What is Altcoin Season? Why Does It Happen?

2021 has been a heady time for cryptocurrency. Led by Bitcoin, the whole sector has seen huge rises in prices and tremendous volatility along the way. There’s been a massive development of decentralized finance (DeFi) technology applications and cryptocurrency ecosystems that allow people to trade and lend their tokens without the support of a traditional financial institution.

With all this activity and volatility, some have wondered what it will mean for the cryptocurrency ecosystem. Will Bitcoin continue to dominate and soar? Will other coins rise up to take the top spot in the field? Insiders have already coined a phrase for the possibility of Bitcoin stalling out and other cryptocurrency products and token rising in value. It’s known as “altcoin season.”

Altcoins: What Are They?

Basically, altcoins are cryptocurrencies that aren’t Bitcoin or Ethereum. In fact, Bitcoin is so dominant in the field that even Ethereum is sometimes referred to as an altcoin.

Bitcoin is the big kahuna of cryptocurrency, the one that started it all, the one that’s traded the most every day, the one that’s gotten the most backing from mainstream financial institutions, and, of course, the one that’s worth the most ($885,497,080,149 as of December 17, 2021). Ethereum is similar: a long track record, a variety of projects and systems built on top of it, substantial trading volume, and a high overall value (worth $459,827,737,310 as of December 17, 2021).

Altcoins are just about everything else. Sometimes they’re tokens built on top of Ethereum for DeFi projects, sometimes they’re offered in an “initial coin offering” for use with a specific product, sometimes they’re spun up by developers because they think there’s something wrong or missing in the current crypto ecosystem. This could be variants or forks of mainstream coins (like Litecoin (LTC) or Bitcoin Cash), or a whole new type of coin with a specific usage (stablecoins like Tether or USDC), or tokens for use in a specific ecosystem, like XRP for use in Ripple.

When Does “Altcoin Season” Happen?

Altcoin season happens when there’s steady outperformance of tokens and coins that aren’t Bitcoin.

There’s no promise or guarantee that every runup in Bitcoin will turn into a downturn later or that altcoins will start outperforming the original crypto. In fact, it’s not uncommon for all cryptos to rise together, as excitement about the sector grows and new money goes into all sorts of coins looking for profits.

There are a number of theories for why altcoin season could potentially happen. One popular one is that Bitcoin investors will pocket their gains from a surging Bitcoin, maybe by selling some of it, and then move those gains into other cryptocurrencies.

They might do this for one of two reasons:

1.    To realize gains. This might happen if the value of Bitcoin owned by an investor has gone up relative to the dollar or other fiat currencies or cryptocurrencies, and they want to spend some of those gains on things that can’t be bought with crypto itself.

2.    Expectations of future growth change. After a large runup of Bitcoin, an investor’s projected future growth or value of an asset might change compared to the price of investing. So, with inflated Bitcoin values, it’s possible that altcoins could be a better investment going forward. And if enough investors and traders make that decision, they will be.

How Do You Know If It’s Altcoin Season?

You can’t determine altcoin season just by looking at the price of altcoins or Bitcoin or any other cryptocurrency in isolation.

Looking at their “market cap”, or the total value of all the circulating tokens, can be a better indicator of what’s going on with investor valuation of cryptocurrencies. This is because price isn’t just determined by investor interest or disinterest, but also by the number of outstanding coins.

How Are Altcoins Doing Relative to Bitcoin?

To tell if we are in altcoin season, we have to look at two things. The first is Bitcoin’s “dominance” vis a vis the rest of the crypto market as well as the performance of altcoins relative to Bitcoin.

At the time of writing in December 2021, according to CoinMarketCap, Bitcoin’s dominance is 41% of the total market. Near the beginning of this year, it stood at 70%. Bitcoin’s highest dominance was 96% in late 2013, Bitcoin’s lowest dominance was early 2018, when it stood at around 33%. Its lowest this year is around 40%, which it hit in May of this year.

Bitcoin has fallen in value by almost 40%, giving a chance for altcoins to gain value in comparison. But we can also compare Bitcoin market value to that of altcoins:

•   Bitcoin’s market value has grown from $176 billion to $885 billion.

•   XRP, the cryptocurrency associated with Ripple, has had its market cap grow from $9 billion to just under $38 billion.

•   Cardano (ADA), whose token is called ADA, has grown from about $3 billion to $41 billion.

•   Litecoin, a Bitcoin alternative founded in 2011 and thus one of the oldest altcoins, has grown from around $3 billion to $10 billion.

•   Ethereum (ETH), the least alt of the altcoins, the most well established of all non-Bitcoin tokens, has grown from $29 billion to $459 billion.

Whether altcoin season is happening at all — and if so, whether it will continue — still remains to be seen.

The Takeaway

Altcoin season describes a time period when altcoins steadily outperform Bitcoin. There are a few ways to try to determine altcoin season, but it remains impossible to predict. Basically, you’ll know it when you’re in it.

Interested in crypto? With SoFi Invest®, you can trade cryptocurrency online from a selection of more than two dozen coins – from Bitcoin and Ethereum to altcoins like Chainlink, Dogecoin, Solana, Litecoin, Cardano, and Enjin Coin.

Find out how to get started with SoFi Invest.

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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.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
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.
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What is Delta in Options Trading?

In options trading, Delta is an important assessment tool used to measure risk sensitivity. Delta is a risk metric that compares changes in a derivative’s underlying asset price to the change in the price of the derivative itself.

Essentially it measures the sensitivity of a derivative’s price to a change in the underlying asset. Using Delta as part of an options assessment can help investors make better trades.

Delta is one of “the Greeks,” a set of options trading tools denoted by Greek letters. Some traders might refer to the Greeks as risk sensitivities, risk measures,or hedge parameters. The Delta metric is the most commonly used Greek.

Recommended: A Beginner’s Guide to Options Trading

Option Delta Formula

Analysts calculate Delta using the following formula with theoretical pricing models:

Δ = ∂V / ∂S

Where:

•   ∂ = the first derivative

•   V = the option’s price (theoretical value)

•   S = the underlying asset’s price

Some analysts may calculate Delta with the much more complex Black-Sholes model that incorporates additional factors. But traders generally don’t calculate the formula themselves, as trading software and exchanges do it automatically. Traders analyze these calculations to look for investment opportunities.

Option Delta Example

For each $1 that an underlying stock moves, an the equity derivative’s price changes by the Delta amount. Investors express the Delta sensitivity metric in basis points. For example, let’s say there is a long call option with a delta of 0.40. Investors would refer to this as “40 delta.” If the option’s underlying asset increased in price by $1.00, the option price would increase by $0.40.

However, the Delta amount is always changing, so the option price won’t always move by the same amount in relation to the underlying asset price. Various factors impact Delta, including asset volatility, asset price, and time until expiration.

If the price of the underlying asset increases, the Delta gets closer to 1.0 and a call option increases in value. Conversely, a put option becomes more valuable if the asset price goes lower than the strike price, and in this case Delta is negative.

How to Interpret Delta

Delta is a ratio that compares changes in the price of derivatives and their underlying assets. It uses theoretical price movements to track what will happen with changes in asset and option price. The direction of price movements will determine whether the ratio is positive or negative.

Bullish options strategies have a positive Delta, and bearish strategies have a negative Delta. It’s important to remember that unlike stocks, options buying and selling options does not indicate a bullish or bearish strategy. Sometimes buying a put option is a bearish strategy, and vice versa.

Recommended: Differences Between Options and Stocks

Traders use the Delta to gain an understanding of whether an option will expire in the money or not. The more an option is in the money, the further the Delta value will deviate from 0, towards either 1 or -1.

The more an option goes out of the money, the closer the Delta value gets to 0. Higher Delta means higher sensitivity. An option with a 0.9 Delta, for example, will change more if the underlying asset price changes than an option with a 0.10 Delta. If an option is at the money, the underlying asset price is the same as the strike price, so there is a 50% chance that the option will expire in the money or out of the money.

Call Options

For call options, delta is positive if the derivative’s underlying asset increases in price. Delta’s value in points ranges from 0 to 1. When a call option is at the money the Delta is near 0.50, meaning it has an equal likelihood of increasing or decreasing before the expiration date.

Put Options

For put options, if the underlying asset increases in price then delta is negative. Delta’s value in points ranges from 0 to -1. When a put option is at the money the Delta is near -0.50.

How Traders Use Delta

In addition to assessing option sensitivity, traders look to Delta as a probability that an option will end up in or out of the money. The more likely an option is to generate a profit, the less risky it is as an investment.

Every investor has their own risk tolerance, so some might be more willing to take on a risky investment if it has a greater potential reward. When considering Delta, traders recognize that the closer it is to 1 or -1 to greater exposure they have to the underlying asset.

If a long call has a Delta of 0.40, it essentially has a 40% chance of expiring in the money. So if a long call option has a strike price of $30, the owner has the right to buy the stock for $30 before the expiration date. There is a 40% chance that the stock’s price will increase to at least $30 before the option contract expires.

Traders also use Delta to put together options spread strategies.

Delta Neutral

Traders also use Delta to hedge against risk. One common options trading strategy, known as neutral Delta, is to hold several options with a collective Delta near 0.

The strategy reduces the risk of the overall portfolio of options. If the underlying asset price moves, it will have a smaller impact on the total portfolio of options than if a trader only held one or two options.

One example of this is a calendar spread strategy, in which traders use options with various expiration dates in order to get to Delta neutral.

Delta Spread

With a Delta spread strategy, traders buy and sell various options to create a portfolio that offsets so the overall Delta is near zero. With this strategy the trader hopes to make a small profit off of some of the options in the portfolio.

Using Delta Along With the other Greeks

Delta measures an option’s directional exposure. It is just one of the Greek measurement tools that traders use to assess options. There are five Greeks that work together to give traders a comprehensive understanding of an option. The Greeks are:

•   Delta (Δ): Measures the sensitivity between an option price and the price of the underlying security.

•   Gamma (Γ): Measures the rate at which Delta is changing.

•   Theta (θ): Measures the time decay of an option. Options become less valuable as the expiration date gets closer.

•   Vega (υ): Measures how much implied volatility affects an option’s value. The more volatility there is the higher an option premium becomes.

•   Rho (ρ): Measures an option’s sensitivity to changing interest rates.

The Takeaway

Delta is a useful metric for traders evaluating options and can help investors determine their options strategy. Traders often combine it with other tools and ratios during technical analysis. However, you don’t need to trade options in order to get started investing.

A great way to begin investing is by opening an investment account on the SoFi Invest® app. While SoFi does not offer options trading, it does allow you to research, track, buy and sell stocks, ETFs, and crypto right from your phone.

Photo credit: iStock/PeopleImages


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.
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Source: sofi.com

What Is Fibonacci Retracement in Crypto Trading?

A retracement level is the price at which a stock or cryptocurrency tends to see a reversal in its trend. Fibonacci retracement is a popular tool in technical analysis that helps determine support and resistance levels on a price chart.

What Are Fibonacci Retracement Levels?

Fibonacci numbers are a series where each number equals the sum of the two previous numbers. The most basic series is: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377 etc.

When it comes to technical analysis, investors use Fibonacci Replacement Levels, expressed as percentages, to analyze how much of a previous move a price has retraced. The most important Fibonacci Retracement levels are: 23.6% 38.2%, 50% and 61.8%.

Some analysts refer to 61.8% as “the golden ratio,” since it equals the division of one number in the series by the number that follows it. For example: 8/13 = 0.6153, and 55/89 = 0.6179.

The other Retracement levels reflect other calculations: Dividing one number by the number three places to its right equals 23.6%. For example: 8/34 = 0.2352. Bitcoin traders often use 78.6%, which is the square root of 0.618,

Some prefer the 0.618 and 0.382 levels because these are the retracement levels analysts believe are most likely to generate a trend reversal. These levels are considered inflection points where fear and greed can alter price action. When an asset is trending upward but loses momentum, it’s possible that a pullback to the 0.618 price level could result in a bounce upward, for example.

How Does Fibonacci Retracement Work and What Does it Do?

There are several theories as to why the fibonacci retracement works. Some of these include:

•   Fibonacci price levels reflect the effects of extreme fear and greed in the market. To use this to their advantage, traders might buy when people are panicking and sell when others are getting greedy.

•   Fibonacci patterns are often observed in nature as well as in mathematics. For example: fruits and vegetables. If one would look at the center of a sunflower, spiral patterns could appear to curve left and right. Counting these spirals, the total often is a Fibonacci number. If one could divide the spirals into those pointed left and right, then two consecutive Fibonacci numbers could be obtained. Therefore, it’s thought that these patterns may be important in financial markets as well.

•   The law of numbers: If a greater percentage of people practice Fibonacci crypto trading, then the likelihood of its accuracy increases.

At its core, a Fibonacci retracement is a mathematical measurement of a particular pattern. When it comes to Fibonacci in crypto, traders try to apply these patterns to price action to predict future price movements.

Who Created Fibonacci Retracements?

While traders commonly use Fibonacci in crypto today, the number sequences pre-date the invention of cryptocurrency by many centuries. Fibonacci numbers are based on the key numbers studied by mathematician Leonardo Fibonacci (or Leonardo of Pisa) in the 13th century, although Indian mathematicians had identified them previously. He was a medieval Italian mathematician famous for his “Book of the Abacus”, the first European work on Indian and Arabian mathematics, which introduced Hindu-Arabic numerals to Europe.

Formula

In an uptrend or bullish market, the formulas for calculating Fibonacci retracement and extension levels are:

UR = High price – ((High price – Low price) * percentage) in an uptrend market; where UR is uptrend retracement.

UE = High price + ((High price – Low price) * percentage) in an uptrend market; where UE is an uptrend extension.

For example: A stock price range of $10 – $20, could depict a swing low to swing high.

Uptrend Retracement (UR) = $20 – (($20 – $10) * 0.618)) = $13.82 (utilizing 0.618 retracement)

Uptrend Extension (UE) = $20 + (($20 – $10) * 0.618)) = $26.18 (utilizing 0.618 retracement)

If a stock pulls back $13.82 could be a level that the stock bounces back to reach higher levels than its swing high price, e.g. $20. In an uptrend, the general idea is to take profits on a long trade at a Fibonacci price extension Level ~ $26.18.

What Does a Fibonacci Retracement do?

Markets don’t go straight up or down. There are pauses and corrections along the way. To buy stocks in an uptrend, one would look to get the best price possible.

Some traders use Fibonacci Retracement to determine how much a stock could pull back before continuing higher. Traders can use these retracement levels to find optimal prices at which to enter a trade.

A swing high happens when a security’s price reaches a peak before a decline. A swing high forms when the highest price reached is greater than a given number of highs around it.

Swing low is the opposite of swing high. It refers to the lowest price within a timeframe, usually fewer than 20 trading periods. A swing low occurs when a lowest price is lower than any other surrounding prices in a given period of time.

Support and Resistance

Support is the price level that acts as a floor, preventing the price from being pushed lower, while resistance is the high level that the price reaches over time. Analysts often illustrate these as horizontal lines on a graph.

A support or resistance level can also represent a pivot point, or point from which prices have a tendency to reverse if they bounce (in the case of support) or retreat (in the case of resistance) from that level.

Learn more: Support and Resistance: What Is It? How To Use It for Trading

Limitations of Fibonacci Retracement

Fibonacci retracements in crypto or other markets may be slightly predictive. But over relying on them can be counterproductive for reasons such as:

•   Fibonacci retracements, like any other indicators, could be used effectively only if investors understand it completely. It could end up being risky if not used properly.

•   There are no guarantees that prices will end up at that point, and retrace as the theory indicates.

•   Fibonacci retracement sequences are often close to each other, therefore it may be tough to accurately predict future price movements.

•   Using technical analysis tools like Fibonacci retracements can give investors tunnel vision, where they only see price action through this one indicator. Assuming that any single indicator is always correct can be problematic.

A Fibonacci retracement in crypto trading could wind up being even less predictive than in other financial markets due to the extreme volatility that cryptocurrencies often experience.

Fibonacci Retracements and Bitcoin

Fibonacci retracements can also be used for trading cryptos such as Bitcoin (BTC), similarly to how they’re used in stocks. In this case, one would use the levels 23.6%, 38.2%, 50%, 61.8% and 78.6% to determine where the cryptocurrency price would reverse.

Crypto prices are very volatile, and leverage trading is common. Leverage is the use of borrowed funds to increase the trading position, beyond what would be available from the cash balance alone. Therefore, it can be important to have some reference as to when the price could reverse, to not incur major losses.

Using the Fibonacci Retracement Tool to Trade Cryptocurrencies

In order to get started with a Fibonacci Retracement Tool, a trader could find a completed trend for a crypto, say, Bitcoin, which could either be an uptrend or downtrend.

Below are some steps on how to use Fibonacci retracement tool:

1.    Determine the direction of the market. Is it an uptrend or downtrend?

2.    For an uptrend, determine the two most extreme points (bottom and top) on the Bitcoin price chart. Attach the Fibonacci retracement tool on the bottom and drag it to the right, all the way to the top.

3.    For a downtrend, the extreme points are top and bottom and the retracement tool could be dragged from the top to the bottom.

4.    For an uptrend or downtrend, one could monitor the potential support levels: 0.236, 0.382, 0.5 and 0.618.

Recommended: Crypto Technical Analysis: What It Is & How to Do One

Fibonacci Retracement Example for Bitcoin

In December 2017, Bitcoin fell from $13,112 to around $10,800, within a short timeframe. After that, it rallied up to $12k twice, but did not break above that level until 2021. That indicates a bearish pattern, as it couldn’t break above its previous high. In technical analysis it is called a double top.

On the Fibonacci tool, the $12k resistance point coincided with the 50% level of retracement. When the price could not reach this level, it started to fall again. In this scenario, traders using Fibonacci Retracement might consider this a good time to exit a long position or establish a short position. A short trade is based on the speculation that the price of Bitcoin is going to fall.

By February, 2018, the trade materialized as Bitcoin continued its downtrend falling all the way to $9,270. The short trade would have worked and traders could have realized a profit from using the crypto Fibonacci Retracement tool, although those who managed to HODL for years after that would have made even more.

FAQ

Does Fibonacci retracement work with crypto?

While the Fibonacci retracement tool is traditionally used for analyzing stocks or trading currencies in the forex market, some analysts believe it is also helpful in determining a crypto trading strategy.

How accurate is fibonacci retracement?

In crypto, Fibonacci retracement levels are often fairly accurate, although no indicator is perfect and they are best used in combination with other research. The accuracy levels increase with longer timeframes. For example, a 50% retracement on a weekly chart is a more important technical level than a 50% retracement on a five-minute chart.

What are the advantages of using fibonacci retracement?

Here are some benefits of using Fibonacci Retracement.

•   Trend prediction. With the correct setting and levels, it can often predict the price reversals of bitcoin at early levels, with a high probability.

•   Flexibility. Fibonacci Retracement works for assets of any market and any timeframe. One must note that longer time frames could result in a more accurate signal.

•   Fair assessment of market psychology. Fibonacci levels are built on both a mathematical algorithm and the psychology of the majority, which is a fair assessment of market sentiment.

The Takeaway

The Fibonacci Retracement tool can help identify hidden levels of support and resistance so that analysts can better time their trades. Analysts believe this tool is more effective when utilized with types of cryptocurrency that have higher market-capitalization, like Bitcoin and Ethereum, because they have more established trends over extended time frames.They consider it less effective on cryptocurrencies with a smaller market capitalization.

Whether you use Fibonacci Retracement or other methods to create your cryptocurrency trading strategy, a great way to get started is by opening a brokerage account on the SoFi Invest investment app. You can use it to trade more than a dozen different coins, including Bitcoin, Ethereum, Litecoin, Cardano, and Dogecoin.

Photo credit: iStock/HAKINMHAN


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. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
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Source: sofi.com

Understanding Your Student Loan Promissory Note

Generally speaking, promissory notes are legally binding contracts that state the terms of a loan, such as the amount to be repaid, the interest rate that will be charged, and any other important terms and conditions of that particular loan.

A student loan promissory note is no different; you’ll be required to sign one, accepting the terms of your student loan(s) before the lender disburses your money.

If a student loan promissory note sounds super important, that’s because it is. You can think of it as your student loan contract. Like any legal contract, it’s important to know the nuances of what you’re signing. Here’s what you should know about student loan promissory notes and master promissory notes.

What Is a Student Loan Promissory Note?

A promissory note is your student loan contract. It details the terms and conditions of that loan, as well as any rights and responsibilities you have as a borrower. Both federal student loans — loans backed by the U.S. government — and private student loans require that you sign a promissory note.

With private student loans, borrowers will generally be required to sign a promissory note for each student loan they borrow, because each loan’s terms and conditions may be different. Federal student loan borrowers may have the option to sign just one master promissory note.

What Is a Master Promissory Note?

Borrowers with federal student loans may be able to sign just one master promissory note. If eligible, a master promissory note covers all federal loans borrowed for a period of 10 years. There are versions of the master promissory note for both students borrowing Direct Subsidized or Unsubsidized Loans and a version for borrowers who are using Direct PLUS Loans.

Whether you’ll be able to sign a master promissory note is determined by the school you attend and the types of federal loans you have. Some schools do not offer the option to have students sign a master promissory note that covers borrowing over multiple years.

So be certain to understand what your school allows, and whether you need to sign multiple promissory notes or one master promissory note. The financial aid office at your college should be able to guide you through the process.

What Should I Look for on My Student Loan Promissory Note?

Understanding the terms and conditions of a student loan promissory note is akin to understanding the terms of student loans. Here are some important items to consider on your loan, and note:

Loan type: First, it is important to know what type of loan you have. Federal loans will have different terms than private loans, which are loans accessed through an independent bank, credit union, or other lender.

Repayment options: Federal loans come with some options to help you manage your debt post-graduation, such as student loan forgiveness and income-driven repayment. If you have federal loans and access to multiple repayment plans, take some time to understand the ins and outs of different plans.

Deferment options: Federal loans may also offer options for student loan deferment, which would allow you to suspend making payments during periods of economic hardship, immediately after you leave school, etc. Private loans may also offer some deferment options, but every lender is different, so you’ll need to check your note.

Interest rate: The interest rate is a percentage of the principal loan amount that the borrower is charged for borrowing money. Be certain to understand the interest rate on your student loans, and whether that rate is fixed or variable. Federal student loans have fixed interest rates.

Private student loans may offer variable rates. If the rate is variable, it is possible that it will increase in the future, which would also increase your monthly payments. Be especially wary of private loans that offer introductory rate offers that later expire — they could end up costing you quite a bit of money.

Additional costs: In addition to the loan’s interest rate, a student loan promissory note should include information on any additional costs, such as a loan fee (also known as an origination fee). Student loan fees will vary by lender, so be sure to check yours. Sometimes a loan fee is deducted directly from the amount that is disbursed.

Prepayment fees: Speaking of additional costs, one thing to check for is whether your student loan allows you to “pre-pay” loan payments. If you think there’s a chance you’ll want to pay your loan back faster than the stated terms, check to see whether prepayment is allowed, and if so, how additional payments are applied and whether there are any fees attached. Making prepayments on the principal value of the loan could help reduce the amount of money you owe in interest over the life of the loan.

Cosigner removal: With some loans, especially private loans, you may be required to have a cosigner. (That’s because private loans rely on your — or your cosigner’s — creditworthiness to determine the terms of your loan. Federal loans do not.) Upon graduation, some borrowers want to release their cosigner of the responsibility of having their name on the loan, so you may want to find out whether that’s a possibility.

Allocation of funds: Some loans may require that the money is spent only on designated expenses, such as books or tuition. If you’re looking to upgrade your apartment, you might not be allowed to do so using student loan funds. Make sure to check on any stipulations on how you can spend the money.

When Is the Promissory Note Signed?

In general, borrowers will need to sign the promissory note for their loans before receiving any funds. Students who are borrowing federal student loans are able to sign their master promissory note online by logging into their federal student loan account.

Private lenders may have their own policies for signing a promissory note, it’s helpful to check-in directly with the lender if you have any questions.

Understanding Your Options

If you haven’t picked up on it already, knowing how student loans work and understanding your student loan contract is the name of the game. Taking out a student loan can be a huge financial commitment and shouldn’t be done without careful consideration — which means knowing what’s on that promissory note.

Before going to sign your student loan promissory note, it’s also a good idea to spend some time thinking about your financial goals. A good place to start is by looking at how much you’ll take out in loans, total, and compare that to how much money you can expect to make after you graduate from school. Use a student loan calculator to get an idea of what your monthly payments could be given your total debt and the interest rate.

Rarely is it financially sound to take out more in loans than you absolutely need. It might seem like Monopoly money now, but this is all money that you’ll have to pay back, with interest. The repayment process can be painstaking, especially as a person early in their career or during a setback, like layoffs or a health issue. Taking out the bare minimum in student loans may mean working part-time in college, exploring more affordable college options, or continuing to apply for scholarships after you’re enrolled.

Once you’ve graduated, keep in mind that refinancing your student loans is a way for some graduates to lower the interest rates on their loans or lower their monthly payments. Refinancing is a process where your existing loans are consolidated and paid off with a new loan from a private lender.

Generally, the borrower has the option to keep the same repayment schedule or increase or decrease the amount of time left on their loan. (Increasing the duration of a loan may result in paying more interest over time, whereas decreasing the duration of a loan may result in higher monthly payments, but less interest paid overall.)

If you’re planning on using your federal loans’ flexible repayment plans or student loan forgiveness programs, refinancing with a private lender may not be the right choice for you as you will lose access to those federal benefits. However, some private lenders, like SoFi, offer protections to borrowers who lose their jobs or experience economic hardship. SoFi even provides career counseling to help their borrowers get back on track.

The Takeaway

A student loan promissory note is a contract between the borrower and the lender that details the loan’s terms and conditions and where the borrower promises to repay the loan. Federal student loan borrowers may be able to sign just one master promissory note, which will cover all federal loans for a period of up to 10 years. Private lenders generally require a promissory note for each individual loan.

Understanding the terms and conditions of your loan when signing of the promissory note can help you set your expectations for borrowing and ultimately repaying your student loans.

Whether you need help paying for school or help paying off the loans you already have, SoFi offers competitive interest rates and great member benefits as well.

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5 Mortgage REITs for Yield-Hungry Investors

In the search for rich dividend yields, mortgage REITs (mREITs) are in a class all their own. 

These are companies are structured as real estate investment trusts (REITs), but they own interest-bearing assets like mortgages and mortgage-backed securities rather than physical real estate.

One of the biggest reasons to own mortgage REITs is their exceptional yields, currently averaging around 8% to 9%, according to Nareit – the leading global producer on REIT investment research – more than four times the yield available on the S&P 500. These outsized yields are enticing, but investors should approach these stocks with caution and hold them only as one part of a larger, more diversified portfolio. 

One reason for this is their sensitivity to changes in interest rates. When interest rates rise, mortgage REIT earnings generally decline. The Federal Reserve is signaling plans for multiple rate hikes in 2022 that could create headwinds for these stocks.   

And increasing interest rates hurt mREITs because these businesses borrow money to fund their operations. Their borrowing costs rise with interest rates, but the interest payments they collect from mortgages remain the same, causing profit margins to compress. Some of this risk can be managed with hedging tools, but mortgage REITs can’t eliminate interest-rate risk altogether.  

Another caveat is that mortgage REITs frequently cut dividends when times are tough. During the height of the COVID-19 pandemic in 2020, 30 of this sector’s 40 companies either cut or suspended dividends. On the flip side, dividends were quickly restored in 2021, with 20 mREITs raising dividends.

We searched the mortgage REIT universe for stocks whose dividends appear safe this year.

Read on as we explore five of the best mREITs for 2022. A few of these REITs are reducing interest-rate risk via acquisitions or an unusual lending focus, while others have strong balance sheets or outstanding track records for raising dividends. And all of them offer exceptional yields for investors.

Data is as of Jan. 12. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price. Stocks are listed in order of lowest to highest dividend yield.

1 of 5

Hannon Armstrong Sustainable Infrastructure Capital

green investing conceptgreen investing concept
  • Market value: $4.1 billion
  • Dividend yield: 2.9%

Hannon Armstrong Sustainable Infrastructure Capital (HASI, $48.56) is a bit of an oddball for a mortgage REIT in that it specializes in clean energy and infrastructure rather than pure real estate. Specifically, the real estate investment trust invests in wind, solar, storage, energy efficiency and environmental remediation projects – making it not only one of the best mREITs, but also one of the best green energy stocks to own.

Its loan portfolio encompasses 260 projects and is valued at $3.2 billion. In addition to its own loans, Hannon Armstrong manages roughly $8 billion of other assets, mainly for public sector clients.   

This mREIT boasts a $3 billion pipeline and is ideally positioned to capture some portion of the spending from the $1.2 trillion infrastructure bill that was passed by Congress in late 2021.  

Over the last three years, Hannon Armstrong has generated 7% annual earnings per share (EPS) gains and 1% yearly dividend growth. Over the next three years, HASI is targeting accelerated gains of 7% to 10% yearly earnings per share growth and 3% to 5% in dividend hikes. Future earnings growth should be enhanced by the firm’s prudent 1.6 times debt-to-equity ratio.

Hannon Armstrong produced exceptional September-quarter results, showing 45% year-over-year loan portfolio growth and a 14% increase in distributable earnings per share. 

Analysts expect earnings of $1.83 per share this year and $1.91 per share next year – more than enough to cover the REIT’s $1.40 per share annual dividend.

HASI is well-liked by Wall Street analysts, with five of the six that are tracking the stock calling it a Buy or Strong Buy. 

2 of 5

Starwood Property Trust

little red house surrounded by little white houseslittle red house surrounded by little white houses
  • Market value: $7.7 billion
  • Dividend yield: 7.6%

Starwood Property Trust (STWD, $25.44) has a $21 billion loan portfolio, making it the largest mortgage REIT in the U.S. The company is affiliated with Starwood Capital Group, one of the world’s biggest private investment firms. 

STWD is considered a mortgage real estate investment trust, but it operates more like a hybrid by owning physical properties as well as mortgages and real estate securities. Its portfolio comprises 61% commercial loans, but the REIT also has sizable footholds in residential loans (11%), properties (12%) and infrastructure lending (9%), a relatively new focus for the company.

The mREIT benefits from access to the databases of Starwood Capital Group, which makes over $100 billion in real estate transactions annually and has a portfolio consisting of 96% floating-rate debt. This high percentage of floating-rate debt and unusually short loan durations – averaging just 3.3 years – minimizes Starwood’s risk from rising interest rates. 

STWD is also one of the nation’s largest servicers of commercial mortgage-backed securities (CMBS) loans; sizable, reliable loan servicing fees help mitigate risk if loan credit quality deteriorates.

Starwood Property Trust closed $3.8 billion of new loans during the September quarter and generated distributable earnings of 52 cents per share – up sequentially from June and slightly above analysts’ consensus estimate. After the September quarter closed, the mREIT booked a huge $1.1 billion gain on the sale of a 20% stake in an affordable housing real estate portfolio.   

The company has made 12 consecutive years of quarterly dividend payments, and unlike many other mortgage REITs, held its ground in 2020 by maintaining an unchanged dividend.

Of the seven Wall Street pros following STWD, one says it’s a Strong Buy, five call it a Buy and just one says Hold. Adding fuel to the bullish fire, CNBC analyst Jon Najarian recently tapped Starwood as one of his top stocks to watch, given its impressive 7.6% dividend yield.

3 of 5

Arbor Realty Trust

mortgage-backed securities conceptmortgage-backed securities concept
  • Market value: $2.8 billion
  • Dividend yield: 7.7%

Arbor Realty Trust (ABR, $18.70) stands out as one of the best mREITS given its six straight quarters of dividend hikes and a compound annual growth rate (CAGR) of nearly 18% for dividend growth over the past five years. 

What’s more, Arbor Realty Trust has delivered 10 straight years of dividend growth while maintaining the industry’s lowest dividend payout rate.

This mortgage REIT is able to steadily grow dividends thanks to the diversity of its operating platform, which generates income from agency and non-agency loans, physical real estate (including rentals) and servicing fees.

Agency loan originations and the servicing portfolio have grown at a 16% CAGR over five years. And during the first nine months of 2021, Arbor Realty Trust set a new record with balance sheet loan originations, coming in at $7.2 billion – 2.5 times its previous record. Loan volume rose 45% over its previous record to total $13.2 billion over the nine-month period.

While September EPS declined year-over-year due to a reduced contribution from equity affiliates, earnings for the first nine months of the year were up 164% from the year prior to $1.56 per share.

Arbor Realty Trust earns Buy ratings from two of the three Wall Street analysts following the stock, and Zacks Research recently named ABR one of its top income picks for 2022. 

Valued at only 10 times forward earnings – which is 15.4% below industry peers – ABR shares appear bargain-priced at the moment.   

4 of 5

MFA Financial

person looking for business loan on laptopperson looking for business loan on laptop
  • Market value: $2.1 billion
  • Dividend yield: 8.2%

MFA Financial (MFA, $4.68) just closed an impactful acquisition that reduces its exposure to interest-rate changes and accelerates loan growth. This REIT was already hedging its bets by investing in both agency and non-agency mortgage securities. 

Agency securities are guaranteed by the U.S. government and tend to be safer, lower-yielding and more sensitive to interest rates than non-agency securities. By combining these in one portfolio, MFA Financial generates nice returns while reducing the impact of changes in interest rates and prepayments on the portfolio. 

Through the July acquisition of Lima One, MFA Financial becomes a major player in business purpose lending (BPL), an attractive niche comprised of fix-and-flip, construction, multi-family and single-family rental loans. 

An aging U.S. housing stock is creating demand for real estate renovations and causing BPL to soar. BPL loans are good quality and high-yielding, but difficult to source in the marketplace. With the purchase of Lima One, MFA Financial gains a $1.1 billion BPL loan-servicing portfolio and an established national franchise for originating these types of loans. 

Lima One’s impact was apparent in MFA Financial’s September-quarter results. The REIT originated $2.0 billion of loans, the highest quarterly total on record, and grew its portfolio by $1.5 billion after runoff. 

Net interest income increased 15% on a sequential basis, and gains recorded on the Lima One purchase contributed 10 cents to the mREIT’s earnings of 28 cents per share. MFA Financial also took advantage of the strong housing market to sell 151 properties, booking a $7.3 million gain on the sale. MFA’s book value – the difference between the total value of a company’s assets and its outstanding liabilities – rose 4% sequentially to $4.82 per share, a modest 3% premium to its current share price.

Raymond James analyst Stephen Laws upgraded MFA to Outperform from Market Perform – the equivalents of Buy and Hold, respectively – in December. He thinks the Lima One acquisition will accelerate loan growth and reduce the mortgage REIT’s borrowing costs.

MFA Financial has a 22-year track record of paying dividends. While payments were reduced in 2020, the REIT recently signaled improving prospects with a 10% dividend hike in late 2021.

5 of 5

Broadmark Realty Capital

real estate contract with keys and penreal estate contract with keys and pen
  • Market value: $1.3 billion
  • Dividend yield: 8.6%

Broadmark Realty Capital (BRMK, $9.77) is unusual for its zero-debt balance sheet, robust loan origination volume and sizable monthly dividends. This mortgage REIT provides short to mid-term loans for commercial construction and real estate development that are less interest-rate sensitive. As such, BRMK is a solid play on America’s housing boom.  

Lending activities focus on states with favorable demographics and lending laws. Plus, 60% of its business comes from repeat customers, ensuring low loan acquisition costs.

Broadmark Realty Capital achieved record loan origination volume of $337 million during the September quarter, roughly twice prior-year levels and up 68% sequentially. The overall portfolio grew to $1.5 billion. Broadmark Realty Capital also originated its first loans in Nevada and Minnesota, with expansion into additional states planned during the December quarter. 

Despite rising revenues and distributable EPS, Broadmark Realty’s results came in slightly below analyst estimates and its share price declined in reaction. However, this price slip may present an opportunity to pick up one of the best mREITs at a discount. At present, BRMK shares trade at just 12.7 times forward earnings and 1.1 times book value – the latter of which is a 15% discount to industry peers.

The mortgage REIT cut its dividend in 2020, but continued to make monthly payments to shareholders. And in 2021, it raised its dividend 17% in early 2021. While dividend payout currently exceeds 100% of fiscal 2021 earnings, analysts are forecasting a 17% rise in fiscal 2022, which would comfortably cover the current 84 cents per share annual dividend.     

Source: kiplinger.com

Tax Loss Carryforward

A tax loss carryforward is a special tax rule that allows capital losses to be carried over from one year to another. In other words, capital losses realized in the current tax year can also be used to offset gains or profits in a future tax year.

Investors can use a capital loss carryforward to minimize their tax liability when reporting capital gains from investments. Business owners can also take advantage of loss carryforward rules when deducting losses each year.

Knowing how this tax provision works, and when it can be applied, is important from an investment tax-savings perspective.

What Is Tax Loss Carryforward?

Tax loss carryforward is the process of carrying forward capital losses into future tax years. A capital loss occurs when you sell an asset for less than your adjusted basis. Capital losses are the opposite of capital gains, which are realized when you sell an asset for more than your adjusted basis.

Adjusted basis simply means the cost of an asset, adjusted for various events (i.e. increases or decreases in value) through the course of ownership. Whether a capital gain or capital loss is short-term or long-term depends on how long you owned it before selling. Short-term capital losses and gains apply when an asset is held for one year or less, while long-term capital gains and losses are associated with assets held for longer than one year.

The Internal Revenue Service allows certain capital losses, including losses associated with personal or business investments, to be deducted from taxable income. There are limits on the amount that can be deducted each year, however, which depend on the type of losses that are being reported.

In order to allow taxpayers to claim the full capital loss deduction they’re entitled to, the IRS makes it possible to carry tax losses forward into future years.

Recommended: What to Know about Paying Taxes on Stocks

How Tax Loss Carryforwards Work

In general terms, a tax loss carryforward works by allowing you to report losses realized on assets in one tax year on a future year’s tax return. IRS loss carryforward rules apply to both personal and business assets. The main types of carryforwards allowed by the Internal Revenue Code are capital loss carryforwards and net operating loss carryforwards.

Capital Loss Carryforward

IRS rules allow investors to “harvest” tax losses, meaning they use capital losses to offset capital gains. An investor could sell an investment at a capital loss, then deduct that loss against capital gains from other investments, assuming they don’t violate the wash sale rule.

The wash sale rule prohibits investors from buying substantially identical investments within the 30 days before or 30 days after the sale of a security for the purposes of tax-loss harvesting.

If capital losses are equal to capital gains, they would offset one another on your tax return, so there’d be nothing to carry over. For example, a $5,000 capital gain would cancel out a $5,000 capital loss and vice versa.

If capital losses exceed capital gains, you can claim the lesser of $3,000 ($1,500 if married filing separately) or your total net loss shown on line 21 of Schedule D for Form 1040. Any capital losses in excess of $3,000 could be carried forward to future tax years. The IRS allows you to carry losses forward indefinitely.

Net Operating Loss Carryforward

A net operating loss (NOL) occurs when a business has more deductions than income. Rather than posting a profit for the year, the business operates at a loss. Business owners may be able to claim a NOL deduction on their personal income taxes. Net operating loss carryforward rules work similar to capital loss carryforward rules, in that businesses can carry forward losses from one year to the next.

For losses arising in tax years after December 31, 2020, the NOL deduction is limited to 80% of the excess of the business’s taxable income, according to the IRS. To calculate net operating loss deductions for your business, you first have to omit items that could limit your loss, including:

•   Capital losses that exceed capital gains

•   Nonbusiness deductions that exceed nonbusiness income

•   Qualified business income deductions

•   The net operating loss deduction itself

These losses can be carried forward indefinitely at the federal level.

Note, however, that the rules for NOL carryforwards at the state level vary widely. Some states follow the federal rules, but others do not.

How Long Can Losses Be Carried Forward?

According to the IRS, tax loss carryforward rules allowed losses to be carried forward indefinitely. That includes both capital losses associated with the sale of investments or other assets, as well as net operating losses for a business. Prior to the Tax Cuts and Jobs Act of 2017, business owners were limited to a 20-year window when carrying forward net operating losses.

It’s important to keep in mind that capital loss carryforward rules don’t allow you to simply roll over losses. IRS rules state that you must use capital losses to offset capital gains in the year that they occur. You can only carry capital losses forward if they exceed your capital gains for the year. The IRS also requires you to use an apples-to-apples approach when applying capital losses against capital gains.

For example, you’d need to use short-term capital losses to offset short-term capital gains. You couldn’t use a short-term capital loss to balance out a long-term capital gain or a long-term capital loss to offset a short-term capital gain. This rule applies because short- and long-term capital gains are subject to different tax rates.

Example of Tax Loss Carryforward

Assume that you purchase 100 shares of XYZ stock at $50 each. Thirteen months after purchasing the shares, their value has doubled to $100 each so you decide to sell, collecting a capital gain of $5,000. You also hold 100 shares of ABC stock, which have decreased in value from $70 per share to $10 per share over that same time period.

Your capital losses would total $6,000 (the difference between the $7,000 you paid for the shares and the $1,000 you sold them for). You could use $5,000 of that loss to offset the $5,000 gain associated with selling your shares in the first company. Per IRS rules, you could also apply the additional $1,000 loss to reduce your ordinary income for the year.

Now, say you also have another stock that you sold at a $5,000 loss. You could apply $2,000 of that loss to offset ordinary income, then carry the remaining $3,000 forward to a future tax year, per IRS rules. All of this, of course, assumes that you don’t violate the wash sale rule when timing the sale of losing stocks.

The Takeaway

If you’re investing in a taxable brokerage account, it’s important to include tax planning as part of your strategy. Selling stocks to realize capital gains could result in a larger tax bill if you’re not deducting capital losses at the same time. With tax-loss harvesting, assuming you don’t violate the wash sale rule, it’s possible to carry forward investment losses to help reduce the tax impact of gains over time. This applies to personal as well as business gains and losses. Thus, understanding the tax loss carryforward provision may help reduce your personal as well as investment taxes.

In order to understand the true impact of gains and losses, it may help to open an investment account with SoFi Invest®. Here you can trade stocks as well as ETFs and even cryptocurrency. Even better, as a SoFi Member you have access to financial professionals who can offer complimentary guidance and answer your most pressing investing questions.

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Average Directional Index (ADX) Explained

The Average Directional Movement Index, or ADX, is an indicator used in technical analysis to help determine the strength of a pricing trend. The indicator was developed by Welles Wilder as part of his Directional Movement System for commodity trading. Since then it has been used for other tradeable investments such as stocks, exchange-traded funds (ETFs), and foreign currency.

The ADX can help investors understand when to buy and sell positions. Here’s a closer look at what ADX is, how to calculate it, and the role it plays in making investment decisions.

What is ADX?

ADX shows an average of price range values that indicate expansion or contraction of prices over time — typically a period of 14 days, but, in some cases it may be calculated for shorter or longer periods as well. Shorter periods may respond quicker to pricing movements but may also have more false signals. Longer periods tend to generate fewer false signals but may cause the indicator to lag the market.

The Average Directional Index is part of Wilder’s Directional Movement System, which attempts to measure the strength of pricing trends in both the positive and negative directions, by using DMI+ and DMI- indicators. The DMI+ indicates positive directional movement, and the DMI- indicates negative directional movement. ADX is calculated as the sum of the differences between DMI+ and DMI- over time. These three indicators are often charted together.

ADX Formula

Calculating the Average Directional Index on your own is a bit complex; it requires a series of calculations to be carried out in a specific order. Luckily, you probably won’t ever have to do it yourself — instead take a look at advanced chart settings for publicly available stock charts on websites like the Wall Street Journal . There is often an option to add an ADX or DMI overlay to the chart.

For those who are curious, here’s a look at the formulas required to calculate ADX:

+DI = (Smoothed +DM/ATR) X 100

-DI = (Smoothed -DM/ATR) X 100

DX= (|+DI – -DI|/|+DI + -DI|) X 100

ADX = ((Prior ADX X 13) + Current ADX))/14

Assumptions:

DM = Direction Movement

ATR = Average True Range

+DM = Current High – Previous High

-DM = Previous Low – Current Low

Smoothed +/- DM = ∑14 t=1DM – ((∑14 t=1DM)/14) + CDM

CDM = Current DM

How to Interpret ADX Results

It’s possible that prices within a given market could be moving up or down within a given range without ever developing into a trend. The ADX is used first and foremost to determine whether or not an up or down trend exists in a market at all.

According to Wilder’s calculations, when ADX is above 25, it indicates a strong trend; when ADX is below 20, that indicates there is no trend.

Generally, analysts conclude that between 20 and 25 represents a bit of a gray area in which some say that a developing trend is possible. It’s also possible that prices are simply ranging back and forth rather than trending.

For those who follow ADX, an ADX between 25 and 50 may represent a moderate strength trend. A result of 50 to 100 indicates trends that are increasingly strong.

How to Read an ADX Chart

Identifying the direction of trends is relatively easy when looking at an ADX chart. A line that’s moving in the upward direction indicates a strengthening trend, while a line moving in the downward direction indicates weakening. The steeper the slope of the line, the stronger the trend.

When ADX turns down, it may be an indicator that a trend is ending, which could be an opportunity for investors to consider whether they want to continue holding a position. If ADX has been low for a period of time and begins to rise by four or five points, it may be a bullish indicator that investors should consider buying to take advantage of a potentially burgeoning trend.

Using ADX, +DMI, and -DMI in tandem can generate crossover signals that can help signal opportunities to buy or sell. For example, the +DMI line crossing above the -DMI line is a potential signal to buy when ADX is above 20.

Investors tend to use ADX in conjunction with other technical analysis indicators such as moving averages to help them analyze price movements.

ADX can be used as a momentum indicator that can signal potential reversals in trends. For example, if ADX and market price are moving in an upward trajectory together, that can indicate that prices are strongly trending higher. However, if ADX declines but prices continue to rise, it may be an indicator that the market is losing momentum and prices will turn down soon.

ADX Comparisons

ADX is related to some other indicators. Here’s a breakdown of similarities and differences.

ADX vs DMI

Like ADX, DMI can be used as an indicator to help determine if the price of a security is trending and how strong that trend is. DMI does not take the direction of the trend into account.

DMI can be positive or negative. Positive DMI, or +DMI, is the difference between a stock’s high price today and its high yesterday. Values from the previous 14 days are then added up.

Negative DMI, of -DMI is the difference between a stock’s low from today and its low price from yesterday. A sum is then taken for these values for the previous 14 days.

ADX is calculated as the sum of the difference between positive and negative DMI over time.

ADX vs the Aroon Indicator

The Aroon Indicator is made up of two indicators, the Aroon-Up and the Aroon-Down. Aroon-up reflects the number of days since the last 25-day high, while Aroon-Down represents the number of days since the 25-day low.

The Aroon Indicator is similar in many ways to ADX. It’s used to identify the beginning of a trend or changes to trends, and determine whether a trend exists or if prices are just fluctuating within a range. It can also help investors determine the strength of a trend.

Higher Aroon values indicate a trend, while low values represent a weakening or nonexistent trend.

Pros and Cons of Using ADX

Like any indicator, the ADX has benefits and limitations. Here’s a look at some of the pros and cons:

Pros Cons
Helps identify whether a trend exists or if prices are simply fluctuating within a given range. False trading signals can occur, for example when crossovers are happening too frequently, which can result in confusion as trades quickly shift direction.
Can indicate shifts in trends to help investors make buy and sell decisions.
When used in conjunction with +DMI and -DMI, investors can examine crossover signals to make buy and sell decisions.

The Takeaway

When using technical analysis to decide when to buy and sell investments, individuals may make use of a wide range of research and analytic tools, such as ADX, DMI, the Aroon Indicator, and other trend indicators.

For investors who prefer this type of hand-on approach, a SoFi Invest® brokerage account offers active investing. For others, who may prefer a more hands-off approach, SoFi Invest offers automated investing accounts — an automatically managed portfolio based on their risk tolerance and goals.

Find out how to get started with SoFi Invest.

Photo credit: iStock/Pekic


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

How Risky is Investing in Rental Properties?

I am trying to buy as many rental properties as possible because of the great returns they provide. I am also trying to help other investors discover the fantastic world of investing in long-term rentals through my blog. However, I run into a lot of feedback from people who are worried about how risky it is to invest in rental properties. I hear: “my friend went broke investing in real estate” or “my parents had a rental and it was a money pit up until the day they were forced to sell it.” There are many horror stories involving real estate, but I have no doubt whatsoever long-term rentals are a great investment if you do your homework and buy properties right. Most of those horror stories come from people who did not do their homework, turned a personal residence into a rental out of necessity, or were hoping for appreciation. What are the real risks of rental properties and how can you mitigate these risks?

What are the main risks of investing in rental properties?

There are real risks with investing in rental properties. Many people felt the wrath of these risks in the last housing crash. Housing values plummeted and in some areas rents plummeted as well. Interestingly enough, not every area saw lower rental rates. Some areas saw rents increase because there were so many more renters (people who lost their houses) and the demand pushed rents up.

The investors who were hurt the most in the housing crash were those who were breaking even on their properties or losing money each month and hoping prices would increase to make money. When the bottom dropped out, they now had a property that was losing money each month and was worth less than they had bought it for. Many investors allowed these homes to go into foreclosure because they didn’t think they were worth keeping.

Other risks come from rentals when people buy a property and do not have enough cash to maintain the property or hold it when it is vacant. Most banks will require a certain amount of reserves when you get a loan on an investment property. But as soon as the property is purchased there is nothing stopping the owners from spending that reserve money. When you own a rental there will be times when the tenants move out, there can be evictions, and rarely a tenant can destroy a property. We see these situations occur quite often because people love to see drama but for the most part our tenants take care of our rentals and are awesome.

Why invest in rentals with these risks?

Rental properties have made me a ton of money over the last decade. Prices have increased significantly, which is great, but the properties also make money every month, and I always get a great deal on everything I buy which means I build equity on day one. There are many ways to mitigate the risks of rentals and the money I have made from my properties more than makes the risks worth it!

A lot of people will assume that when you are investing in large value assets like real estate and there can be huge returns, that the risk must be through the roof. There are types of real estate that can be very risky. We flip houses as well, and that is a much riskier venture than owning rental properties in my opinion. Development can also be much riskier but again come with huge rewards as well.

I also was an REO broker during the housing crash and I talked to many investors who lost homes. I was able to see why they lost their homes, what they could have done differently, and what happened after they lost their homes. For the most part, they bought houses that did not cash flow or make money every month and when things went bad they lost the motivation to keep paying into them. Losing the houses was also not the end of the world for these investors. Many of them had put little money down thanks to the crazy lending that was happening prior to that last crash. They were also able to keep those houses for quite a while after they stopped making payments. Many investors kept collecting rent during this time period which may or may not have been legal, but it did happen.

Many of those investors got right back in the real estate game after recovering and invested the right way with cash flow!

How can you mitigate the risk from rentals?

Buy below market value

One key to a low-risk rental strategy or any successful real estate strategy is to buy property below market value. Buying a property below market enables you to create instant equity, increase your net worth, and protects against a downturn in the market. One of the investors who was hurt badly during the crash was buying brand new houses and turning them into rentals. The houses were in great shape, but he paid full retail value for them.

When I buy rentals I want to pay at least 20% less than they are worth after considering any repairs are needed. For example:

  • A home needs $20,000 in repairs and will be worth $200,000 after those repairs. I want to pay $140,000 or less for that property ($200,000 x .80 – $20k). If I am flipping houses, I need to get an even better deal!

I also usually put about 20% down when I buy rentals which means after the property is repaired I have a loan around $110,000 and a property worth $200,000. Even if prices lost 30%, which is about how much they dropped across the county I am fine.

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Cash flow

I consider cash flow the most important factor in my long-term rental strategy. I want every property to make money each month after paying all expenses. Finding these properties that are also a great deal is not easy, but if you want to change your life with massive returns, it is not easy! When I invest I look for a return of 15% cash on cash. That means I make 15% on the money I have invested into the property. These are very high returns and not everyone needs to make this much but it is what I shoot for.

When you have cash flow coming in every month, it does not matter if values decrease because you do not need to sell the property. While it is true that rents can decrease and lower your cash flow, that is very rare and was even very rare in the last housing crash. There were some areas like Florida and Arizona that were massively overbuilt that saw lower rents, but the nation as a whole barely saw any drop.

My cash flow calculator can help you figure the real income on rentals.

Type of property

The older the property, the better the chance of a major repair needing to be done. I have enough cash flow coming in to account for major repairs, but homes over 100 years old can have issues come up that could wipe out all equity. It is rare, but a foundation or structural problem can make a property uninhabitable and cost tens of thousands of dollars to repair. By purchasing newer properties, I lessen the chances of running into repairs that could wipe out my profit for a year or even two.

Multifamily and commercial real estate can also carry more risk. Those types of properties are more complicated and have fewer buyers. I also buy multifamily and commercial properties but I am very careful what I buy and understand there will most likely be way more costs and exposure if the market changes.

If you buy properties that need a ton of work that can add to the risk as well. On my flips and rentals, the worst deals I have done were properties that needed massive remodels. It takes so much time, so many resources, and there is so much that can go wrong. It can also be risky trying to do all of that work yourself!

Cash reserves

One of the most important things to have when investing in real estate is cash! If you buy rentals or flips that can be expensive at times. It is very important to set aside cash to take care of the problems that might come up. When I figure my cash flow I set aside money for vacancies and repairs. You need to have cash set aside in case something goes wrong and this is one of the biggest mistakes landlords make is not having cash around.

Ironically, getting a loan allows investors to have more cash in many cases. Paying down the mortgage early or trying to pay it off with all your extra cash can leave you in a bad situation. If you do pay a property off and need to access that money in an emergency it can be hard to get to without selling.

Good management

Another way to have problems with your rentals is to manage them poorly. Many people have no idea how to manage a rental but decide they can do it on their own. They choose a bad tenant after not screening them, then never check on the property, and are surprised when it gets trashed. If you are going to manage rentals on your own you have to take the time to learn how to manage them. You have to screen tenants, and keep tabs on the properties!

If you don’t want to manage them yourself, you can hire a property manager as well. It takes time to find a good property manager and this is where it takes from work from the landlord as well. Again, no one said owning rentals was easy, but there are many ways to make them a great investment if you are willing to put in the work.

Liability and damage

Another risk that comes with rental properties is natural disasters or liability from accidents. People can get hurt and can sue tenants or tornados can wipe your property off the earth. Both instances are rare, but they happen. To mitigate the liability side you can put your properties in an LLC or make sure you have the property insurance coverage like a landlord and umbrella policy. With these policies, if you have a tenant destroy property or need to be evicted, they can help cover those costs as well! Putting a property in an LLC can help with getting sued but is not foolproof.

It is important to make sure your insurance agent knows you are using the property as a rental so you have the right coverage. It might be cheaper to leave homeowners insurance on the property if you used to live there but that can cause problems down the road.

Risks that are tough to mitigate

There are some cases where a landlord does everything right but still has a massive loss. These are rare but can happen and just about any investment or simply living life comes with risks.

  • Meth or drug house: If someone is cooking meth or using meth in your house it can cause damage that insurance will not cover. You may have to make major repairs depending on how bad it is. These risks can be alleviated by good tenant screening and checking on the properties often. It is not always the case, but many drug houses we see have cameras all over. That can be a sign to check the house out more if you see cameras on your rental.
  • Floods: Not all floods are covered by insurance. You often need an additional rider or flood coverage. If you are in a flood zone the lender will require the additional coverage but if you pay cash or use private money you may not be required to have it. There is also the risk of a flood outside a flood zone. If the property has a risk of flooding it is important to talk to your insurance agent about additional coverage.

Why does everyone say rentals are risky?

I won’t tell you it is impossible to lose money investing in long-term rentals. It can easily happen if you don’t have a plan, have reserves, or are impatient. It is not easy to buy properties below market value with great cash flow. If it were easy investing in long-term rentals, everyone would be investing in real estate.

The reason so many people think rentals are risky is that they hear anecdotal stories. Stories are good for entertainment and drama but they don’t give the entire picture. “my cousins, aunts, friend, lost all their money when their rental was trashed!” They failed to tell us the person self-managed a property they used to live in from 4 states away and never once talked to the tenant in 3 years. Then they were surprised it was trashed. There are all kinds of stories but usually, you can find one of the main reasons above for why people lose money on rentals. Overall, real estate is one of the best ways to build wealth!

Don’t be scared to invest in rental properties

There are many people who have gotten rich and retired early by investing in long-term rentals. There is a lot of opportunity and many advantages to investing in real estate. Just because you can have some great rewards does not mean there is a massive risk. Some risk? Yes of course and the less you pay attention to your investment the riskier it will get!

Categories Rental Properties

Source: investfourmore.com

Understanding Economic Indicators

An economic indicator is a statistic or piece of data that offers insight into an economy. Analysts use economic indicators to gauge where an economic system is in the present moment, and where it might head next.

Governments use economic indicators as guideposts when assessing monetary or fiscal policies, and corporations use them to make business decisions. Individual investors can also look to these indicators as they shape their portfolios.

There are different types of economic indicators and understanding how they work can make it easier to interpret them.

What Is an Economic Indicator?

An economic indicator is typically a macroeconomic data point, statistic, or metric used to analyze the health of an individual economy or the global economy at large. Government agencies, universities, and independent organizations can collect and organize economic indicator data. In the United States, the Census Bureau, Bureau of Economic Analysis (BEA) and the Bureau of Labor Statistics (BLS) are some of the entities that aggregate economic indicator data.

Some of the most recognizable economic indicators examples include:

•   Gross domestic product (GDP)

•   Personal income and real earnings

•   International trade in goods and services

•   U.S. import and expert prices

•   Consumer prices (as measured by the Consumer Price Index or CPI)

•   New residential home sales

•   New home construction

•   Rental vacancy rates

•   Home ownership rates

•   Business inventories

•   Unemployment rates

•   Consumer confidence

Private organizations also regularly collect and share economic data investors and economists may use as indicators. Examples of these indicators include the Fear and Greed Index, existing home sales, and the index of leading economic indicators.

Together, these indicators can provide a comprehensive picture of the state of the economy and shine light on potential opportunities for investors.

How Economic Indicators Work

Economic indicators work by measuring a specific component of the economy over a set time period. An indicator may tell you what patterns are emerging in the economy — or confirm the presence of patterns already believed to be established. In that sense, these indicators can serve as a thermometer of sorts for gauging the temperature of the economic environment or where an economy is in a given economic cycle.

Economic indicators can not predict future economic or market movements with 100% accuracy. But they can be useful when attempting to identify signals about which way the economy (and the markets) might head next.

For example, an investor may study an economic indicator like consumer prices when gauging whether inflation is increasing or decreasing. If the signs point to a steady rise in prices, the investor might then adjust their portfolio to account for higher inflation. As prices rise, purchasing power declines but investors who are conscious of this economic indicator could take action to minimize negative side effects.

Recommended: How to Invest and Profit During Inflation

Types of Economic Indicators

Economic indicators are not all alike in terms of what they measure and how they do it. Different types of economic indicators can provide valuable information about the state of an economy. Broadly speaking, they can be grouped into one of three categories: Leading, lagging, or coincident.

Leading Indicators

Leading indicators are the closest thing you might get to a crystal ball when studying the markets. These indicators pinpoint changes in economic factors that may precede specific trends.

Examples of leading indicators include:

•   Consumer confidence and sentiment

•   Jobless claims

•   Movements in the yield curve

•   Stock market volatility

A leading indicator doesn’t guarantee that a particular trend will take shape, but it does suggest that conditions are ripe for it to do so.

Lagging Indicators

Lagging indicators are the opposite of leading indicators. These economic indicators are backward-looking and highlight economic movements after the fact.

Examples of lagging indicators include:

•   Gross national product (GNP)

•   Unemployment rates

•   Consumer prices

•   Corporate profits

Analysts look at lagging indicators to determine whether an economic pattern has been established, though not whether that pattern is likely to continue.

Coincident Indicators

Coincident indicators measure economic activity for a particular area or region. Examples of coincident indicators include:

•   Retail sales

•   Employment rates

•   Real earnings

•   Gross domestic product

These indicators reflect economic changes at the same time that they occur. So they can be useful for studying real-time trends or patterns.

Popular Economic Indicators

There are numerous economic indicators the economists, analysts, institutional and retail investors use to better understand the market and the direction in which the economy may move. The Census Bureau, for example, aggregates data for more than a dozen indicators. But investors tend to study some indicators more closely than others. Here are some of the most popular economic indicators and what they can tell you as an investor.

Gross Domestic Product

Gross domestic product represents the inflation-adjusted value of goods and services produced in the United States. This economic indicator offers a comprehensive view of the country’s economic activity and output. Specifically, gross domestic product can tell you:

•   How fast an economy is growing

•   Which industries are growing (or declining)

•   How the economic activity of individual states compares

The Bureau of Economic Analysis estimates GDP for the country, individual states and for U.S. territories. The government uses GDP numbers to establish spending and tax policy, as well as monetary policy, at the federal levels. States also use gross domestic product numbers in financial decision-making.

Consumer Price Index

The Consumer Price Index or CPI measures the change in price of goods and services consumed by urban households. The types of goods and services the CPI tracks include:

•   Food and beverages

•   Housing

•   Apparel

•   Transportation

•   Medical care

•   Recreation

•   Education

•   Communications

CPI data comes from 75 urban areas throughout the country and approximately 23,000 retailers and service providers. This economic indicator is the most widely used tool for measuring inflation. According to the Bureau of Labor Statistics, which compiles the consumer price index, it’s a way to measure a government’s effectiveness in managing economic policy.

Producer Price Index

The Producer Price Index or PPI measures the average change over time in the selling prices received by domestic producers of goods and services. In simpler terms, this metric measures wholesale prices for the sectors of the economy that produce goods, including:

•   Mining

•   Manufacturing

•   Agriculture

•   Fishing

•   Forestry

•   Construction

•   Natural gas and electricity

The Producer Price Index can help analysts estimate inflation, as higher prices will show up on the wholesale level first before they get passed on to consumers at the retail level.

Unemployment Rate

The unemployment rate is an economic indicator that tells you the number of people currently unemployed and looking for work. The BLS provides monthly updates on the unemployment rate and nonfarm payroll jobs. Together, the unemployment rate and the number of jobs added or lost each month can indicate the state of the economy.

Higher unemployment, for example, generally means that the economy isn’t creating enough jobs to meet the demand by job seekers. When the number of nonfarm payroll jobs added for the month exceeds expectations, on the other hand, that can send a positive signal that the economy is growing.

Consumer Confidence

The Consumer Confidence Index can provide insight into future economic developments, based on how households are spending and saving money today. This indicator measures how households perceive the economy as a whole and how they view their own personal financial situations, based on the answers they provide to specific questions.

When the indicator is above 100, this suggests consumers have a confident economic outlook, which may make them more inclined to spend and less inclined to save. When the indicator is below 100, the mood is more pessimistic and consumers may begin to curb spending in favor of saving.

The Consumer Confidence Index is separate from the Consumer Sentiment Index, which is also used to gauge how Americans feel about the economy. This index also uses a survey format and can tell you how optimistic or pessimistic households are and what they perceive to be the biggest economic challenges at the moment.

Retail Sales

Retail sales are one of the most popular economic indicators for judging consumer activity. This indicator measures retail trade from month to month. When retail sales are higher, consumers are spending more money. If more spending improves company profits, that could translate to greater investor confidence in those companies, which may drive higher stock prices.

On the other hand, when retail sales lag behind expectations the opposite can happen. When a holiday shopping season proves underwhelming, for example, that can shrink company profits and potentially cause stock prices to drop.

Housing Starts

Census Bureau compiles data on housing starts. This economic indicator can tell you at a glance how many new home construction projects in a given month. This data is collected for single-family homes and multi-family units.

Housing starts can be useful as an economic indicator because they give you a sense of whether the economy is growing or shrinking. In an economic boom, it’s not uncommon to see high figures for new construction. If the boom goes bust, however, new home start activity may dry up.

It’s important to remember that housing starts strongly correlate to mortgage interest rates. If mortgage rates rise in reaction to a change in monetary policy, housing starts may falter, which makes this economic indicator more volatile than others.

Interest Rates

Federal interest rates are an important economic indicator because of the way they’re used to shape monetary policy. The Federal Reserve makes adjustments to the federal funds rate — which is the rate at which commercial banks borrow from one another overnight–based on what’s happening with the economy overall. These adjustments then trickle down to the interest rates banks charge for loans or pay to savers.

For example, when inflation is rising or the economy is growing too quickly, the Fed may choose to raise interest rates. This can have a cooling effect, since borrowing automatically becomes more expensive. Savers can benefit, however, from earning higher rates on deposits.

On the other hand, the Fed may lower rates when the economy is sluggish to encourage borrowing and spending. Low rates make loans less expensive, potentially encouraging consumers to borrow for big-ticket items like homes, vehicles, or home improvements. Consumer spending and borrowing can help to stimulate the economy.

Stock Market

The stock market and the economy are not the same. But some analysts view stock price and trading volume as a leading indicator of economic activity. For example, investors look forward to earnings reports as an indicator of a company’s financial strength and health. They use this information about both individual companies and the markets as a whole to make strategic investment decisions.

If a single company’s earnings report is above or below expectations, that alone doesn’t necessarily suggest where the economy might be headed. But if numerous companies produce earnings reports that are similar, in terms of meeting or beating expectations, that could indicate an economic trend.

If multiple companies come in below earnings expectations, for example, that could hint at not only lower market returns but also a coming recession. On the other hand, if the majority of companies are beating earnings expectations by a mile, that could signal a thriving economy.

The Takeaway

Economic indicators can provide a significant amount of insight into the economy and the trends that shape the markets. Having a basic understanding of the different types of economic indicators could give you an edge if you’re better able to anticipate market movements when you start investing.

You can use these indicators to help shape your investing strategy. One way to get started building a portfolio is by opening an online brokerage account on the SoFi Invest trading platform, which you can use to trade stocks, exchange-traded funds (ETFs), cryptocurrency and even IPOs.

Photo credit: iStock/FG Trade


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.
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Source: sofi.com

What Is a Naked Put Options Strategy?

A naked put option, also known as an “uncovered put,” is a risky options strategy in which a trader writes (i.e. sells) a put option with no corresponding short position in the underlying asset. While this strategy allows the trader to collect the option premium up front, in hopes that the underlying asset will rise in value, it carries significant downside loss potential should the price of the underlying asset decline.

Here’s what you need to know about naked put options:

Understanding Naked Put Options

As a refresher, the buyer of a put option has the right, but not the obligation, to sell an underlying security at a specific price. On the flip side, the seller of a put option is obliged to purchase the underlying asset at the strike price if and when the option buyer chooses to exercise.

Writing a naked put means that the trader is betting that the underlying security will rise in value or hold steady. If, at the option’s expiration date, the price of the underlying security is above the strike price, the options contract will expire worthless, allowing the seller to keep the premium. The potential profit of the trade is capped at the initial premium collected.

The risk of a naked put option trade is that the potential losses can be much greater than the premium initially gained. If the price of the underlying security declines below the strike price, the option seller can be forced to take assignment of shares in the underlying security. The options seller would then have to either hold those shares, or sell them in the open market at a loss (since they were obligated to purchase them at the strike price).

Recommended: Buying Options vs. Stocks: Trading Differences to Know

Requirements for Trading Naked Put Options

Investors have to clear some hurdles before being able to engage in a naked put transaction.

Typically, that begins with getting cleared for margin trading by their broker or investment trading firm. A margin account allows an investor to be extended credit from their trading firm in order to actually sell a naked put.

There are two main requirements to be approved for a margin account in order to trade naked put options.

•   The investor must demonstrate the financial assets to cover any portfolio trading losses.

•   The investor must declare they understand the risks inherent when investing in derivative trading, including naked put options.

Selling Naked Puts

A trader initiates a naked put by selling (writing) a put option without an accompanying short position in the underlying asset.

From the start of the trade until the option expires, the investor keeps a close eye on the underlying security, hoping it rises in value, which would create a profit for them. If the underlying security loses value, the investor may have to buy the underlying security to cover the position, in the event that the buyer of the put option chooses to exercise.

With a naked put option, the maximum profit is limited to the premium collected up front, and is obtained if the underlying security’s price closes either at or above the option contract’s strike price at the expiration date. If the underlying security loses value, or worse, the value of the underlying security plummets to $0, the financial loss can be substantial.

In real world terms, however, the naked put options seller would see the underlying security falling in value and would likely step in and buy back the options contract in advance of any further decline in the security’s share price.

Naked Versus Covered Puts

We’ve mentioned a few times so far that in a naked put, the trader has no corresponding short position in the underlying asset. To understand why that is important, we need to talk about the difference between covered puts and naked puts.

A covered put means the put option writer has a short position in the underlying stock. As a reminder, a short position means that the investor has borrowed shares of a security and sold them on the open market, with the plan of buying them back at a lower price.

This changes the dynamics of the trade, compared with a naked (uncovered) put. If the price of the underlying security declines, losses incurred on the put option will be offset by gains on the short position. However, the risk instead is that the price of the underlying security could move significantly upward, incurring losses on the underlying short position.

Recommended: The Risks and Rewards of Naked Options

Example of a Naked Put Option

Here’s an example of how trading a naked put can work:

XYZ stock is trading at $50 per share. Alice, a qualified investor, opts to sell a put option expiring in 30 days with a strike price of $50 for a premium of $4. Typically, when trading equity options, a single contract controls 100 shares – so the total premium, her initial gain, is $400. If the price of XYZ is above $50 after 30 days, the option would expire worthless, and Alice would keep the entire $400 premium.

To look at the downside scenario, suppose the price of XYZ falls to $40. In this case, Alice would be required to buy shares in XYZ at $50 (the strike price), but the market value of those shares is only $40. She can sell them on the open market, but will incur a loss of $10 per share. Her loss on the sale is $1,000 (100 x $10), but is offset by the premium gained on the sale of the option, bringing her net loss to $600. Alternatively, Alice could choose not to sell the shares, but hold them instead, in the hope that they will appreciate in value.

There’s also a break-even point in this trade that investors should understand. Imagine that XYZ stock slides from $50 to $46 per share over the next 30 days. In this case, Alice loses $400 ($4 per share) after buying the shares at $50 and selling them at $46, which is offset by the $400 gained on the premium.

The maximum potential loss in any naked put option sale occurs if XYZ’s stock price goes to $0. In this instance, the loss would be $5,000 ($50 per share x 100 shares), offset by the $400 premium for a net loss of $4,600. Practically speaking, a trader would likely repurchase the option and close the trade before the stock falls too significantly. This can depend on a trader’s risk tolerance, and the stop-loss setting on the trade.

The Takeaway

The big risk of a naked put option trade is that the potential losses can be much greater than the premium initially gained, while the maximum profit is limited to the premium collected up front. The seller of an uncovered put thinks the underlying asset will rise in value or hold steady.

Like most options trading strategies, the complexity of naked options trading and the associated risks make it a strategy that’s typically best for experienced traders. There are plenty of less risky ways for beginner investors to start building a portfolio. One way to do just that is by opening a brokerage account on the SoFi Invest trading platform. Using the SoFi app, you can select company stocks, exchange-traded funds and fractional shares to build your portfolio, or you can opt for the automated features which build a portfolio on your behalf.

Photo credit: iStock/damircudic


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.
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Source: sofi.com