, you can wait a quarter or six months to see how a company’s stock fluctuates following the IPO, and then decide whether to invest. Stocks can often fall to form a base price before beginning to rise again. Or you can just invest a small amount at first and add more later.

You can also expose yourself to a broad portfolio of new IPO stocks through an exchange-traded fund or ETF. ETFs offer a weighted balance of stocks and are adjusted over time. By diversifying your portfolio you benefit from any standout successes while avoiding huge losses.

The Takeaway

IPOs are all over the news for a reason, it’s exciting when a company opens up to public investment! If you’re a newer investor, it can be challenging to know when and how to add new IPO stocks to your portfolio.

With SoFi Invest®, individuals have the tools to build a portfolio that’s right for them. They can set up an Active Investing account if they want to pick for themselves from a diverse array of company stocks, ETFs or fractional shares. If the do-it-yourself approach isn’t for them, investors can opt for the Automated Investing service, which builds and rebalances portfolios for SoFi Members.

Get started with SoFi Invest® today.

SOIN19121

Source: sofi.com

April 30, 2021

Understanding Pivot Points for New Investors

Pivot points are a tool that traders use to determine price levels of technical significance on intraday charts. A pivot point can help to identify a potential price reversal, which traders can then use (often in tandem with other technical indicators) as a cue to buy or sell.

When used alongside other common technical indicators, identifying pivot points can be part of an effective trading strategy. Pivot points are regarded as being important indicators for day traders.

What is a Pivot Point?

Pivot points are predictive indicators that average the high, low, and closing price from the previous period to define future support levels. These pivot points can help inform a decision to buy or sell.

The main pivot point is considered to be of the utmost importance. This point indicates the price at which bullish and bearish forces tend to flip to one side or the other (i.e., the price where sentiment tends to pivot from). When prices rise above the pivot point, this could be considered bullish, while prices falling beneath the pivot point could be considered bearish.

Brief History of Pivot Points

Pivot points got their start back when traders gathered on the floor of stock exchanges. Calculating a pivot point using yesterday’s data gave these traders a price level to watch for throughout the day. Pivot point calculations are considered leading indicators.

Today, pivot points are used by traders around the world, particularly in the forex and equity markets.

Different Types of Pivot Points

There are several different kinds of pivot points in addition to the standard ones. The variations make some changes or additions to the basic pivot point calculations to bring additional insight to the price action.

Standard Pivot Points

These are the most basic pivot points. They begin with a base pivot point, which is the average of the high, low, and closing prices from a previous trading period.

Fibonacci Pivot Points

Fibonacci projections, named after a mathematical sequence found in nature, connect any two points a trader might see as important. The percentage levels that follow are potential areas of a trend change. Most commonly, these percentage levels are 23.6%, 38.2%, 50%, 61.8%, and 78.6%. It’s thought that when an asset falls to one of these levels, the price might stall or reverse.

Many traders love using Fibonacci projection levels in some form or another. These work well in conjunction with pivot points because both aim to identify levels of support and resistance.

Woodie’s Pivot Point

The Woodie’s pivot point places a greater emphasis on the closing price of a security. The calculation only varies slightly from the standard formula for pivot points.

Demark Pivot Points

Demark points create a different relationship between the open and close price points, using the number X to calculate support and resistance, and also emphasizes recent price action. This pivot point was introduced by a trader named Tom Demark.

How Do I Read Pivot Points?

A trader might read a pivot point as they would any other level of support or resistance. Traders generally believe that when prices break out beyond a support or resistance level, there’s a good chance that the trend will continue for some length of time.

•  When prices fall beneath support, this could indicate bearish sentiment, and the decline could continue.
•  When prices rise above resistance, this could indicate bullish sentiment, and the rise could continue.
•  Pivot points can also be used to draw trend lines in attempts to recognize bigger technical patterns.

What Are the Resistance and Support Levels in Pivot Points?

The numbers R1, R2, R3 and S1, S2, S3 refer to the resistance (R) and support (S) levels used to calculate pivot points. These six numbers combined with the basic pivot point level (PP) provide the seven metrics needed to determine pivot points.

Resistance 1 (R1): The first pivot level above the PP.
Resistance 2 (R2): The first pivot level above R1, or the second pivot level above the PP.
Resistance 3 (R3): The first pivot level above R2, or the third pivot level above the PP.
Support 1 (S1): The first pivot level below the PP.
Support 2 (S2): The first pivot level below the PP, or the second below S1.
Support 3 (S3): The first pivot level below the PP, or the third below S2.

Which Pivot Points Are Best for Intraday?

Because technical analysis has a large subjective component to it, traders will likely have their own interpretations of which pivot points are most important for intraday trading.

While some traders are fond of Fibonacci pivot points, others may prefer different points.

There are communities online, like TradingView, where traders gather to discuss ideas like these.

Pivot Points Calculations

The PP is vital for the pivot point formula as a whole. It’s important to exercise caution when calculating the PP level, because if this calculation is done incorrectly, the other levels will not be accurate.
The formula for calculating the PP is:

Pivot Point (PP) = (Daily high + daily low + close) divided by 3

To make the calculations for pivot points, a chart from the previous trading day will be needed. This is where the values for the daily low, daily high, and closing prices are obtained. The resulting calculations are only relevant for the current day.

All the formulas for R1-R3 and S1-S3 include the basic pivot level (PP) value. Once the PP has been calculated, you can move on to calculating R1, R2, S1 and S2:

R1 = (PP x 2) – daily low
R2 = PP + (daily high – daily low)
S1 = (PP x 2) – daily high
S2 = PP – (daily high – daily low)

At this point, there are only two more levels to calculate, those of R3 and S3.

R3 = Daily high + 2x (PP – daily low)
S3 = Daily low – 2x (daily high – PP)

How Are Weekly Pivot Points Calculated?

While pivot points are most commonly used for intraday charts, the same thing could be accomplished for a weekly time frame by instead using a weekly chart from the previous week as the basis for calculations that would apply to the current week.

The Takeaway

The pivot point indicator is best used with other indicators on short, intraday time frames. This indicator is thought to provide a good guess as to where prices could “pivot” in one direction or another.

Different types of pivot points are preferred by different traders, and they all can potentially be incorporated into a successful trading plan.

For hands-on investors, active investing with a SoFi Invest® online brokerage account lets members make trades and manage their account directly from the convenient mobile app.

Find out how to get started with SoFi Invest.

Source: sofi.com

April 30, 2021

What Does Buying the Dip Mean?

A down stock market could create an opportunity for investors to buy the dip. In simple terms, this strategy involves making an investment when stock prices are low.

This is a way to capitalize on bargain pricing and potentially benefit from price increases down the line. But like any other investing strategy, buying the dip involves some risk—as it’s often a matter of market timing.

Knowing when to buy the dip (or when not to) matters for building a solid portfolio while managing risk.

What Does It Mean to Buy the Dip?

To buy the dip is to invest when the stock market is down with the potential to go back up. A dip occurs when stock prices drop below where they’ve normally been trading, but there’s an indication that they’ll begin to rise again at some point. This second part is crucial; if there’s no expectation that the stock’s price will bounce back down the line then there’s little incentive to buy in.

Why Do Stock Dips Happen?

Dips can happen for a variety of reasons. For example, general stock market volatility can cause stock prices to tumble temporarily on a broad scale. A recent example of a dip would be the lows the market experienced in the spring of 2020 connected to economic fears surrounding the coronavirus pandemic, followed by a gradual rise in stock pricing.

Stock pricing dips can also be connected directly to a particular company, rather than overall market trends. If a company announces a merger or posts a quarterly earnings report that falls below expectations, for instance, those could trigger a short-term drop in its share price.

What’s the Benefit of Buying the Dip?

If you’re wondering, “why buy the dip?” or “should I buy the dip?” it helps to understand the upsides of this strategy.

Buying the dip is a way to cash in on the “buy low, sell high” mantra that’s so often repeated in investment circles. When you buy into a stock below it’s normal price, there is a potential (but not a guarantee) to reap significant profits by selling it later if prices rebound.

Example of Buying the Dip

Say, for example, you’ve been tracking a stock that’s been trading at $50 a share. Then the company’s CEO abruptly announces they’re resigning—which sends the stock price tumbling to $30 per share as overall investor confidence wavers. So you decide to buy 100 shares at the $30 price.

Six months later, a new CEO has been installed who’s managed to slash costs while boosting profits. Now that same stock is trading at $70 per share. Because you bought the dip when prices were low, you now stand to pick up a profit of $40 per share if you sell. The potential to earn big gains is what makes buying the dip a popular investment strategy for some people.

Risks of Buying the Dip

For any investor, it’s important to understand what kind of risk you’re taking when buying the dip. Timing the market is something even the most advanced investors may struggle with—as it’s impossible to perfectly predict which way stocks will move on any given day. Understanding trend indicators and what they can tell you about the market may help, but it isn’t foolproof.

For these reasons, knowing when to buy the dip is an inexact science. If you buy into a stock low and then are able to sell it high later, then your play has paid off. On the other hand, you could lose money if you mistime the dip or you mistake a stock that’s in freefall for one that’s experiencing a dip.

In the former scenario, it’s possible that a stock’s price could drop even further before it starts to rebound. If you buy in before the dip hits bottom, that can shrink the amount of profits you’re able to realize when you sell.
In the latter case, you may think a stock has the potential to recover but be disappointed when it doesn’t. You’ve purchased the stock at a bargain but the profit you’re able to walk away with, if anything, may be much smaller than you anticipated.

How to Manage Risk When Buying the Dip

For investors who are interested in buying the dip, there are a few things to keep in mind that may help with managing risk.

Understand Market Volatility

First, it’s important to understand how market volatility may impact some sectors or industries over others.

For example, take consumer staples versus consumer discretionary. Staples represent the things most people spend money on to maintain a basic standard of living, like food or personal hygiene products. Consumer discretionary refers to the “wants” people spend money on, like furniture or electronics.

Recommended: How to Handle Stock Market Volatility

In the midst of a recession, people spend more on staples than discretionary expenses—so consumer staples stocks tend to fare better. But that may create a buying opportunity for discretionary stocks if they’ve taken a hit. That’s because as a recession begins to give way to a new cycle of economic growth, those stocks may start to pick back up again.

Consider the Reason for the Dip

Next, consider the reasons behind a dip and a company’s fundamentals. If you’ve got your eye on a particular stock and you notice the price is beginning to slide, ask yourself why that may be happening. When it’s specific to the company, rather than something general happening across the market, it’s important to analyze the stock and try to understand the underlying reasons for the dip—as well as how likely the stock’s price is to make a comeback later.

Buy the Dip vs. Dollar-Cost Averaging

Buying the dip is more of a hands-on trading strategy, since it requires an investor to actively monitor the markets and read stock charts to evaluate when to buy the dip or when to sell. If an investor prefers to take a more passive approach or has a lower tolerance for risk, they might consider dollar-cost averaging instead.

Dollar-cost averaging is generally an investing rule worth keeping in mind. With dollar-cost averaging, an individual continues making new investments on a regular basis, regardless of what’s happening with stock prices. The idea here is that by investing consistently over time, one can generate returns in a way that smooths out the ups and downs of the market.

Example of Dollar-Cost Averaging

For example, you might invest $200 every month into an index mutual fund that tracks the performance of the S&P 500. As time goes by and the S&P experiences good years and bad years, you keep investing that same $200 a month into the fund.

Recommended: What to Know About Dollar Cost Averaging

You’ll buy shares during the dips and during the high points as well but you don’t have to actively track what’s happening with stock prices. This may be a preferable strategy if you lean toward a buy and hold investing approach versus active trading or you’re a beginner learning the basics.

The Takeaway

Knowing when to buy the dip can be tricky, but there are times when it may pay off for some investors. A few things that can help: knowing when to buy in and understanding how likely it is that a stock or the market as a whole will rebound.

You can buy the dip with individual stocks or use exchange-traded funds instead to manage risk. Both strategies are options with SoFi Invest® online trading, where investors can start trading with as little as $1.

Find out how to get started with SoFi Invest.

SOIN21121

Source: sofi.com

April 29, 2021

Federal Reserve Interest Rates, Explained

If you pay attention to the news, you have probably noticed that the Fed makes headlines every so often—and it usually dovetails with other major events. In response to a stock market spiraling in the face of COVID-19 in 2020, the Fed cut its interest rates swiftly and seriously, to between 0.0% and 0.25%. As of April 2021, the current federal interest rate—otherwise known as the federal funds rate—remains between 0.0% and 0.25%.

There’s a connection between the Fed’s rates and the national economy, as well as your personal finances. The Fed works to help balance the economy over time—and its actions and influence on monetary policy can have an affect on individual wallets.

Here’s what consumers should know about the Federal Reserve interest rate, and how it trickles down to the level of individual wallets.

How Does the Fed Influence the Economy?

“The Fed” is short for the Federal Reserve System, which is the central US bank. The Fed is the main regulator of the US banking system and is made up of a dozen smaller banks, each of which is localized to a specific geographical region in the country.

Along with setting its target interest rate, the Fed also has other financial duties and powers—more so than regular banks—to take measures to ensure systemic financial stability. These duties include:

•  Supervising and regulating smaller banks
•  Conducting and implementing national financial policies
•  Maintaining widespread financial stability, in part by setting interest rates
•  Providing financial services like operating the national payments system

The Fed has authority over other US banking institutions and can regulate them in order to protect consumers’ financial rights. But perhaps its most famous job is setting its interest rate, otherwise known as the federal funds rate.

The federal funds rate, or federal interest rate, is a target interest rate that’s assessed on the bank-to-bank level. It’s the rate at which banks charge each other for loans borrowed or lent on an overnight basis.

The federal funds rate is not directly connected to consumer interest rates, like those that might be paid on a personal loan or home loan. But it can have a major influence on those interest rates, and over time has the ability to impact how both businesses and individuals access lines of credit.

Recommended: The Federal Reserve Cheat Sheet

How Is the Federal Funds Rate Set?

The federal funds rate is set by the Federal Open Market Committee (FOMC), at a minimum of eight times per year—though the committee will meet more often than that if deemed necessary.

Federal funds rate adjustments are decided based on key economic indicators that may show signs of inflation, recession, or other issues that may impact economic growth.

Current Federal Funds Rate

The federal funds rate is a recommended target—banks can ultimately negotiate their own rate when borrowing and lending from one another. Over the years, targets have varied widely depending on the economic outlook—as high as 20% in the early 80s (due to inflation), and as low as 0.0% to 0.25% in 2020 as a response to the COVID-19 pandemic, where it remains as of April 2021.

How Does the Federal Funds Rate Affect Interest Rates?

Although the federal funds rate doesn’t have a direct influence on the interest levels for loans taken out by consumers, it can change the dynamics of the economy as a whole through a kind of trickle-down effect.

The Fed often slashes rates as a response to turmoil in the market as an attempt to boost the economy. Lower rates may make it easier for businesses and individuals to take out loans and thus create more cash flow.

On the other hand, the Fed may raise interest rates when the economy is strong in order to keep borrowing (and inflation) in check, which can help prevent the kind of bubbles that can lead to crises like we saw in 2008.

The Fed’s rate changes have an impact across a broad swath of financial areas—from credit cards to mortgages, from savings rates to life insurance policies. The Fed’s rate change can affect individual consumers in a variety of specific ways.

The Prime Rate

A change to the federal funds rate can influence the prime interest rate (also known as the Bank Prime Loan Rate ). The prime interest rate is the interest rate banks offer their most creditworthy customers when they’re looking to take out a line of credit or a loan.

While each bank is responsible for setting its own prime interest rate, many banks choose to set theirs based in large part on the federal funds rate.

Generally, the rate is set approximately three percentage points higher than the federal funds rate—so, for example, if the rate is at 0.25%, a bank’s prime interest rate might be 3.25%.

Even for consumers who don’t have excellent credit, the prime interest rate is an important figure. It’s the baseline from which all of a bank’s loan tiers are calculated.

That applies to a wide range of financial products, including mortgages, credit cards, automobile loans, and personal loans. It can also have an effect on existing lines of credit that have variable interest rates.

Savings Accounts and Certificates of Deposit

Interest rates bend both ways. Although a federal rate cut may mean a consumer enjoys lower interest rates when borrowing, it also means the interest rates earned through savings, certificates of deposit (CDs), and other interest-bearing accounts will drop.

In many cases, this decrease in interest earnings is no reason to pull out of a savings plan entirely, because it is important to maintain an emergency fund that one can access immediately, if necessary.

But it could be a good opportunity to use any excess funds to pay off existing debts while interest rates might be lower than usual.

How Does the Federal Funds Rate Affect the Stock Market?

While the federal funds rate has no direct impact on the stock market, it can have the same kind of ripple effect that is felt in other areas of the US financial system.

Generally, lower rates make the market more attractive to investors who are looking to maximize growth. Plus, cheaper or more available money can translate to more spending and higher company earnings, which can in turn result in rising stock performance.

On the other hand, an increased rate has tended to dampen the market, since bonds can be more appealing. (An exception to this trend are stocks in the financial sector, which may have higher profits.)

What Other Factors Affect Consumer Interest Rates?

Although the Federal Reserve interest rate can impact personal finance in a variety of ways, it may take up to 12 months to feel the full effect of a change.

And it’s also only one piece of the answer to the larger question, “How are interest rates determined?”

On a consumer level, interest rates for credit cards and loans are calculated using a complex algorithm, which takes everything from personal creditworthiness to loan convertibility into consideration. Banks use benchmarks to determine an individual’s interest rate.

The Takeaway

The federal funds rate—or federal interest rate—set by the Federal Reserve is intended to guide bank-to-bank loans, but ends up having impact across various parts of the national economy—right down to individuals’ personal finances.
For investors, the federal funds rate can be an indicator of where the market may be headed. At least, it’s a factor that investors may watch.

Whether they are hands on or hands off, investors will find what they are looking for on SoFi Invest®, which offers both active and automated investing options. And members can manage their accounts from the convenience of the mobile app.

Find out how to start investing with SoFi Invest.

Source: sofi.com

April 29, 2021

Pairs Trading, Explained

Pairs trading is a market-neutral trading tactic that allows investors to use the historical performance of stocks to place long and short bets to make big profits.

Pairs trading was first used in the mid-1980s as a way of using technical and statistical analysis as a way to find potential profits. It remained the province of Wall Street professionals until the internet opened online trading and real-time financial information to the public. Before long, there were seasoned amateur investors using pairs trades to make money, while managing their risk exposure.

What Is Pairs Trading?

Pairs trading is a day trading strategy in which an investor takes a long position and a short position in two securities that have shown a high historical correlation, but which have fallen momentarily out of sync.

The correlation between the two securities refers to the degree that two securities move in relation to one other. More specifically, correlation is a statistical measurement that measures the relationship between the historical performance of two securities. It’s usually expressed as something called a correlation coefficient. This measure falls between -1.0 and +1.0, with negative 1 indicating that two securities move in exactly opposite ways. A correlation coefficient of positive one indicates that the two securities move up and down at exactly the same times under the same conditions.

Pairs Trading Example

In a pairs trade, an investor will look for two securities that have a historically high correlation, but have fallen out of sync. If “stock Alpha” and “stock Beta” have historically risen and fallen in step, they’d have a very high correlation, maybe as high as positive of 0.95. But, for whatever reason, the two stocks have diverged, with Alpha racking up big gains, while Beta languished. That has knocked the short-term correlation coefficient between the two down to paltry 0.50.

This is the most common scenario for a pairs trade. In it, an investor will take a long position on stock Alpha, which has underperformed. At the same time, they’ll short stock Beta, which has outperformed. What they’re doing in a pairs trade is betting that the relationship between the two stocks will return to their historical norm, either by one security falling, the other one rising, or some combination of the two.

Pairs Trading Strategy: Market Neutral

The pairs trade is considered a “market-neutral” strategy. There are many of these strategies, which share a common aim to profit from both rising and falling security prices, while sidestepping the risks of the broader market.

Many hedge funds will employ market-neutral strategies, because they are paid based on their absolute returns. A common market-neutral trade may involve taking a 50% long and a 50% short position in one industry, sector or market. They usually do so to take advantage of pricing discrepancies within those areas. In addition to earning a return, their main goal is often to hedge out as much systematic risk as possible.

For less affluent investors, there are market-neutral mutual funds. Because there are so many market-neutral strategies, and ways to execute them, these funds can vary widely in their returns. Interested investors may want to learn the fund’s particular approach to the strategy before jumping in.

How to Successfully Execute a Pairs Trade

For investors who are ready to incorporate pairs trading into their investment strategy, there are several steps they need to take in order to be successful.

Step One: Decide on Trading Criteria

The first step is to decide what securities to consider for the trade, and can be the most time-consuming in the entire process. This involves researching a vast array of possible investment pairs to find ones that have a historically high correlation coefficient but have since drifted apart. Then investors will want to build and test a model for those securities, using those results to arrive at the best possible buy-and-sell guidelines, as well as how long they intend to stay in a trade.

Step Two: Select Specific Securities

After the investor has settled on a process to select candidates for a pairs trade, it’s time to put that process into action and find securities that currently meet that criteria. Some investors may use manual research, while others prefer mathematical models. Regardless, investors need to think of how they want to use a pairs trade. For investors who want to get in and out of a trade in a matter of hours or days, they’ll need to run their process to find possible trades on a regular basis. But investors whose trades will last for months won’t need to run their research as often.

Step Three: Execute the Trade

Once an investor has confirmed that a trade fits all their criteria, it’s time to execute the trade. With a pairs trade, there are small but important details to consider. For instance, most experienced pairs traders will execute the short side of the trade before making the long side.

Step Four: Manage the Trade

With the trade in place, the investor now has to wait and watch. This means sizing up the activity of the two securities in the trade to see if they’re approaching the criteria that would trigger one of the predetermined buy-and-sell rules. It also means watching the broader market, as well as any news that might have an impact on either security in the trade. Experienced traders will also constantly adjust the trade’s risk/return profile as markets shift and other news emerges.

Managing the trade is as important as setting it up. If a trader has a pairs trade they expect to last a month, but it reaches 50% of its profit objective in the first day after execution, what should they do? They may choose to close out of the trade that day, because the additional return isn’t worth the risk or the opportunity cost. But they also have other options. They might initiate a trailing stop loss level in the two positions as a way of locking in a portion of the profit. The decision isn’t easy, and may involve a host of other considerations.

Step Five: Close the Trade

The final step is to close the trade. But even this can come with questions and challenges, especially with trades that haven’t worked out, and whose predetermined durations are coming to an end. But it can also be the case with trades that have succeeded and are nearing their time limit. The urge to give a trade more time to turn around—or to do just a little better—has the potential to be the undoing of an otherwise successful trader.

That’s why experienced pairs traders often stress discipline as being as important as research, close monitoring and clear rules when it comes to earning consistent profits with the strategy.

The Takeaway

Pairs trading is a trading strategy that involves the simultaneous purchase and sale of securities in anticipation of a price trend. The idea is that the two securities typically have shown a high historical correlation, but have fallen momentarily out of sync. The investor making the pairs trade is betting that the two stocks will return to their historical norm.

Investors looking for a hands-on trading experience might consider opening an opening an online brokerage account. SoFi Invest® offers an active investing solution that allows you to choose stocks, ETFs, crypto, and more, and manage your account from the convenient mobile app.

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