Investors Column – Market, Limit, and Stop; Margin; IPOs


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Money Matters

September 24, 2021 by NEWSTORY - Views: 41

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Investors Column – Market, Limit, and Stop; Margin; IPOs

This month’s column explains some common terms which an investor will often encounter. 

Buying and Selling Stock

The stock market is open Monday  through Friday,  from 9:30 a.m. to 4:00 p.m., except holidays.

When placing an order to buy and sell stock, a number of Order Types are available.  Each has advantages depending on your situation.

The easiest order type to understand is Market Price.  If you buy or sell some stock at Market Price, you are accepting the price at that instant.  Prices fluctuate, changing within fractions of a second.  When you specify that a purchase is at Market Price, you are accepting whatever the price is at the moment of the sale.  That frequently means a lower sale price or a higher purchase price than you expected.  

S162-1.jpgMarket Price is the easiest,  but usually not the best choice.

When you put a Limit on a stock purchase, you are telling the broker the absolute highest price you want to pay for the stock.  If the stock price is above that, your sale is held pending until and if the price falls at or below your limit.

When you put a Limit on stock you wish to sell, you are telling the broker the absolute lowest price you will accept for the stock.  Until the stock price rises above that Limit, you are saying you do not want the trade at all.  

Setting a Limit is a good way to buy or sell a stock, because you know how much the trade will cost to buy or how much you will get paid for its sale.  However, there is no assurance the price of the stock will move to the level of your limit; your trade may not occur.

Typically, a Limit order lasts for one day, or until you cancel the order.  Placing an order with a Limit can be done at any time – even before the Market opens, which is at 9:30 a.m. Eastern Time.  Limit pricing is a good practice if your regular job makes following the Market impossible.  

Placing a Stop order protects you from falling stock prices.  If you tell your broker to sell your stock if the share price falls below a certain level (“sell 100 shares of XYZ with a Stop price of $50”), your stock will be sold if the stock should fall to that price.  If you are worried about market fluctuations or a downturn in the stock price or the  market generally, a Stop order protects you from greater losses.  The caveat is that it is not uncommon for a stock’s price to fall enough to trigger the a Stop order sale, and then bounce back. Significant fluctuations occur throughout normal daily trading.

Be warned:  a Stop order does not necessarily  trigger at the stated price.  The stock price may drop several cents (or dollars!) below the stop amount.  Expect the actual sale price to be slightly below your requested Stop order amount.  When setting a Stop price, you may want to add a small amount of padding.

The value of a Stop price is that it generally protects you against falling stock prices.  If you need to assure that you have a certain amount of cash available for some personal reason, a Stop order provides for that.

There are other, more complex order types, but Market, Stop, and Limit order types will cover most situations.  

S162-2.jpgBuying on Margin

Buying on Margin, where permitted by your broker, allows you to buy more stock than you can actually afford.  Buying on Margin uses your purchased stock as collateral for a loan to cover the new stock’s cost.  

The dangers of buying on Margin are twofold.  

(1)  Buying on margin is essentially borrowing money – taking out a loan.  The cost of the interest you must pay on that loan means the stock price must rise that much higher before you can sell the stock at a profit, and each  day you are charged  more interest.  Margin buying eats up your profits.

(2)  If the prices of your stocks should fall, your stocks may no longer have enough value to be considered sufficient collateral for the loan.  Your broker may demand immediate cash payment (i.e., a deposit from you) to cover the loan.  If you cannot, the broker may sell enough of your other stock(s) to cover the loan.  That sale, of course, may be at a loss, or, if at a profit, will then require payment of taxes to the IRS.  Murphy’s Law says such a sale will surely occur at the worst possible moment for you.  

Owning stocks bought on margin during a market downturn (especially a quick market downturn) is one of an investor’s worst nightmares.

A Fundamentals trader (as discussed in last mont’s Investors’ Column) buys stock with the intent of keeping it for the long term.  That leaves no room for buying on Margin.  

What is an IPO?

“IPO” is short for Initial Public Offering.  It refers to the first (initial) sale of stock to the public in a company whose owners have decided to “take the company public”.  In other words, to sell publicly-traded shares of stock in what had previously been a privately-owned company.

Switching from being a privately-owned company to one that is a publicly-traded stock is a complicated legal process.  The Securities Exchange Commission has numerous legal requirements which must be met prior to the change.  Those requirements are intended to protect any stock owners from malfeasance or other criminal schemes which are intended to dupe stock buyers out of the money they invest.  

Should I buy stock at an IPO?

Generally, buying an IPO stock is not a good idea for the beginning investor.  Companies offering an IPO of course put the best light possible on their past performance.  If the company is well-known, excitement will push the stock price up very  quickly.  But soon the euphoria dies down, and the stock price will fall back quite a bit.  The stock’s price afterwards may be slow to rise, or even fall further for several months as the trading public learns  what that company’s  true value is.  

They key question for any investor is:  Why is the company going public?  

One possible reason is that the owners wish to retire.  As the owners of the company, the money paid to purchase the new stock goes to them.  The IPO is a way to recoup their own investments of  time and money.  

However, if they retire and leave the company, what will happen to it?  Many times the owners of a small company are its crucial “knowledge base” – they hold all  of the know-how and information on which the company’s success is based.  If the founders depart, or start being less diligent  how will the company continue to be successful?

Another possible reason for an IPO is that a young company has reached the limits of what it can do without a large infusion of cash to take a step upwards in its further growth and development.  That is fairly common.  An IPO is a great way to get that cash.  The owners, of course, retain enough shares for themselves to still be in control of the company.  

The question still remains, however, as to whether company management is smart enough to invest that money so as to successfully grow the company to its new, higher levels.  If  so, those who bought the stock and held on to it for the years it will take will be very happy they did.

There are all sorts of reasons to take a company public.  As with so many other choices in making investments, research by you as an investor is key.  

Having more investment successes than failures requires research, knowledge, and information.  


Next Month:  

More Investing Terms, Strategies, Ideas, and Techniques■

 

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