The easiest answer to this topic is that Bonds are a form of debt. You are loaning money and expect that money to be returned with a little extra for your trouble. When you are purchasing a stock you are taking an equity stake in a company, that is, you become an owner in that company., how large an owner depends on how many shares of stock you have purchased. When you purchase a Bond you will have a creditor stake in the company, you have loaned money to the company for them to finance some project or another. Companies, cities and even governments issue bonds for sale with the promise they will pay you back in full with interest. A company may sell bonds to build a new facility, a city to build a bridge and the government to finance its daily operations. Bonds normally have a specific term or what is called maturity date. This is the legnth of time when the bond can be redeemed.  This also differes from a sharae of stock which can be owned indefinately if the purchaser so chooses or sold right after its purchase.

When you purchase a bond you know that after a certain period of time you are going to get your money back and during that time you will also know at what point or what intervals you will collect your interest for loaning that money (buying the bond). If you need to sell your bond before the “maturity date” the price you will get for it will depend upon the current interest rates. If the company (or city, etc.) that issued the bond goes bankrupt, well, you probably won’t get back all your money, but you do have priority over stock holders as if you remember they are “owners” of the company and “lenders” have priority in getting paid back after selling off the company’s assets.

So what establishes the price of a bond and the interest rate? Well, it comes down to risk. The length of time till maturity, this is the amount of time you are loaning the money for, which is just the maturity date. The longer the time to maturity the greater the risk that something could go wrong such as financial difficulties, a natural disaster will force bonds to drop in value. They drop in value because less people will want to buy them at the original price when the can purchase bonds in more secure companies for relatively the same cost.

Interest rates also play a huge role in the price of bonds as anyone who has been watching the business news on television lately. The interest rates on bonds is fixed when they are sold, so as economic conditions change the interest rates change, if interest rates go higher the value of bonds will go down and if interest rates go down the value of bonds will increase.  Remember that the interest rate of the bond you already purchased doesn’t change. So, if interest rates have gone up from the point that they were sometime in the past year or so, an individual just looking to buy bonds could get a higher interest rate than the person who bought a bond last year. If you are holding the bonds you bought last year at the lower interest rate, the only way some other investor would buy them is if you sold them cheaper than what you paid for them last year.

In a nutshell, risk is the determining factor in interest rates and bond value. Risk can be looked at as the length of time to maturity or the credit worthiness of a company or city, etc., the more risk you take the more you deserve as a return on your investment. United States Treasury Bonds have always been considered the safest bond investment due to the fact that the chance of the US government actually defaulting on them is very slim. A riskier bond would need to provide a higher return to make up for the higher risk incurred by the bond purchaser.

The bottom line for the new investor to understand is that risk comes in various forms, the amount of time until maturity, the credit worthiness of the issuer, General Electric should be less of a risk than Joe’s 5 day old fish market and finally what are the interest rates being offered.

What is a stock?

The purpose of this upcoming series of articles is to enlighten the novice who is interested in the stock and financial markets but has little knowledge of them. It is for this reason that I am going to offer the basics, beginning with a bit of common terminology and then in latter posts how all these terms relate to you and your quest for financial security. So the best place to begin is in understanding the most common items you may come across either on television, the papers or your financial advisor.

Lets say you have a reasonably successful company and you need money to expand. Perhaps you need to hire additional staff, build new facilities or purchase new assets, these things do not come cheap and you realize you will need to raise money to accomplish this. You can go about this in two ways, you can borrow the funds needed and pay an interest rate on a common debt instrument (called a bond) or you can raise the capital (money) from investors by selling them a piece (shares of stock) of the company.

If you purchase shares of stock in this company, no matter how few shares (even one share) you become a part owner of that company and are entitled to a share of the assets and earnings of that company relative to the number of shares you own. Remember if you own 1 share or 1000 shares, the amount you own per share is the same; you just multiply dividends or stock price by the number of shares you own. Small investors who do not purchase large blocks of shares rarely consider the fact that they are owners and are merely concerned with how much the stock is worth at a particular period in time compared to the price they paid for it and although they may have voting rights relative to the number of shares they own, they usually don’t have a large say in the day to day operations of the company. Large institutions such as unions or pension funds that have huge amounts of a particular stock can sway votes in the company however, and are called institutional investors.

If you bought a top of the line PowerBook G3 in 1997 for $5700 get ready to pinch yourself… if you had purchased the equivalent in Apple shares instead it would have grown to a whopping $330,563 over the past 13 years.

It is this claim that investors have on their shares of stock that create the value of that issue. Lets assume a company needs money to expand and sold stock at $2.00 a share, but the company had yet to produce and market a product to the public and could not give Its investors (you included) a piece of the earnings, but after a short time one of the products they manufactured started selling like hotcakes! The company began making great money. Remember, how Apple grew when it produced the iPods and iPhones. Well, because the company is now making a lot of money those shares you bought at $2.00 a share are worth a lot more because the earnings from that company are considerably greater. So, if a person wanted to purchase a claim on those earnings (shares of stock) you might consider selling the shares that you purchased at $2.00 a share for $10.00 a share. That is a profit of $8.00 a share (multiplied by the number of shares you own).

This process of buying stocks and holding on to them in hopes of them rising in price is known as investing. If you own shares of stock in several different companies, this would be called your portfolio of stocks. Some may rise in price while others may drop and you would then decide which you deem are worthy of keeping or increasing the number of shares owned, and those you have less confidence in and may consider limiting your loss potential by selling off shares. Investing in stocks is usually done over a longer time horizon than trading, in which stocks may be bought and sold in a relative short period of time in order to take advantage of short-term price fluctuations.

Different types of stocks have different characteristics but the most familiar to individual investors would be the type known as common stock, which is what we discussed here. Preferred stock, which usually has no voting rights, but gives the holder a priority position on claim over common stock share holders in regards to dividends and any possibly bankruptcy claims on assets. Unlisted stocks will be discussed much later but are usually purchased in direct placements from the issuer or purchased in what is called a secondary market, and these unlisted stocks may carry and even greater degree of security and yield on their investment.

Our next lesson will be on Bonds and who might want to use them as an investment.

The easiest place to begin to understand how options work and why the may be a good investment tool is to go right for the easiest to understand, the long call.  I remember that my first bit of insight into trading options was through a great friend, Marc Friedfertig, author of “The Electronic Day Trader”.  We were on the “D” train heading south into Brooklyn when my instruction began, and as with many, the long call was my beggining.

 We already know that buying a call gives the investor the right to purchase 100 shares of the underlying stock at a specific price up until the expiration date of that call option. But who should buy this option? This is a good position for those just getting their feet wet in option trading as it requires minimal skill and is easy to understand. An investor who believes that the underlying stock will increase in value, yet wants to invest limited capital and has no problem in absorbing the risk of the premium paid, yet still have a potentially unlimited maximum reward should consider buying a call.

 Buying a call is about as basic as you can get in options trading, which is why it is a perfect entry level trade into these types of investments. Later we will go over how this and other types of options can be combined to create other strategic investments to serve a multitude of purposes, but for the beginner buying a call is usually a great starting point.

 So, we have now purchased a call, referred to as long call, if you were the seller of the call, you would now be short the call, remember for every buyer there must be someone who has the contra point of view just as in buying and selling stocks. Your maximum risk is the premium you paid for the call, the maximum reward is unlimited and the breakeven point, (the price at which you would neither make nor lose money) would be the strike price minus the premium you paid for the call. Strike Price! Wait, you never mentioned a strike price! What the heck is that? Remember earlier we mentioned a specific price you can purchase the stock for up until the Call’s expiration date? That price is known as the strike price.

 In later articles we will not only go over other types of option contracts but how time decay and price fluctuations can also affect the price of the option. But for now, go to the Wall Street Journal or Investor’s Business Daily and notice how option prices and expiration dates are listed as this could be the subject of our next post on the basics of Option trading.

Trading lessons 2

Identify the breakout possibilities

I really want to get into the subject of “Hot Stocks” and have asked some of my close friends who are considered heavy hitters in the day trading arena to lend an occasional post, however it is a tricky subject so I thought some general beginners information on how to determine if a stock is or may maybe a hot pick, should be in order. Much of this information can be found in numerous fine books available on Amazon.com. Check the carousel at the bottom right of this page for some favorites, all of which I have either read or had a part in writing.

Finding a hot stock on your own is probably the best feeling you can get, knowing that you have beaten others to the punch by interpreting movements in the market and a particular stock before it hits the street. I was going from chart to chart on some of my favorite stocks and I noticed one was just sitting there at a mid support level when the volume spiked way above what I felt was normal for that stock, at that time of day. What got me thinking was that with the high volume the price didn’t rise as much as I felt it should have with such a spike. With today’s technology, you can check for any news stories while still keeping vigil on the charts. The street was quiet in regards to this issue, which to my trained eye meant only one thing, someone or possibly an institutional trader was silently acquiring this stock! When you see such a occurrence such as high volume, no news and little price movement, keep an eye out as there is a possibility some news or rumors may have leaked out, and savvy traders or insiders are slowly accumulating this issue. You don’t necessarily need to buy this stock at that point, but be ready because there is a good chance the breakout is coming and when it does it moves like lightning!

Although most of my posts deal with the art of Day trading or Swing trading, I have been asked by many to include information for those of you interested in trading options. Holding a series 4 license, I am qualified to discuss this type of trading but will do so in an informational capacity only. A primer to options trading so to speak. The Series 4 license is for managers supervising options sales personnel or supervising compliance for a FINRA brokerage firm.  Now let’s start at the beginning.

 What are options and what do they let us do? Options give the investor flexibility to put together a strategy or series of strategies to achieve a specific investment objective. Options give the investor leverage. It allows him or her to control more shares of a stock for less capital outlay.  In general, one option contract will represent 100 shares of a specific stock. If you bought 100 shares of stock XYZ trading at 25 dollars a share your capital outlay would be $2500. If you bought one option contract on the same stock you may only be paying a $2.50 premium and a cash outlay of $250 to control the same number of shares (1 contract = 100 shares x $2.50 = $250). So if you purchased a call option (the right to buy 100 shares of stock) you can control the same number of shares of XYZ stock until the specified expiration time of that option. REMEMBER: unlike purchasing a stock, if the option contract expires unexercised, you will lose the entire premium, in this case $250 dollars.

 Purchasing options allows the investor to trade with added leverage. Because we are controlling the same number of shares as if we purchased the stock itself with about 10% of the capital.

 Many investors, especially those who rely on income derived from their investments can also trade options to increase that income on a semi regular basis. If an investor owns shares of XYZ stock already, he can write (sell) calls against the stock he owns (this is known as covered call writing) and if the options expire unexercised the investor keeps the premium.  This is relatively safe as opposed to naked call writing which has unlimited risk the same as selling short.

 Depending upon the view of the investor as to the future direction of the stock and general economy, the investor can employ numerous strategies to take advantage of movements and fluctuations. Various combinations of buying and selling puts ( the right to sell a stock) and calls (the right to buy a stock) can allow the investor to profit from the numerous factors that cause stocks to fluctuate. 

 Options can also give the investor some protection from risk. The proper combination of owning stock, selling and buying options and the direction of the market can often not only minimize risk, but eliminate it altogether. With any type of investment there is risk, options can minimize risk, or be extremely risky instruments.  They are complex investments and require a great understanding of what they are, how to use them and especially what the ultimate investment objective is.