Brokers and Online Trading

Introduction

Brokers share the undesirable reputation of lawyers, bankers and accountants. They earn a living by selectively sharing knowledge that the general public can’t easily access. But, like it or not, they are the individual investor’s direct link to Wall Street. Although technology and the internet have made it easier for individual investors to take control of their portfolios, the basic rule still applies: you need some kind of broker if you want to trade stocks and bonds.

In any profession, you will find people who take advantage of those who aren’t in the know. Whenever you buy something, there is the possibility of being cheated. Furthermore, with a broker you purchase advice, which is hard to price. But not all brokers fit the swindler stereotype. In fact, there are many brokers who do a phenomenal job of guarding their clients’ interests. There are also many discount brokerages that provide remarkable services for a reasonable price.

It’s up to you to pick the broker that meets your needs. This tutorial will go over some important factors to consider when making the choice.

Source: investopedia.com

Fund Costs and Expenses

Overview Of Mutual Fund Expenses

If you took a vote among investment professionals on the single most important investment quality to look for in a mutual fund, the result would readily confirm Mr. Bogle’s position, which he has championed since he founded the Vanguard Group. Simply stated, costs reduce investment returns. While it is impossible to eliminate all fund-related expenses, it is possible, and necessary in this decade’s low-return investment environment, to avoid some and minimize others. (To read more about John Bogle, see The Greatest Investors: John Bogle.)

So let’s take a comprehensive look at all the costs and expenses associated with mutual fund investing and pinpoint key indicators in a fund’s expense structure that will score high in a Fund Investment-Quality Scorecard and lead you to top performing, low-cost mutual fund investments.

There are essentially four major components of a mutual fund’s overall cost structure: sales charges, expense ratios, transaction commissions and redemption fees. An understanding of what these costs are and how they impact a fund’s performance is extremely important in making informed fund investing decisions.

Sales Charges
Among other distinguishing features, mutual funds are acquired with a sales charge (load) or without a sales charge (no load). If there is a load, the charge can be as high as 8%, although it seems that a 3-5.75% range is most common. This charge is paid by the investor (the buyer of the fund) to the seller (a financial intermediary such as a brokerage firm, insurance company, financial planner or investment advisor) for services rendered. The charge is deducted from the amount being invested.

No-load mutual funds are offered directly to the investing public by fund companies, or they are sold to investors by financial intermediaries who have a compensation arrangement (hourly, flat fee or a percentage of assets) with the purchaser. In this case, a sales charge is not involved, and the investor fully invests his or her available money into funds sponsored by a no-load fund company. (For more insight, read The Lowdown On No-Load Mutual Funds.)

There are five general aspects of the load/no-load debate worth considering:.

  1. Fund investors definitely need to understand that a load is a selling commission paid to a financial intermediary and not the fund company. It does not buy increased investment expertise by fund management. On the other hand, financial intermediaries defend their fees as fair compensation for the investment advisory services they provide to the investor.
  2. The load-fund business has complicated things for investors by confusing them with a variety of fund share classes: A, B and C. In brief, these simply represent three different ways of applying a sales charge. With A shares you pay up front and with B shares you pay at the back end. With C shares, called “level-load,” the year-to-year costs are usually high but spread out over time. (To learn more, see The ABCs Of Mutual Fund Classes.)
  3. A fund’s load is not included in the computation of a mutual fund’s expense ratio (see below) and, therefore, is an additional cost to be considered when investing in load funds. (To learn more, see Stop Paying High Fees.)
  4. The long historical record on mutual funds shows that there is little difference in the total return performance of load and no-load funds.
  5. Employee participants in a defined-contribution, company sponsored retirement plan, such as a 401(k) and the like, generally need not be concerned about loads. In most instances, these retirement plans waive any sales charges on their fund investment options.

Expense Ratio
A mutual fund’s expense ratio is the result of a calculation as opposed to a type of expense. The ratio’s numerator is the sum of a variety of administrative and operating expenses; its denominator is an average of the fund’s assets. It is expressed as a percentage – lower is better – and is a key indicator of a fund’s investment quality.

In general operating terms, stock funds are more expensive than bond funds, international funds are more expensive than domestic funds and small and mid cap funds are more expensive than large cap funds.

The largest component of a fund’s operating expenses is the fee paid to its investment advisors, or managers. A fund must also pay for recordkeeping, custodial services, taxes, legal costs and accounting and auditing fees.

In addition to these conventional operating expenses, some funds also have a marketing, or distribution, fee commonly referred to as a 12b-1 fee. If this fee is charged, it is included in a fund’s operating expenses, unlike a fund’s sales charge, which is not considered an operating expense. In the mutual fund industry’s early days, a provision in the regulations permitted funds to incur promotional expenses to help develop mutual fund activity. The maximum 12b-1 fee allowable is an annual 1% of a fund’s assets. To be considered a no-load fund, the 12b-1 annual charge must be no more than 0.25%.

Many mutual fund observers find it hard to justify this type of fee. With the increasing popularity of mutual funds, how much more “promotion” is really necessary? Today, the 12b-1 fee is used almost exclusively to reward intermediaries for selling a fund’s shares. There is a movement underway to eliminate the fee, but the fund industry as a whole is resisting the change.

Lastly, it seems that some mutual fund investors are not all that clear on how operating expenses are paid. The simple answer is that whatever is included in a fund’s operating expense is charged against the assets under management. In other words, the fund’s investors pay the tab. This is how costs reduce investment returns.

Invisible Charges
Investment experts have speculated that brokerage commissions can add as much as 0.15% to a fund’s annual expenses. However, these costs are not included in a fund’s expense ratio. They seem to fit the definition of an operating expense but, as of today, are not so considered.

Redemption Fee
Designed to discourage market timers, an increasing number of mutual funds are charging a flat fee, usually 1%, on withdrawals (shares redeemed) made within a certain time frame. Generally, redemption fees are in effect for one year or less following the date of the investor’s initial purchase. If you are an investor (in for the long term), as opposed to a speculator (in and out for the short term), this type of fee will have no effect on your fund investment.

Also remember that a mutual fund is a business and seeks to return a legitimate profit to its owners. The fund business is a very profitable one. As such, investors should seek out those funds that run a lean operation and align their interests with those of investors for a win-win relationship.

Source: investopedia.com

Fund Management Issues

Passive Vs. Active Management

In almost all economic endeavors, the quality of management is generally a key component of a successful operation. Managing a mutual fund is no exception to this rule. The fund investment quality we are going to discuss in this section focuses on two important fund managerial qualities: tenure and structure. However, it is worth noting that a fund’s investing style, growth, risk and return profile, trading activity, costs and performance are also all a product of management’s efforts. How well management “scores” in all these areas is an important consideration for mutual fund investors.

Managed Funds Vs. Index Funds
To begin with, we need to make a distinction between mutual funds that are managed and those that are indexed. The former are actively managed by an individual manager, co-managers, or a team of managers. The index funds are passively managed, which means that their portfolios mirror the components of a market index. For example, the well-known Vanguard 500 Index fund is invested in the 500 stocks of Standard & Poor’s 500 Index on a market capitalization basis.

Which is better, managed or indexed fund investing? Both have their positive aspects. Let us first look at the index variety.

Index Mutual Funds
Index mutual funds are an easily understood, relatively safe approach to investing in broad segments of the market. They are used by less experienced investors as well as sophisticated institutional investors with large portfolios. Indexing has been called investing on autopilot. The metaphor is an appropriate one as managed funds can be viewed as having a pilot at the controls. When it comes to flying an airplane, both approaches are widely used.

Here is how an index fund works. The money going into an index fund is automatically invested proportionately into individual stocks or bonds according to the percentage their market capitalizations represent in the index. For example, if IBM represents 1.7% of the S&P 500 Index, for every $100 invested in the Vanguard 500 Fund, $1.70 goes into IBM stock. (For more on index funds, see Index Investing.)

David Swensen, an investment expert, author and former chief investment officer of Yale University’s highly successful endowment fund, makes a strong case for indexing. In his 2005 book, “Unconventional Success”, he concludes that because “most individual investors lack the specialized knowledge necessary to succeed in today’s highly competitive investment markets … passive index funds are most likely to satisfy investor aspirations.”

Swensen, and a high percentage of investment professionals, find index investing compelling for the following reasons:

  • Simplicity. Broad-based market index funds make asset allocation and diversification easy.
  • Management quality. The passive nature of indexing eliminates any concerns about human error or management tenure.
  • Low portfolio turnover. Less buying and selling of securities means lower costs and fewer tax consequences.
  • Low operational expenses. Indexing is considerably less expensive than active fund management.
  • Asset bloat. Portfolio size is not a concern with index funds.
  • Performance. It is a matter of record that index funds have outperformed the majority of managed funds over a variety of time periods.

Managed Mutual Funds
Well-run managed funds that have long-term performance records that are above their peer and category benchmarks are also excellent investing opportunities. There are a number of top-rated fund managers that consistently deliver exceptional results. Such well-run funds will register very high on the Fund Investment-Quality Scorecard you are learning about in these pages.

It is worth remembering that despite their impressive long-term records, even top-rated fund managers can have bad years. Such an occurrence is little cause to abandon a fund run by a highly respected manager. Typically, managers will stick to their fundamental strategies and not be swayed to experiment with tactics geared to improving results over the short term. This type of posture best serves the long-term interests of fund investors.

In recent years, a number of fund management-related issues have received more public attention in the financial press than in the past. These fall under the general heading of fund stewardship and include such issues as a manager’s financial stake in a fund, performance fees and the composition of a fund’s board of directors.

While the discussion on these issues is important, there is no universal agreement as to what constitutes appropriate standards of conduct.

By connecting shareholder and managerial interests, having managers investing significantly in the funds they manage seems like a good idea. Likewise, compensating managers on the basis of performance rather than as a percentage of a fund’s assets also seems like a good thing. However, there are reasonable arguments that take an opposite point of view on both of these issues. Less controversial is the practice of having a majority of independent directors serve on a fund’s board of directors. But here too, there continues to be differences of opinion. The good news for fund investors is that the debates surrounding these issues heighten public and regulatory awareness of what constitutes proper mutual fund stewardship.

Source: investopedia.com

Conversion Arbitrage

Introduction

Conversion arbitrage does not typically find its way into books about options trading. It is not surprising, given that the term alone would cause most eyes to glaze over. With a little extra effort, however, this stock and options combination strategy should not be too difficult to fully understand.To help demystify conversion arbitrage, we begin with an uncomplicated model of conversions, making some simplifying assumptions to get at the core concept. Later, as we proceed through other sections of this tutorial, assumptions are dropped as more complex relationships are introduced into the picture.While understanding conversion arbitrage does not require an advanced degree in finance or being a veteran market maker, it will require a basic understanding of put and call options (both buying and selling), familiarity with stock buying/shorting and knowledge of the stock dividend process. Conversions incorporate these elements, and a few others, in their cost and profitability structures and in the dimension of risk assessment, so you should brush up on them before getting started. (To learn more, read Put-Call Parity And Arbitrage Opportunity, When To Short A Stock and How And Why Do Companies Pay Dividends?)Market Efficiency, or Lack Thereof
When we speak of arbitrage of any kind, it is always associated with the idea of taking advantage of some sort of marketplace mispricing – pricing that is out of line with theoretical or fair value. The textbook story is one where the arbitrageur is supposed to play the role of keeping prices efficient by seizing opportunities when prices deviate from fair values, and thus driving them back to efficient levels.

In the options markets, it is the process of conversion and reverse conversion that helps keep put and call prices efficient. If an arbitrage opportunity appears for the options strategist seeking to lock in a potential profit using a conversion strategy, the purchase and sale of conversions act ultimately to remove that opportunity for profit.

Conversions have a long history, which is usually associated with market makers or floor traders who have a trading edge as a result of being on the trading floor, operating with lower margin requirements and having much lower transaction costs.

These key advantages – plus earning interest on short sales in reverse conversions – helped give this approach its reputation of not being for the retail guy. In today’s more level playing field for trading, however, conversion opportunities may be available for any astute trader. (Arbitrage is no longer just for market makers; find out more in Arbitrage Squeezes Profit From Market Efficiency.)

If prices are efficient, there is no way to extract a profit from conversion arbitrage above the risk free rate of interest. You would be better off buying a Treasury bill or CD and saving yourself the trouble – not to mention the transaction costs.

As you will see, it is possible to find profitable conversions, especially when incorporating dividend payments and interest earned on credit balances (for reverse conversions). It is absolutely essential to fully understand exactly how to cost-price these strategies before jumping into positions. Otherwise, you may ultimately make money on the trade only to learn that you could have made just as much, or more, by plunking your money down and buying a CD. Or worse, you may actually experience a loss due to not properly understanding the hidden risks. (To learn more, read Don’t Let Stock Prices Fool You.)

With this in mind, the availability of efficient online trading tools, deep discount commissions and new margin rules offer traders a better opportunity for finding conversions that provide potential profits above a CD rate or risk-free rate of interest. Hopefully this tutorial will encourage you to further explore this approach.


Source: investopedia.com

Employee Stock Options (ESO)

Introduction

Employee stock options, or ESOs, represent one form of equity compensation granted by companies to their employees and executives. They give the holder the right to purchase the company stock at a specified price for a limited duration of time in quantities spelled out in the options agreement.

ESOs represent the most common form of equity compensation. In this tutorial, the employee (or grantee) also known as the “optionee”, will learn the basics of ESO valuation, how they differ from their brethren in the listed (exchange traded) options family, and what risks and rewards are associated with holding these during their limited life. Additionally, the risk of holding ESOs when they get in the money versus early or premature exercise will be examined.

In Chapter 2,we describe ESOs at a very basic level. When a company decides that it would like to align its employee interests with the aims of the management, one way to do this is to issue compensation in the form of equity in the company. It is also a way of deferring compensation. Restricted stock grants, incentive stock options and ESOs all are forms equity compensation can take. While restricted stock and incentive stock options are important areas of equity compensation, they will not be explored here. Instead, the focus is on non-qualified ESOs.

We begin by providing a detailed description of the key terms and concepts associated with ESOs from the perspective of employees and their self interest. Vesting, expiration dates and expected time to expiration, volatility pricing, strike (or exercise) prices, and many other useful and necessary concepts are explained. These are important building blocks of understanding ESOs – an important foundation for making informed choices about how to manage your equity compensation.

ESOs are granted to employees as a form of compensation, as mentioned above, but these options do not have any marketable value (since they do not trade in a secondary market) and are generally non-transferable. This is a key difference that will be explored in greater detail in Chapter 3, which covers basic options terminology and concepts, while highlighting other similarities and differences between the traded (listed) and non-traded (ESO) contracts.

An important feature of ESOs is their theoretical value, which is explained in Chapter 4. Theoretical value is derived from options pricing models like the Black-Scholes (BS), or a binomial pricing approach. Generally speaking, the BS model is accepted by most as a valid form of ESO valuation and meets Financial Accounting Standards Board (FASB) standards, assuming that the options do not pay dividends. But even if the company does pay dividends, there is a dividend-paying version of the BS model that can incorporate the dividend stream into the pricing of these ESOs. There is ongoing debate in and out of academia, meanwhile, about how to best value ESOs, a topic that is well beyond this tutorial.

Chapter 5looks at what a grantee should be thinking about once an ESO is granted by an employer. It is important for the employee (grantee) to understand the risks and potential rewards of simply holding ESOs until they expire. There are some stylized scenarios that can be useful in illustrating what is at stake and what to look out for when considering your options. This segment, therefore, outlines key outcomes from holding your ESOs.

A common form of management by employees to reduce risk and lock in gains is the early (or premature) exercise. This is somewhat of a dilemma, and poses some tough choices for ESO holders. Ultimately, this decision will depend on one’s personal risk appetite and specific financial needs, both in the short and long term. Chapter 6 looks at the process of early exercise, the financial objectives typical of a grantee taking this road (and related issues), plus the associated risks and tax implications (especially short-term tax liabilities). Too many holders rely on conventional wisdom about ESO risk management which, unfortunately, may be loaded with conflicts of interest, and therefore may not necessarily be the best choice. For example, the common practice of recommending early exercise in order to diversify assets may not produce the optimal outcomes desired. There are trade offs and opportunity costs that must be carefully examined.

Besides removing the alignment between employee and company (which was the purportedly one of the intended purposes of the grant), the early exercise exposes the holder to a large tax bite (at ordinary income tax rates). In exchange, the holder does lock in some appreciation in value on their ESO (intrinsic value). Extrinsic, or time value, is real value. It represents value proportional to probability of gaining more intrinsic value. Alternatives do exist for most holders of ESOs for avoiding premature exercise (i.e. exercising before expiration date). Hedging with listed options is one such alternative, which is briefly explained in Chapter 7 along with some of the pros and cons of such an approach.

Employees face a complex and often confusing tax liability picture when considering their choices about ESOs and their management. The tax implications of early exercise, a tax on intrinsic value as compensation income, not capital gains, can be painful and may not be necessary once you are aware of some of the alternatives. However, hedging raises a new set of questions and resulting confusion about tax burden and risks, which is beyond the scope of this tutorial.

ESOs are held by tens of millions of employees and executives in North America, and many more worldwide are in possession of these often misunderstood assets known as equity compensation. Trying to get a handle on the risks, both tax and equity, is not easy but a little effort at understanding the fundamentals will go a long way toward demystifying ESOs. That way, when you sit down with your financial planner or wealth manager, you can have a more informed discussion – one that will hopefully empower you to make the best choices about your financial future.

Source: investopedia.com

Commodity Investing 101

Introduction

From the orange juice we drink to the gas we use to power our vehicles and heat our homes, commodities play important roles in our daily lives. They can be found literally all over the world, and can be traded on the global marketplace as part of a diversified investment portfolio. In fact, billions of dollars are invested in commodities every day.

While they can be traded on either spot (real-time) or futures (options) markets, most individual commodities are traded in the form of futures, where what is being traded is not the commodity itself but rather a contract to buy or sell it for a certain price by a stated date in the future. This carries the potential for wild market fluctuations, but it also offers exciting opportunities for investors willing to ride out market volatility in anticipation of rewards.

Like any investment, the goal in commodities trading is to buy low and sell high. The difference with commodities is that they are highly leveraged and trade in contract sizes instead of shares. What’s more, investors can buy and sell positions whenever the markets are open, so there’s no chance of waking up one morning to find 10,000 bushels of corn on the front lawn. (Commodities can make investing in gold, oil or grain an easier prospect. Find out more in Commodity Funds 101.)


Source: investopedia.com

Options Basics Tutorial

Introduction

Nowadays, many investors’ portfolios include investments such as mutual funds, stocks and bonds. But the variety of securities you have at your disposal does not end there. Another type of security, called an option, presents a world of opportunity to sophisticated investors.

The power of options lies in their versatility. They enable you to adapt or adjust your position according to any situation that arises. Options can be as speculative or as conservative as you want. This means you can do everything from protecting a position from a decline to outright betting on the movement of a market or index.

This versatility, however, does not come without its costs. Options are complex securities and can be extremely risky. This is why, when trading options, you’ll see a disclaimer like the following:

Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with risk capital.

Despite what anybody tells you, option trading involves risk, especially if you don’t know what you are doing. Because of this, many people suggest you steer clear of options and forget their existence.

On the other hand, being ignorant of any type of investment places you in a weak position. Perhaps the speculative nature of options doesn’t fit your style. No problem – then don’t speculate in options. But, before you decide not to invest in options, you should understand them. Not learning how options function is as dangerous as jumping right in: without knowing about options you would not only forfeit having another item in your investing toolbox but also lose insight into the workings of some of the world’s largest corporations. Whether it is to hedge the risk of foreign-exchange transactions or to give employees ownership in the form of stock options, most multi-nationals today use options in some form or another.

This tutorial will introduce you to the fundamentals of options. Keep in mind that most options traders have many years of experience, so don’t expect to be an expert immediately after reading this tutorial. If you aren’t familiar with how the stock market works, check out the Stock Basics tutorial.

Source: investopedia.com

Beginner’s Guide To MetaTrader 4

ntroduction

MetaTrader 4 is a trading platform developed by MetaQuotes Software for online trading in the forex, contract for differences (CFDs) and futures markets. MT4, as it is commonly known, can be downloaded at no charge directly from the MetaQuotes web site (metaquotes.net) or through dozens of online forex brokers. MT4 provides tools and resources that allow traders to analyze price, place and manage trades, and employ automated trading techniques. This tutorial will provide an introduction to many of MetaTrader 4’s features, including chart settings, technical analysis tools and trade placement.

Source: investopedia.com

OptionsXpress – Brokerage Review

Introduction

Unlike many of the online brokerages competing for investor accounts, optionsXpress is a relative newcomer to the market. A little more than a decade old, the company built itself around options trading before adding futures capabilities through an acquisition. OptionsXpress was itself then acquire by Charles Schwab in 2011 and operates as a subsidiary. SEE: Charles Schwab Broker Summary

Account Types and Minimum Deposits

For a company that would appear to be built to focus on options traders, optionsXpress actually offers a relatively wide array of account types. Customers can choose between cash and margin accounts, and accounts are available in a wide variety of categories, including IRAs, trusts and business accounts.

There are no minimums for most accounts, though margin accounts do have a $2,000 minimum.

Services Offered

Perhaps not surprisingly given the name, optionsXpress offers an array of services to options traders. What may surprise some, though, is the extent to which other types of trading are available. To start with, optionsXpress offers full options trading, including facilitating more elaborate/complex options strategies, and penny options.

OptionsXpress also offers a very wide range of futures trading; while many brokerages now offer some futures trading, it is often limited to a select number of exchanges.
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Figure 1: Some benefits of trading futures with optionsXpress.

This brokerage also offers online stock trading, bond trading, ETFs and mutual funds. Investors can also access other services provided through Charles Schwab, including banking services. (For related reading, see TD Ameritrade Thinkorswim.)


Source: investopedia.com

Beginner’s Guide To NinjaTrader

Introduction

NinjaTrader, LLC was established in 2004 as a privately held company. Headquartered in Denver, Colorado, NinjaTrader, LLC develops high-performance trading software and market data services. NinjaTrader is its award winning trading platform developed for active traders interested in the stock, futures and forex markets. There is no fee for using NinjaTrader’s standard features, which include advanced charting, market analytics, automated strategy development, backtesting and optimization, and trade simulation. Traders who wish to use NinjaTrader to execute live trades through a brokerage account may either purchase a lifetime license or lease the platform on a quarterly, semi-annual, or annual basis. NinjaTrader users may select from hundreds of international brokerage providers that support live trading with the NinjaTrader platform, including:
· CQG

· FXCM

· GAIN Capital/FOREX.com

· Interactive Brokers

· MB Trading

· Patsystems

· PFBBEST.com

· TD Ameritrade

· Trading Technologies

· Vision Financial Markets

· Zen Fire

Source: investopedia.com