Terms Beginning With 's'

Stock Markets

While thinking of stock markets, you will imagine prices going up and down every second. Stock markets are, in some ways, perceived as a money-making place like Casino, and many people also prefer punting in stock markets.

But stock markets are also filled with intellectual investors seeking to build wealth. Word of mouth can be a source of positive or negative news. People especially small investors or short-term investors, looking to invest might have got scared by losses exhibited by sensible investors. Even the most successful investor can indeed incur losses.

There have been many successful investors who have navigated market cycles, economic cycles, booms and burst in markets. One thing that remains consistent is the discipline such investor possesses. 

Stock markets or equity markets are a part of a broader capital markets system. Stocks means shares, so only shares are traded in stock markets. A stock market is a crucial element of a country’s financial ecosystem.

In order to grow and expand, businesses require capital. One way of raising this capital requirement is through getting the shares traded on one or various stock markets and allowing the general public to invest. Stock Market is a medium which connects investors and capital seekers/companies, who are willing to sell a part of their ownership for a sum of money, which is the stock price.

What is a share/stock?

Also known as equity, it represents the ownership of an entity along with its profits, voting power, losses, and assets. Equity is a long-term source of financing the business and is non-redeemable by nature.

Voting rights are available to equity investors, giving them the authority to control the business and management. It enables the equity investors to choose the people who will run the business, and power to decide on the transactions to carried out by the firm that could impact shareholders, like a stock-merger.

Given that these shares are traded in stock markets, the ownership of business continues to change hands, as trades get settled every day. Hence, if an investor wants to become one of the holders in a particular company or wants to withdraw its ownership, it can simply be done by buying or selling of shares of that company in stock markets.

Equity shares have been responsible for creating the wealth of many investors. Shares prices movement also depends on the value of assets, cash flows and profits of a company. Price increases/decreases over time, providing investors with a capital gain/or loss on their investments. Meanwhile, equity shares could pay dividends to the shareholder, depending on the level of the residual cash left with the business.

Share price movement is backed by numerous factors, including rising competition, disruption in the industry, management decisions, losses, and windfall gains. In some cases, the companies shut down, leaving equity investors in the process of liquidation.

Equity is also seen as a hedge to inflation due to its unrestricted price appreciation potential since share price can go down to zero, but there is no upper limit defined. The rate of price appreciation could be higher than the rate of erosion in purchasing power, leaving the real value of invested assets positive.

Ordinary Shares: It is the most common equity instrument that is traded in stock markets. Also known as common stocks/shares, the holders of these instruments are the owners of the entity with voting rights over the decisions of the company. Companies pay dividends to ordinary shareholders after all other commitments are duly taken care of.

Preferred Shares:  Shareholders of preferred share are ranked above ordinary shareholder in the event of a dividend payment. They have a right to receive dividends prior to the ordinary shareholder that is why the term ‘preferred’ is used. However, there are no voting rights available to the preferred shareholders.

Why owners of the company sell their shares?

A business seeking funding has two options: debt or equity.

In debt funding, the business is granted a loan by the lender or investors. A loan can be received in the form of bank facilities, working capital facilities, bonds etc. Debt funding remains a popular choice for business as it helps to retain the voting and other rights of the shareholders by not diluting their stake, but the entity is obliged to repay the principal amount along with interest.

Equity funding allows the owners of the entities to sell a part of ownership to the investors at a price derived either through an Initial Public Offering (IPO) process or by the fight between demand and supply of a particular share. Equity holders are not required to be paid on a regular basis similar to debt capital providers, but ownership of the business is transferred.

Stock markets are not only like a funding bridge to the company, but they also provide a price value to the company’s shares. Stocks trade either at a discount or at a premium to their book value or earnings per share and stock markets provide multiples to those values.

Founders of the business are inclined to monetise their ownership in consideration for a sum of money, which is received by the founders in multiples of the underlying value of the business. Not limiting this to the founders, equity shareholders also benefit from the expansion of these multiples in the event of a favourable business environment.

What is a securities exchange?

A securities exchange is a market where buyers and sellers transact across various asset classes, including equity shares. It is an important part of the financial ecosystem of a country, provides a large marketplace for asset classes, including bonds, derivatives, commodities.

Shares of companies are listed on the stock exchange after a successful Initial Public Offering, and market participants can transact the shares of the company after the listing. Moreover, a stock exchange provides a secondary market for stocks.

At the same time, companies that are already listed on the exchange can continue issuing additional shares to raise further capital from the markets. A listing on a stock exchange requires necessary compliances to be adhered by the company, including continuous disclosure of material updates, disclosure of financials and much more.

Stock exchange charge fee from the companies that are listed on its board or are willing to list. In Australia, the Australian Securities Exchange (ASX) is a dominant exchange in the Australian capital market.  

Who regulates stock markets?

In most of the jurisdictions, the capital markets are regulated by a separate body designated to supervise the activity in capital markets, but there could be more than one regulator in a country with different roles.

Since capital markets are primarily financial in nature, there remains a need for financial regulators or more than one regulator. In Australia, the primary regulatory body concerned with investments and companies is the Australian Securities and Investment Commission (ASIC), and others include Foreign Investment Review Board (FIRB), Australian Takeovers Panel, Australian Transaction Reports and Analysis Centre (AUSTRAC).

Regulators not only ensure that investor interests are not compromised, but they also supervise the company’s transactions, including mergers and acquisitions, foreign investment in a business, and anti-money laundering.

A fairly regulated capital market is better for all the stakeholders, and financial regulators remain the backbone for ethical practices in capital markets.

Difference between actual and an expected return. For example, if a stock increased by 7% because of some update, but the average market only increased by 3% and the stock has a beta of 1, then the abnormal return was 4% (7% - 3% = 4%)

In the recent past, the absolute return approach of Investing has turned out to be one of the fastest-growing investment strategies worldwide. A lot of financial advisors talk about such investments providing absolute returns. So, what exactly are the “Absolute Returns” and are they are promising? What is meant by Absolute return? Absolute return computes the increase or decrease, in an asset over a period of time, as a proportion of the original investment amount. The focus here is only on that specific asset or portfolio and not related market events. Absolute returns only consider the price movement for any specified time period. Absolute return, reckons an investment’s performance without considering the expanse of time for which investment was committed. Absolute returns can be computed for a quarter, semi- annual, annual period, 3-year duration or more. Absolute Returns are independent of Market movements and thus do not draw relative comparisons. It is one of the most commonly used investment performance metric in Hedge Funds and Mutual Funds. How to compute Absolute return? Suppose an investor Mr. Rich, invested AUD 50,000 5 years back, and the current value of his investment is AUD 75,000. The Absolute return on Mr. Rich’s investment would be 50 %, calculated using- Copyright © 2021 Kalkine Media Pty Ltd Copyright © 2021 Kalkine Media Pty Ltd So, Copyright © 2021 Kalkine Media Pty Ltd Absolute returns are just returns from point of time to other. The notion of an 'absolute return' seems very attractive to get investors’ attention as it ignores the relative market movement and promises an appreciation with zero correlation to markets. Anyhow, Absolute Return technique of computing investment yields is an apt way of calculating return on investment, predominantly in the early stages. There are numerous other types of return metrics an investor can look for later on. Major 4 types mattering most to investors being –  Absolute Return, Relative Return, Total Return & CAGR. What is the difference between Absolute Return, Relative Return, Total Return & CAGR? Absolute return refers to the gain/ loss in a single investment asset/ portfolio but to comprehend how their investments are acting relative to various market yardsticks, relative return is taken into consideration.   Relative return is the excess or deficit an asset achieves over a timeframe matched to a market index. Benchmark Return – Absolute return, gives the Relative return also called sometimes as alpha. Example, if S&P index gives a 10% return during a given period and one’s investment portfolio gives an absolute return of 12% then relative return on investment is positive/ excess 2%. Total returns take into account the effect of intermittent incomes as well as dividends. For example, in an equity investment of AUD 200 having current value AUD 240, the company also declares a dividend of AUD 10 during the year. Total returns will take into account this $10 dividend too. Thus, Total returns on the investment of AUD 200 now will be 25.00% = {(240+10-200)/200} x 100 Absolute and Total returns are easy to calculate as performance metrics, but the real challenge is when comparisons are drawn based on time period of return. Here comes in CAGR, it takes into account the term of the investment too, thus giving a more correct and comparable picture. It is computed as: CAGR (%) = Absolute Return / Investment period (equated in years) Consider for example, two investment options: One where investor earns absolute returns of 10% in 24 months and another where investor earns 5% absolute returns in 9-month duration. So, CAGR would be- For option one: CAGR = 5.00% i.e.  10%/2 (24 months/12 months is equals to 2 years) For option two: CAGR = 6.66% i.e. 5%/0.75 (9 months/12 months is equals to 0.75 years) What’s wrong with just measuring investment performance using Absolute Returns? Absolute returns will only tell an investor how much his/her investments grew by; they do not tell anything about the speed at which investments grew. When people talk about their real estate investments and say, “I bought that house for X in the year 2004. It’s worth 4X today! It has quadrupled in 17 years.” This is an application of absolute return. The drawback here is that it takes into account only the capital appreciation and doesn’t draw comparison with options having different time horizons. Investors can rely on this measure of investment performance only if they are looking for higher returns, without bothering how fast they were generated. Absolute return also doesn’t convey much about an investment compared to relative markets. Then, why do Hedge Fund/ Mutual Fund Managers choose an Investment strategy based on Absolute returns? Absolute returns should be used at times when investors are willing to shoulder some risk in exchange for a prospective to earn excess returns. This is irrespective of the timeframe and Fund administrators who measure portfolio performance in relation of an absolute return typically aim to develop a portfolio that is spread across asset categories, topography, and economic phases. They are looking for below mentioned points in their portfolios- Positive returns- An absolute returns approach of investment targets at producing positive returns at all costs, irrespective of the upside & downside market movements. Independent of yardsticks- The returns are in absolute terms and not in comparison to a benchmark yield or a market index. Diversification of portfolio- With the intention of distribution of risk, among different investment options producing positive returns in diverse ways a mixed bag of absolute return assets give a diversified investment portfolio. Less volatility- The total risk of investment is spread across the different asset held in such a portfolio. Ensuring less overall volatility in collective returns. Actively adjustable to market movements– Usually, investments look for positive returns with zero market correlation. Market shares a negative correlation with absolute return investments and vice versa. In any investment atmosphere, there are varied investment strategies and goals. Absolute return investment strategies are looking to avoid systemic risks using unconventional assets and derivatives, short selling, arbitrage and leverage. It is appropriate for investors who are prepared to bear risk for short and long-term gains.

An alternative to traditional stock exchanges, dark pools are referred to private forums or exchanges formed for trading of securities. They offer an opportunity to investors to make trades without revealing their intentions publicly.

Darvas Box system Every great trader/investor in the history of the markets had a specific method to approach the markets, which eventually led them to create a good fortune, Darvas Box system is one such method. It is a trend following strategy developed by Nicholas Darvas in the 1950s to identify stocks for good upside potential. This is one of the few methods to trade the markets which uses the combination of both the technical analysis and fundamental analysis for a much more refined decision.  The fundamentals were used to identify the stocks, and technical analysis was used to time the entry and exits. Who was Nicholas Darvas? Nicholas Darvas was arguably one of the greatest stock traders/investors during 1950s – 1960s, but surprisingly he was a ball dancer by profession and not a professional stock trader. Even while trading and building his fortune, he was on a world tour for his performances in many countries and took up trading as a part-time job. In November 1952 he was invited to a Toronto Nightclub for which he received an unusual proposition of getting paid in shares by the club owners. At that time, all he knew was there is something called stocks which moves up and down in value, that’s it. He accepted the offer and received 6k shares of a Canadian mining company Brilund at 60 cents per share, with the condition that if the stock falls below this price within six months, then the owners would make up the difference. This was the introduction of a professional ball dancer to the stock market. Nicholas Darvas couldn’t perform at the club, so he bought those shares as a gesture. Within two months, Brilund touched $1.9, and his initial investment of $3000 turned to $11400, netting in almost three times of his investment. This triggered a curiosity into the stock markets, and he started to explore trading. Origin of the Darvas Box theory Initially, he was trading on his broker’s recommendation, tips from wealthy businessmen, he even approached some advisory services or any source that he could get his hands on for the tips, but all led him to losses. After losing a lot of money, he decided to develop his own theory, and after a lot of trial and error, his observations and continuous refinements he eventually invented his theory “The Box Theory”. So what exactly is the Box Theory? Fundamentals Analysis As stated earlier, the box theory uses a judicious bend of both the technical and fundamentals. Darvas believed that in order to spot a good stock or even a multibagger, there should be something brewing up in the respective sector as a whole or some major fundamental change in that specific company. Generally, the fundamentals that Darvas used to study were on a broader sector level, and not the company-specific fundamentals. Even for the specific company Darvas used to look from a general perspective like, is the company launching a new product which could be a blockbuster hit. He completely refrained from looking at numbers and financial statements as his initial experiment with ratios and financial statements didn’t yield any good result. To know more on the three financial statements read: Income Statement (P&L) Balance Sheet Cash Flow Statement Technical Analysis Darvas was a big believer in price action and volume of the stock. He believed if some major fundamental changes were to take place in a company, this soon shows up in the stock price and its volume of trading as more people get interested in buying or selling the stock. With his observations here realized by just observing the price action, he can participate in the rally which gets triggered by some major fundamental development without actually knowing about the change. Using the box theory, Darvas used to scan stocks based on rising volume as he needed mass participation in the rally. Also, he only picked up those stocks that were already rising. His theory is all about “buy high, sell higher” instead of the conventional belief of “buy low, sell high”. After the stock satisfies both the parameters of increasing price and volume with major underlying fundamental change, Darvas looks to enter the stock. Good read on momentum trading. How and where to enter? Major part of the box theory is based on entry and exit levels. To enter a stock, Darvas looked for a consolidation phase preceded by a rally. A consolidation phase is the price action wherein the price moves up and down in a tight range, that is, a non-directional move. He would then mark the high and low of the consolidation phase with the horizontal line, essentially making it a box-like structure, hence the name “Box Theory”. The high point is called the ceiling, and low is called the floor. Whenever the stocks break above the ceiling, Darvas would look to buy one tick above the ceiling with one tick below floor as a stop-loss point. Pyramiding Darvas discovered early on, in order to become successful in the market your winning bets should yield much more profit than the loss in the losing bets. This led him to do pyramiding in his winning trade, which is clearly defined in the box theory. Pyramiding means to increase the existing position if the stock is going in the favour, which leads to a much higher profit in the winning trades. According to the box theory, the repetition of the entry criterion is the new signal for adding onto the existing position. In other words, after a position, if the stocks stage the same setup, that is, a consolidation after a rally, then the break above the ceiling of this new box would signal to increase position with the revised stop loss of 1 tick below the new floor. In any case, whenever the stock falls below the current floor, the entire position would we sold off at once. This is the only exit condition in the box theory, and there is no method of booking profit upfront as Darvas believed in holding on to a rising stock. The only way to book profit is to let the stock to take out the revised stop loss.

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