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Investing 101 !

Toggle is a Fintech platform that analyzes billions of data points, distilling significant patterns into easy-to-understand insights. We equip our investors with the tools and knowledge to cut through the noise and understand why a stock is moving. Taking this a step further, we give you the turn-by-turn directions, explaining where the stock may move over a certain period of time, and laying out the price levels at which the roadmap is no longer viable.

## Benefits

Think of TOGGLE as Google Maps for Investing. It helps you navigate by highlighting relevant information (traffic, potholes, nearest gas station) but won't push you onto a particular path. If you’re looking for the next investment, it’ll organize the information to help you understand the relevant drivers that are impacting the asset. The asset overview was designed specifically with this in mind. The AI can analyze billions of data points in no time to provide you with bullish/bearish signals for a large number of frequently traded assets. 

[Video](https://www.youtube.com/embed/05xThhUhGr4)

What is TOGGLE?

There are 2 ways to inform the system about assets you are interested/invested in. You can go into “User” and under Watchlist, use the Search bar to add to your selection at will. You can also connect your portfolio to the platform and TOGGLE will automatically add all your holdings to MY TOGGLE. 

## Method 1:

On login, click on the User pane to configure your watchlist. 

Toggle AI uses this information to carefully select investment insights specifically tailored to your interests.

You'll be taken to a page where you can add and delete assets you'd like to follow (e.g. SPX, Alibaba, etc). You can add an unlimited number of assets to your watchlist and change the list at any time, with a paid account. 

Your watchlist will help TOGGLE know what assets to watch on your behalf. You can see a list of all the insights related to your watchlist on the Explore tab: just click on the My Watchlist filter. These insights are ordered according to the time they were generated: the most recent articles come first.

You can also go to the My TOGGLE page which lists all your holdings in alphabetical order. Assets with insights released today will be at the top of our screen. This will give you a holistic view of what could potentially be driving the price of assets in your watchlist/portfolio. You can also add assets to your watchlist through MY TOGGLE. notifications for all assets in your watchlist. On the left-hand side you will see the recent notifications that TOGGLE has generated for assets in your watchlist. You can filter this list by clicking on the asset. In addition, on top there are convenient filters for you to narrow down further by bullish, bearish, or unread insights.

![MYTOGGLE page when a new insight is released](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/d2493a_83bb63b0fe7a479cafae992a8dcf353c_mv2_560f373b80/d2493a_83bb63b0fe7a479cafae992a8dcf353c_mv2_560f373b80.png)

You will also receive email alerts for names on your watchlist, as well as push notifications if you have the app installed.

![email alerts when a new insight is released](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/alert_email_036a281063/alert_email_036a281063.png)

## Method 2: 

You can also connect your portfolio(s): that way, TOGGLE will automatically adjust the assets it’s watching for you as your holdings change. By doing so, TOGGLE will give you timely alerts on your holdings, making sure you never miss any insights.

You can connect via Settings. TOGGLE connects with all major brokers in the US & Canada. 

After navigating to the User page, you'll first be asked to select your default currency. This allows TOGGLE to map securities from all over the globe back into your preferred value. 

Afterwards you'll be able to choose your provider(s) and connect one or multiple portfolios. The Interactive Brokers option will open a new window where you can log into your account. Selecting Other Platforms will open a prompt from Plaid, allowing you to connect to all major brokerages.

Tracking TOGGLE Insights

## TOGGLE Asset Overview 

TOGGLE covers more than 35,000 global assets across Foreign Exchange, Equities (single names, ETFs, and indexes), Fixed Income, Credit and Commodities.

This number will continue to grow as we onboard new clients in new markets. 

![TOGGLE asset coverage pie chart](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/d2493a_e1388e054eb6421180322157d3c110d0_mv2_a9f68ebc73/d2493a_e1388e054eb6421180322157d3c110d0_mv2_a9f68ebc73.webp)




TOGGLE covers more than 35,000 global assets across Foreign Exchange, Equities (single names, ETFs, and indexes), Fixed Income, Credit and Commodities. This number will continue to grow as we onboard new clients in new markets. 

What does TOGGLE Cover?

[Video](https://www.youtube.com/embed/yKEaKMUFjHU)

## Stars

Stars represent quality checks: robustness across business cycles, frequency and sparseness of the pattern, and strength of backtest and risk/return profile. 

![TOGGLE stars to encompass robustness of relationship](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/Screen_Shot_2022_01_26_at_12_53_28_PM_bd9b6b311a/Screen_Shot_2022_01_26_at_12_53_28_PM_bd9b6b311a.png)

## Path (stop loss)

When TOGGLE provides forward price paths based on historical price patterns, several things are shown.The line represents the security's median return, and the boxes the confidence interval around the median. The "optimal" horizon will appear highlighted, a blue-green if positive and red if negative. All other boxes are not shaded.  

For example, the below shows a bullish pattern in American Express, where the horizon selected is a 3M holding period.

![American Express projection over a 3M horizon](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/American_Express_projection_8ea4926d82/American_Express_projection_8ea4926d82.png)

The horizontal red line is a possible re-evaluation or stop-loss level: it signifies the point where price action has deviated too far from the expected path and the insight is invalidated. The horizontal green line indicates the level the asset is expected to reach if historical analogs hold.

## Confidence Interval 

The shaded area that overlay forward price projections in each chart give users a sense of the typical range of outcomes. The range of outcomes shows a 1-Standard Deviation confidence interval given the outcome of historic precedents.

You can find more detail on the intervals themselves in the table below:

![Range of outcomes over different horizons](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/d2493a_b6c7bd0195fd4c57bc2d858a187be03d_mv2_95b968dd89/d2493a_b6c7bd0195fd4c57bc2d858a187be03d_mv2_95b968dd89.png)

## Horizon

TOGGLE assesses the accuracy of each signal across many horizons.
We report the horizon that shows the biggest statistical shift of its distribution, relative to baseline. A summary of all horizons examined can be found in the "what does that mean" section.

## Drivers and Definitions

TOGGLE's system continuously monitors hundreds of thousands of time series, searching for and detecting interesting developments that may be relevant to users. It scans for compelling milestones in data series, including new highs and lows, among other signals. It's on alert for emerging trends (characterized by a persistent move up or down over a longer time period), a move through zero or other important barrier, and sudden large moves up or down

![Drivers monitored by TOGGLE](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/d2493a_5ee388d47bd24e73bd197aba10b9dc02_mv2_53984286c6/d2493a_5ee388d47bd24e73bd197aba10b9dc02_mv2_53984286c6.png)

## Past Performance Graphs

To give you a sense of the insight's profit potential, the line chart shows the cumulative return from trading on this insight each time it appeared in the past, starting with $1. Ideally, an insight has a high cumulative return and small drawdowns (left graph).

The scatter plot visualizes how well the insight performed out of sample. The x-axis shows the expected returns given the insight conditions, while the y-axis records the actual returns the security realized. A perfect foresight would see complete alignment of expected and actual returns along the 45° diagonal. The scatter plot shows the actual past returns based on this insight, to help compare the risk of losses vs. potential gains. Each of TOGGLE’s insights is rigorously backtested to help you assess its accuracy (scatter plot - right)

![backtesting line graph and scatter plot](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/d2493a_7fc5b5264a49430ca9e0333dff29b6c3_mv2_af4a67ccc8/d2493a_7fc5b5264a49430ca9e0333dff29b6c3_mv2_af4a67ccc8.png)


What is a TOGGLE insight? 

[Video](https://www.youtube.com/embed/sdKbYp8vc0s)

How to analyze an insight

## How should I use TOGGLE Insights?

A natural question that comes to mind as you peruse TOGGLE insights is - does this really work? And if so, why would they give it to me? A past-its-prime hedge fund industry still seems like a great gig. 

The key thing about TOGGLE Insights is that they are NOT buy and sell recommendations. TOGGLE helps you piece together a mosaic of relevant data points to make a maximally informed investment decision, much like investors already do with a mish-mash of tools. It can’t eliminate the uncertainty of outcomes, but it can give you a better sense of what they are, and their odds. Put differently, TOGGLE uses data to help you turn unknown unknowns into known unknowns.  

## _TOGGLE can’t eliminate the uncertainty of outcomes, but it can give you a better sense of what they are, and their odds._

Investors are bombarded by news and data from all sides. The issue every investor confronts is the ever-growing mountain of information that needs processing. And this is where machines can help: sifting tirelessly through billions of data points to complement the investor’s own efforts.

## Risk management
TOGGLE analysis always shows you the full range of possible outcomes, as informed by history. Each chart displays clearly marked confidence bands that help investors determine whether the observed price behavior conforms to expectations. The moment a price movement falls outside the norm may be the natural time to re-evaluate the thesis (and the position): do I still believe this investment thesis is working? 

## How accurate are these expected ranges?
Insights are always thoroughly back-tested, and the results are displayed in each article. TOGGLE shows you exactly how many data points the relationship was tested on, and how well the relationship did in anticipating the direction of the asset’s move. 

![Statistical backtest showing the distribution of returns both in-sample and out-of-sampleStatistical backtest showing the distribution of returns both in-sample and out-of-sample](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/why_should_u_care_0f2e3c8d1c/why_should_u_care_0f2e3c8d1c.webp)

## Impartial 3rd party test
In addition to back-testing every Insight, TOGGLE enlisted the help of a third party to test the predictive power of Insights. Between March 3 and April 14 of 2020, when US stocks created a sharp V-shaped pattern, this third party tested a large number of Insights to assess their accuracy. 

![S&P 500 price chart showing the March 2020 dropS&P 500 price chart showing the March 2020 drop](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/spx_mar_2020_feb86b1c5f/spx_mar_2020_feb86b1c5f.png)

The asset universe tested were single stocks, primarily in the US. Overall, the results are extremely encouraging because they came during the most difficult point for tactical trading: a sharp move both down and up in the overall market. 

They show that a) **TOGGLE stock selection bias is very good** and b) **the range of past outcomes can serve as a great risk management tool**. 

Across nearly 1,800 trades - the confidence intervals TOGGLE includes in its charts served as a guide for stop loss and take profit. That element of risk control created a very clear fat tail to the positive side: **virtually no trade lost more than 16% during the period when the S&P 500 dropped 30%**.

![Distribution of returns for TOGGLE Insights during the volatile March 2020 period](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/distribution_of_toggle_insights_48aef5b036/distribution_of_toggle_insights_48aef5b036.jpeg)

Moreover, looking at only the long positions, only a few lost anything comparable to the S&P 500 and many gained during that time. 

![Distribution of returns for trading long positions based on TOGGLE Insights during March 2020](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/distribution_across_long_positions_9ae0f8ca2c/distribution_across_long_positions_9ae0f8ca2c.png)

On balance, **short positions did better**. This isn’t surprising since the test started in the last third of the market drop, its most ferocious part. **But long positions handily outperformed the overall index**, confirming that the selection bias is good. 

![Distribution of returns for trading short positions based on TOGGLE Insights during March 2020](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/distribution_of_short_trades_b8bf163add/distribution_of_short_trades_b8bf163add.png)

Furthermore, returns were further improved by using TOGGLE’s confidence intervals as a risk management tool. That meant trades that could have gone wrong were stopped out very early, and once the market turned trades were left to run a while. 

## TOGGLE internal tests
TOGGLE also conducted internal tests across single stocks and major currencies, picking two distinct periods to test them. First TOGGLE monitored insights on a number of blue chip US securities, following them monthly from 2017 to 2019. Across 63 trades, the hit ratio was 76%.

![Backtest of trading stocks based on TOGGLE Insights from 2017 to 2019](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/individual_US_stocks_14a19f5ca2/individual_US_stocks_14a19f5ca2.png)

Afterward, TOGGLE conducted a much larger study over the 2010-2012 period, including major US and EU single names for a total of 936 trades. Yet again, the results were outstanding: a 58% hit rate across a broad range of securities and geographies over a period of 2 years. 

![Backtest of trading stocks based on TOGGLE Insights from 2010 to 2012](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/backtest_of_trading_stocks_c90c12a0f6/backtest_of_trading_stocks_c90c12a0f6.png)

Repeating the test with major USD FX crosses, 40 in all, monitoring the outcome of 183 trades, the resulting hit ratio was very high: 74%.

![Backtest of trading FX (currencies) on TOGGLE Insights from 2010 to 2012](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/backtesting_currencies_17df742f2d/backtesting_currencies_17df742f2d.png)

## Summing it all up
In conclusion, TOGGLE proved its value during the most ferocious episode of recent US market history when seasoned investors often didn’t. It did so as a valuable complement, rather than a replacement, to investor judgement. Furthermore, even in larger numbers and across different periods, TOGGLE insights demonstrated remarkable robustness: the drivers TOGGLE highlighted anticipated the timing and direction, if not always the magnitude, of the subsequent price move. 

Do TOGGLE insights really work? 

Data is an essential ingredient in any investment process. But when does an observed relationship - correlation, pattern, mean reversion - become a tradable insight? 

In a portfolio that consists of thousands of small trades, with frequent buys and sells, statistical confidence may be all that’s required. 

Machines are in a league of their own when it comes to processing large amounts of information. They can look through mountains of data, easily outpacing an army of human analysts. The rigor and uniformity of the process ensures that whatever they uncover meets predetermined standards of statistical confidence. 

But for a typical discretionary portfolio, that’s not enough. Many non-professional investors have at most 15 trades in their portfolios, and half of them have even fewer than that. For those investors, a statistically significant relationship isn’t sufficient to pull the trigger. There are a lot of other factors to be considered. 

So do machines warrant a place in a discretionary investment process? 

## Man-machine collaboration
TOGGLE’s AI sifts through billions of data points, leaving no stone unturned in the quest to uncover new patterns and relationships. But is a statistically solid, logically sound relationship - if A, then B (90% of the time) -  all that an investor needs to know before placing a new trade? 

At TOGGLE, after a pattern has been identified - strong momentum in stock A typically leads to market outperformance over the following X months - the relationship is tested for a range of other criteria. The goal is to distill machine-generated findings down to those that satisfy the most intuitive checks a discretionary investor will typically perform.

## Accuracy
Discretionary investors rely on analogical inference… “have I seen something like this before? If so, what happened?” They judge the environment through the lens of their own investing experiences. When they identify a familiar sequence of events, they act based on how consistently that sequence of events previously led to a certain move in the asset price.

TOGGLE thinks in very similar terms. It starts the analysis by checking the first metric a human analyst would likely look at, accuracy: how often did the relationship produce the expected result, i.e. when A happened, how often did B occur afterwards? 

TOGGLE AI performs both an in-sample as well as out-of-sample test. An in-sample test considers “how frequently was this right, historically”. An out-of-sample test is a little more involved. Let’s say a relationship was observed 8 times in the past. TOGGLE initially restricts itself to the first 3 times to make a prediction about the 4th occurrence, and checks it against the actual outcome. Then it repeats this for the 5th occurrence, using only the first four ... and so on and so forth. Approaching the test in this manner means that the predictive power of the relationship is more robust,. You haven’t biased it with information that wasn’t known at the time.

![what is TOGGLE predicting and across what horizon](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/insight_preview_example_8eca3444fd/insight_preview_example_8eca3444fd.png)

## Risk-Reward
At the heart of every investment process is the consideration of how much a trade might make (return) versus the risk it might entail. Risk comes in many forms, but in most cases investors focus on two: what are the chances I am wrong? If I am right, how bumpy is the path? 

![Forward projection for a bullish insight the UK FTSE Index](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/looking_deeper_in_the_projection_2790ee7394/looking_deeper_in_the_projection_2790ee7394.png)

The latter is important because, even if a thesis ultimately proves correct, a very volatile path will be a challenge and might lead the investor to sell at the wrong time because they can’t take the pain of negative P&L. In portfolio management, the metric that tries to capture this is the Drawdown ratio (sometimes called the Calmar ratio).

TOGGLE helps investors assess whether a pattern is compelling enough to justify a trade by 1) measuring historical outliers - how much would you have lost when the thesis didn’t play out, and 2) what was the distribution of returns along the way - how painful was the asset’s path.

## Stability of the pattern
Another important question is “does the relationship only hold during specific periods?” (during a financial crisis, Fed tightening cycle etc.) TOGGLE tests to make sure that the relationship has been robust across business cycles, and therefore isn’t beholden to any particular environment. 

![History chart for a bullish insight on the UK FTSE Small Index](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/UK_FTSE_history_bc37b0cf30/UK_FTSE_history_bc37b0cf30.png)

## Regularity
Another desirable characteristic of a trade is regularity. If a pattern occurs with some regularity (say, every few months) there is less worry that an unknown systemic variable might be causing a relationship, like during a specific market environment (e.g. the Great Financial Crisis). 

A solid insight doesn’t need to satisfy all of these criteria...but the more criteria it satisfies, the more compelling it is, and the more compelling it is for investors to include the insight in their decision making framework. 

## Bringing it all together
Discretionary investors usually seek to deploy ideas that score as high as possible along similar measures of “desirability”. 

At TOGGLE, we espouse this approach and have created a concise rating that allows users to gauge the idea in this framework. All ideas gain a “star” ranking with the best ones reaching a full rank of 8 stars.

![Understanding the 8 conditions which encompass robustness stars](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/Screen_Shot_2022_01_26_at_2_22_50_PM_968f110147/Screen_Shot_2022_01_26_at_2_22_50_PM_968f110147.png)

[Video](https://www.youtube.com/embed/kvieOkx998I)

Turning Data into Insights

The best way to get in touch with the TOGGLE team is through email or live chat:

Email support@toggle.ai 

Chat with us via the website help robot -> “Chat with us”

![finding live chat on TOGGLE](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/Screen_Shot_2022_02_07_at_3_44_21_PM_d06a1b2c52/Screen_Shot_2022_02_07_at_3_44_21_PM_d06a1b2c52.png)

	3. Call us: +1 646-844-1878

	4. Social media: @Toggle AI on Twitter, Facebook, LinkedIn 


Please email us for any of the following requests: 

- How can I join the daily brief newsletter?
- How can I change the email associated with my account? 
- I am interested in trialing TOGGLE Pro
- How can I delete my account?
- Where can I submit feedback or suggestions? 

Additional Support Resources 

The TOGGLE Leading Indicator of 5,000 US stocks is an aggregated breadth measure of how many insights produced by TOGGLE are bearish or bullish.

The intuition behind the indicator is that when TOGGLE insights tend to be for the majority bullish, pressures on the aggregate market are to the upside. And vice versa of course.

**Performance so far (updated: Jan 30th, 2022)**

We have been studying the indicator throughout 2021 and observed that the indicator appears to correctly point to upside or downside risk in the broad market.

When the indicator rallies above 0.15 or falls below -0.15, then the chance of upside or downside moves respectively becomes higher statistically.

**Where to find the TLI**

The TLI is currently only available in the Friday Edition of the TOGGLE Daily Brief. Work is underway to bring the indicator in-app.

**How to read the charts below**

The **first chart** shows SPX overimposed on blue and red bars. The bars represent moments when the TLI reached bullish (blue) or bearish (red) thresholds, set at 0.15 and -0.15 respectively.

The **second chart** shows the TLI moved to the right by 12 days, and compared with the performance range of SPX. To be precise, the orange area shows the range of max-to-min returns experienced by SPX.

The **third chart (bottom-left)** is the scatterplot version of the second chart. It additionally shows the maximum and minimum returns one can expect based on the relationship between TLI and SPX in the past.

The **fourth chart (bottom-right)** finally shows the Granger correlation analysis of the TLI vs SPX returns. The chart confirms that for the period under study the TLI had a higher correlation with future returns of SPX rather than with its current returns. In other words, this chart seeks to confirm the TLI is a leading indicator rather than a coincident one.

![TOGGLE leading indicator graphs](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/aggregate_toggle_signals_spx_6_7_8_stars_4_182fc5e8c1/aggregate_toggle_signals_spx_6_7_8_stars_4_182fc5e8c1.png)

The TOGGLE Leading Indicator

The realized volatility is a measure of the average size of the returns offered by a security in a determined period. For example, a stock that falls or rises 30% in a few days is considered very volatile, and conversely a Treasury bond that moves 1% at most on a given week has low volatility.

Volatility by its nature is a range-bound measure on the low side, it can never go below 0. This allows traders to distinguish regimes of low volatility.

The more appropriate name for this measure would be “standard deviation of returns” but financial jargon

Volatility is used in two different settings at least:

- For security due diligence and structuring: stocks that have experienced a long spell of low volatility offer interesting opportunities ahead of catalysts that might make them more volatile. Usually, when realized volatility is low then so is the price of options
- For portfolio construction and risk budgeting: realized volatility (and its sibling measure VaR) are used to construct portfolios with specific risk/volatility targets

Realized Volatility

Guide to TOGGLE

## TL:DR

- A portfolio is the umbrella term used to describe a combination of investments and other assets
- The 4 steps to building a portfolio

## What is a portfolio?

Your portfolio holds all of your investments - whether you hold a diversified basket of etfs or just a handful of options on TSLA. 

## What does a portfolio look like?
Here’s a few examples of portfolios

- A risky investment portfolio: Ali owns a portfolio, of which 50% is invested in stocks, 20% in cryptocurrencies and 30% in real estate. . If you look at this portfolio, you will see there’s a lot of risky assets, barely balanced by some real estate. So this is a risky portfolio. This would be a good portfolio to hold for an investor who does not rely on their portfolio as income and is willing to take more risk, to achieve a higher return. 
- A risk averse portfolio: Gianluca owns a portfolio of which 50% is invested in government bonds, 30% in exchange traded funds (ETFs) and 20% in blue chip stocks like Amazon. Compared to Ali, Gianluca holds a much less riskier portfolio as his major exposure is in government bonds (an almost risk-free asset). The rest of his assets are much less volatile compared to Ali’s. This is a good portfolio to hold for someone who is investing over a long term and is using their portfolio as a place to store money in safe assets, maybe preparing for retirement. 
- A FAANG portfolio: Jenny invests in only FAANG assets (some of the largest securities on the equity market and hence the least volatile) like Facebook, Apple, Amazon, Netflix and Google. An investor may have preference for such a portfolio if the equities market is looking strong but they still want to protect themselves from volatility, so they invest in the biggest equities. However, by doing this, they are heavily exposed to the technology industry. 

## What are the key characteristics of a portfolio?

NAV: Net Asset Value = Total Value of Assets - Total Value of Liabilities

The per/share unit price of a portfolio at a specific time and date. This can be calculated at the end of each day using the market close price. 

Concentration: Percentage of exposure in a specific industry

An investor may choose to invest in a wide variety of industries to diversify their capital, or invest in a specific industry and be highly exposed to a single industry. 

Risk: Chance of losing some or all of your investment 

Leverage: Trading using borrowed funds with the hope of earning a higher return

## How do I construct a portfolio?

Constructing a portfolio is a fun exercise for an investor. It allows you to combine all your investing (and ethical) views into a single investing basket that will hopefully outperform the market

Read more about this in our “Construct a portfolio” article

What is a portfolio?

## TL: DR

- The stock market is place where buyers and sellers of publicly traded company shares come to transact 
- For a practical example, NYSE and Nasdaq are two of the most famous stock exchanges

## What is the stock market?

The stock market is a marketplace to buy and sell shares of publicly traded companies. 

The stock market operates similarly to an auction market. 

Buyers list the highest price they are willing to pay per share (the bid) and sellers list the lowest price they are willing to accept and sell to (the ask). When a buyer accepts the price of a seller (or vice versa) then a transaction takes place.

When talking about “the stock market” investors more precisely refer to stock exchanges such as NYSE and Nasdaq in the US, or their counterparts in other countries. 

Example of a stock market transaction: _Pansy wants to sell 5 stocks of XYZ and RJ wants to buy 5 stocks of XYZ. Pansy looks at the list of sellers and sees that RJ is willing to buy stocks at $1.00 per share. If she accepts RJ’s price, then the exchange records a transaction at $1.00 per share and that is the last price of the stock. Or she can say “I am only willing to sell at $1.25” and put herself on the list of sellers waiting for someone to accept her price._

What is the stock market? 

## TL:DR

- A stock represents part ownership in a company 
- It carries two fundamental rights: the right to dividends, and the right to vote
- Shares can be traded on public exchanges or privately. 
- Why buy stock: capital appreciation, dividends (if applicable) and shareholder rights
- Types of shares: common shares and preferred shares
- Large potential for capital appreciation but high risk present too 

## What is a stock? 

A stock is a financial security that represents part ownership of a company. 
ALT: A stock represents part ownership of a company, and is also known as a financial security.

This gives the holder of the stock the right to own a certain amount of a company’s assets and profits, based on the number of “shares” they own. The owner of a share is called a shareholder and his/her ownership depends on the number of shares they own versus the total number of company shares (aka shares outstanding). 

_For example: Giuseppe owns 1,000 shares of Amazon stock. Amazon has a total of 50,000 shares outstanding. That means Giuseppe owns and has a 2.0% (1,000/50,000 * 100) claim to the company’s assets and earnings._

All publicly traded company shares are transacted on exchanges like NYSE and Nasdaq, but private companies can only sell shares privately to individual investors. Companies issue shares in order to raise funds to operate and maintain the business. There are two types of shares: common and preferred shares. 

The transactions must follow regulations set forth by the SEC in order to protect investors buying private shares (which can be risky). Historically, stocks have outperformed all other asset classes over the long run. 

## Why do people buy stocks?

There are 3 reasons why an investor buys stocks: 

- Capital appreciation: growth of investment amount as the price of a stock rises
- Dividends: some companies directly pay their shareholders a portion of its earnings 
- Rights: by holding a company’s stock, some shareholders can vote and have an influence on company decisions

## Why does a company issue stock?

The main reason a company issues stock to the public is to raise money to fund operations. This includes activities like paying off debt, supporting research & development projects to grow the business or simply maintaining business operations. 

Money raised from selling shares on the public market is called equity. A company’s market value of equity (total amount of equity) is equal to the number of shares outstanding * current stock price. Major companies are funded through equity and debt (explained later). 

## What kind of stocks can you invest in?

The two main types of stocks are, common stock and preferred stock.

Common stock: most common form of equity ownership which gives the owner the right to vote at shareholder meetings and receive dividends if they are offered. 

Preferred stock: alternative form of equity ownership where the owner does not have voting rights, but has preference over common stockholders in order of receiving dividend payments and repayment if the company goes bankrupt. 

## Advantages and disadvantages of trading stocks: 

Stocks provide investors with an opportunity for large capital appreciation. As mentioned above, stocks have outperformed all other asset classes over the long term. However, in the shorter term, stock prices move down as well. 

If a company goes bankrupt and all its assets are liquidated, common shareholders (the most common form of stockholders) are last in line to receive any repayment. The hierarchy of repayment in such a situation starts with bond holders, preferred shareholders and then common shareholders are left with residual value. Hence, common shareholders are at the highest risk of losing most/all of their investment. 

If a company is not bankrupt and faced with negative information (like missing earnings expectations, strict government regulation, bad press), this will result in the price of the stock going down. As a result, common shareholders will be in a loss, if the market price crosses their average cost. 

This risk can be managed through investing in different stocks, so that the correlation of your assets is lower. Essentially, if one stock price goes down due to bad information, the other stocks in your portfolio will not be affected (if the news is on a micro scale). This will be explained further in the “diversification” article. 



What is a stock? 

## TL;DR

- You make an investment when you purchase an asset, with hopes of receiving recurring income, or selling it in the future for a higher value - “reaping monetary benefits in the future” as they say in the textbooks.
- Investing involves risk with the potential loss of the initial capitalinvestment 
- When it comes to public markets, the most common investments include stocks like Tesla, bonds like the US Treasury bond, commodities like Gold and most recently cryptocurrencies like Bitcoin
- There are many other investments categories - like art, collectibles, etc

## What is an investment? 

Let’s start from the very beginning. An investment is the purchase of an asset today with hopes of reaping monetary benefits in the future. An asset is a resource, which comes in a variety of forms, and has an economic value that an individual (aka the investor, aka YOU) or an organization (aka an institution) controls. Monetary benefit can be in the form of providing income in the future or appreciation in the economic value and then sale of the asset at a higher price. 

Example: _Jan buys a pair of limited edition sneakers for $100 today. Over the next few weeks, more people want to buy the sneakers and its price rises to $1,000. Jan can either hold the asset, in hopes of the asset’s value increasing more (but risk it no longer being the hot new shoe), or he can sell the asset now and take $900 profit._

## So, why do people invest?

People invest in hopes of growing their wealth.

Whether it’s to achieve a fast return on a trendy stock or to save long-term for retirement, people invest to make their savings grow over some amount of time.

## What are some types of investments?

An investment can be any resource with the ability to generate future income. This can be in the form of bonds, stocks, real estate, and many other examples. Yes, even sneakers. Investing in a child’s college could even be considered an investment, with hope for the child to get a good education, job and income in the future. 

## Is it risky?

**Yes**, investing inherently entails risk. An investment requires an initial allocation of capital, and its value can fluctuate in your favour or against you. Some investments may not generate any future income or could lose all economic value. 

_For example, investing in a company that goes bankrupt would result in the loss of some or all of your initial investment. Or placing a bet on a volatile cryptocurrency might increase its value ten-fold, or lose 90% of it._

One must carefully analyze an investment before choosing to invest. Think of an investment as something that has the potential to get more value than for what you originally paid to acquire it.  

## What are the main types of investments?

Focusing on investments available via public listed markets, there are six main classes of investments available to investors - both private and institutional. These are called asset classes, and include:

- Equities (like Amazon stock )
- Bonds (like corporate debt)
- Currencies (like the US dollar )
- Commodities (like copper )
- Cryptocurrencies (like Bitcoin )

## How is investment different from speculation? 

The line between speculation and investment can be fuzzy at times, but certain differences are accepted by a large consensus:

### Investing has a longer horizon

In general, it’s assumed investing has longer time horizons, whereas speculation is shorter-lived and aims to “turn a quick buck”. In reality, what constitutes a long horizon for an investor might appear speculative for another.

_A Hedge Fund manager might consider 6 months a very long holding period, whereas a Pension Fund might consider it too short_

### Investing focuses on broader research

Investment is generally associated with a broader research effort aimed at assessing all aspects of an investment, whereas speculation tends to focus on a narrower set of drivers.

_A Private Equity Fund might conduct 6 months of due diligence on a company they seek to purchase, and study its revenues and costs and future prospects. Conversely, a day trader might buy a stock simply because it has reached the intraday low again._

## Pop Quiz (no cheating!)

What qualifies as an investment?

1. Putting $50 on black at a roulette table in Vegas
2. Buying your friend breakfast
3. Purchasing a one of a kind watch 

_Answer: by purchasing a one of a kind watch, you are making an investment. As the price of the watch changes in the future (because of its limited supply), the owner will have the chance to hold or sell the watch later. Roulette is just gambling, and buying your friend breakfast is just nice._



What is an investment? 

## TL;DR

- When investors talk about “risk”, they mean risk of losing money - some part or even the entirety of your original investment
- The opportunity to gain money and the risk of losing money are two sides of the same coin: investors take more risk in order to reap higher profits
- Among investors, risk is usually measured with measures like Volatility and VaR, which we’ll discuss in this article

## What is risk? 

When investors talk about “risk”, they mean the risk of losing money. For example, your shares in TSLA might go down 5% when you expected them to rally 30%. Or your SPY options might expire worthless, losing you all their value.

## Risk & Returns

There is a relationship between risk and return in terms of investments: securities with a risk of larger losses also offer a higher chance of large gains. Put in a different way, investors require a higher return for holding higher risk assets. 

When you read that an opportunity comes with a great risk/return tradeoff, investors are talking about a low level of loss and a comparatively large chance of gain. For example, a US treasury bond is considered a risk free asset because it is backed by the guarantee of the government. However, compared to a corporate bond, a government bond provides a lower rate of return - let’s say 1.36% vs 2.42% on a 10 year tenor.

This is because a corporation is more likely to go bankrupt than the government. On the other hand, since investing in corporate bonds holds default risk (risk of bankruptcy), investors expect a higher return for holding this asset. 

## What is volatility?

Volatility is a measure of the degree to which a security tends to move - we would call a currency that moves 1-2% in a week a low-volatility asset, and a stock that can move 30-40% in the same period a high-vol one.

Volatility is measured as the standard deviation of returns for a security - values ranging from 5% to 40% are all possible for your normal stocks. A portfolio with 5-6% volatility is considered a low-vol one.

Volatility is a key to option pricing (explained later). When you read about the VIX index, that’s an average measure of the volatility of S&P 500 implied in the stock market for the future

## What is VaR?

VaR (value at risk) is a statistic used to measure the risk of loss for investments, giving the investor an idea of how much money an investment/portfolio/position could lose, based on a specific period in normal market conditions. 

## How can you mitigate risk? 

Question time: if you put together a portfolio with 2 stocks, each with a volatility of 20%, what’s the average volatility of your portfolio?

_Answer: the vol of the portfolio will be lower than 20%. This is because using two stocks brings diversification to the portfolio. Maybe when one is dropping, the other rallies and therefore the mix of the two is less risky than each separately_

This is the core of how diversification works. Read more about it here.

## What is diversification in portfolio management? (aka not putting all your eggs in one basket) 

One of the ways to reduce your exposure to the different risks in the market is by diversifying your portfolio, so that you are not heavily affected by one industry or company. Not only can you diversify your equities by investing in different markets, but you can diversify your entire portfolio by investing in different asset classes. By doing this, you reduce your overall portfolio risk. For example, many investors hold commodities in their portfolios as these assets are hedged against inflation. 

For example: 

_Romain (an equity investor) diversifies his equity portfolio and reduces his overall portfolio risk by investing in technology, tourism and agricultural stocks. Specifically in each industry, he invests in a few companies, rather than one, to reduce his exposure to a single company._

_Euri (a macroeconomic investor) diversifies her portfolio and overall risk by investing in different countries. In the case that one country faces negative returns, her portfolio won’t be as heavily affected because she has investments in other countries which have positive returns._

Essentially, by not putting all your eggs in one basket, your wins are able to offset your losses, reducing your overall loss and portfolio risk. 



What is risk? 

## Where are you now and where do you want to be in the future? 

Before anyone starts investing, they must ask themselves the following questions:

- How much money do I have and how much can I invest?

Firstly, you must understand your financial situation. Based on the amount of money you make, you must first allocate money to cover all your expenses and then only invest money you can afford to lose. 

- How important is my investment money to me?

Would you be in a tough position if you lost all your investment money? If that is the case then reduce the amount of money you invest and vice versa if you realize that you have more money to take a risk with. 

- Based on my risk tolerance, what should I invest in? 

Now that you understand how much money you have and are willing to invest, you must decide what you are investing in, based on your risk tolerance and preference. If you’re looking at higher risk investments because you want to earn a higher/faster return, then look at equities and cryptocurrencies. On the other hand, if you’re looking at safer investments, look at fixed income bonds or commodities. 

- How much time do I want to put into investing?

Based on the amount of time you are willing to put into your investments, your investing style will be different. If someone is able to put in 8 hours a day into their investments, they’re better off trading volatile assets to get the most amount of return in a day. If someone is only able to trade once in a few days, it might be better to put your money into long term investments (like blue chip stocks or ETFs). Both strategies entail risk, but the first requires more time to mitigate the risk. 

- How much time do I have left to invest?

Knowing how much time you have left to invest (planning for retirement or investing as a hobby) would result in different investment horizons. Someone with not much time left to invest would have a shorter investment horizon because they are trying to make as many trades as possible. Someone who is just starting would be happy to hold an investment for 6 months because they have a lot of time ahead of them to invest in other securities. 

- What is your goal?

No one can invest without a goal in mind. Are you investing to make a few quick bucks or are you here for the long haul? This will be the basis of all your investing decisions. 

### And a few tips

**Start small**: There’s always time to increase your size, and even small positions can be exciting

**Find your style**: Roaring Kitty likes value investing, other people like technical analysis. Test ideas of different nature and see how you relate to them

Tips before you start investing

Starting from the basics

- Holding equity in a company implies part ownership in the organization and its assets 
- Shares are priced based on the intrinsic value of the company divided by the number of shares outstanding 
- Income is generated through capital or dividend gains (if applicable) 
- Shareholders receive the residual value of a company, in the case of a bankruptcy 
- Different stocks carry different risk-return characteristics



Overview of equity

Whether investing in preferred or common stock, these are a few categories of stocks based on their characteristics.

1. Growth stocks - stocks which have faster earnings growth than the market average. Such stocks are risky, because they are frequently startups in the early stages of the business cycle, such as technology companies. However, they provide the potential for high earnings/capital growth.
2. Income stocks - known for consistently paying investors dividends and generally are stable companies such as utility providers. 
3. Value stocks - characterized by having low valuation measures such as price-to-earnings (PE) ratio, these stocks can be growth or income stocks too. Their low PE ratio reflects that they are currently cheap, compared to stocks with a higher PE, and investors buy such stocks in hope that the market will correct and the price will go up. 
4. Blue chip stocks - shares from large, established companies with a solid track record of growth, often paying dividends too (Amazon). 

Types of stocks 

## TL;DR

- A stock market index covers the entire market or a section of the stock market
- The Wilshire 5000 index covers the entire US stock market
- Sector indexes cover specific sectors of the economy
- Indexes are used to measure performance of the market or compare portfolio performance against a benchmark. 

An equity index or a stock market index, is an indicator for the performance of the stock market, or a specific subset. For example, the largest equities in the US stock market are covered and measured by the performance of the S&P 500. 

On the larger end, the Wilshire 5000 index covers the “entire stock market” because it includes all publicly traded companies headquartered in the US. This index can be used to measure the performance of the US stock market. 

On the more specific side, you can find an index which covers a specific sector of assets. For example, the S&P Technology Select Sector is an index which covers all the technology companies covered in the S&P 500 index. Furthermore, additional indexes cover specific sectors of the economy.

These indexes are used as measures to track the performance of the overall economy or a specific sector. However, indexes can also be used by investors to test the performance of their portfolio against a benchmark. E.g. If RJ's portfolio is lagging behind the performance of the S&P 500 index, this is an indicator for him to rebalance and reposition himself. 

Understanding equity indices

## Initial Public Offerings

Every public company in the world started somewhere: whether it was in a garage like Apple or a basement like Amazon, every company started as private. In order for the company to grow into the size it is today, a major step in the process is going public. This involves offering shares/equity/part ownership to the public in exchange for funds. The process of issuing shares to the public in exchange for funding is done through an Initial Public Offering (IPO). Companies must follow regulations set forth by the Securities and Exchange Commission (SEC) as once a company goes public, its walls and information become transparent. Prior to an IPO, an investment bank is hired to gauge demand for the company’s shares and decide on its listing price. An IPO is especially important for its founding members and investors as it can be an exit strategy to gain profit from their initial investment. 

However, before a company goes public, it must assess whether it is mature enough to handle SEC regulations and the responsibility to public shareholders. Any private company with strong fundamentals and profitability potential can qualify for an IPO as long as it’s ready to cover the cost, risk and financial disclosures. The largest IPO in the world belongs to Alibaba, which went public in 2014 and was valued at $21 BILLION. 

## Benefits and Drawbacks of IPOs

An IPO’s primary benefit to any company is the amount of funds generated from the sale of shares to the public. Additionally, an IPO increases the company’s exposure publicly, which can help drive revenue. Lastly, the required transparency for an IPO, allows companies to gain a favorable image and improve their credit ratings.

However, this can also be a drawback. With the extra transparency, time and effort must be put in to disclose all necessary information. This can cause issues if the disclosed information is false in any way. Additionally, the price of the company’s shares are constantly on everyone’s mind (since they get compensated with stock options) and this can distract employees from achieving real results. Lastly, the benefit from going public must outweigh the costs, as the costs of going public are high. 

SPAC: Another way for a company to go public is through a Special Purpose Acquisition Company. Such a company has no commercial operations, it’s only responsibility is to raise capital through an IPO with the purpose of acquiring a private company. These companies are also known as blank check companies. For example, Holicity, a blank check company, had agreed to take Astra Space public through a SPAC deal. This way, Holicity went public, raising money from public investors, and then reverse-merged into Astra Space, contributing all that money to Astra. As a result, Astra became Holicity in the stock market. SPACs usually have 2 years to complete their acquisition or else money will be returned to investors.

*Disclaimer: the author of this article owns shares of Astra Space 

Initial Public Offering (IPO)

## Stock Split

If a company wants to issue more shares but all its shares outstanding are owned, it can initiate a stock split. This is a decision taken by the company’s board of directors to increase the number of shares held by investors and in the stock market. For example, if a 2-for-1 stock split occurs, each investor with one share will receive an additional share at no additional cost. You might think what a steal? Well, not really. If a 2-for-1 stock split occurs, the price of the stock is also halved. As a result, there is no change in the market value of the company, there are only additional shares trading in the market. 

The primary objective of a stock split is to decrease the price of shares and make shares of the company more attractive to smaller investors. This increases liquidity and makes the company’s share price match other competitors in the industry. The reduced price per share can cause demand for the stock to increase, as this stock now looks relatively cheaper compared to before the stock split. 

## Reverse Stock Split

A stock split helps a company with a high share price decrease its price to make it look more attractive and a reverse stock split does the opposite. This allows companies with a low share price to increase their price, to avoid being delisted or seen as invaluable on the stock market. For example, in a reverse stock split of 1-for-3, 9 million outstanding shares at $0.50 each would become 3 million shares outstanding at $1.50 each. Similar to a stock split, the market value of companies remains unchanged. 

Stock split

Imagine a friend is coming over so you decide to order a large pizza and split it in half. However, another friend crashes the party and now 3 of you are sharing the pizza. Each person still gets pizza except the amount they get per person decreases.

You can think of shares in the same way. A stock dilution occurs when a company issues or creates new shares, causing the original shareholders percentage of ownership in the company to reduce. For any given value of a company, if you add one more share then there’s one more person “eating the pizza”. This negative impact on the value of a slice or share of a company is called dilution. 

The primary reason why a company would choose to dilute its shares would be to raise additional capital. Even though this move affects the current shareholders, it provides the company with the potential for higher profit, growth and eventually increasing the value of its stock. 

Unlike stock splits where the price of the share is adjusted to reflect the same percentage ownership, a stock dilution does affect the percentage of ownership a shareholder has in a company.  

For example: if company LMNO issues 100 shares to 100 shareholders, each shareholder has a 1% claim to the company. However, if LMNO were to issue 100 new shares to 100 different shareholders, this would result in stock dilution, causing each shareholder to only have 0.5% claim to the company. This would also have a negative effect on voting rights since each shareholder now has a smaller claim to the company, its assets and decisions. 

Stock dilution

There are different ways to value an equity security - some are straightforward while others require more work. One can easily be overwhelmed by the number of valuation methods but you can split them into 2 categories: absolute valuation and relative valuation. 

## Absolute Valuation

Absolute valuation aims to calculate the “intrinsic value” of a company based on projections and assumptions about the future performance of a company. This method looks at company fundamentals, such as dividends, growth rate and cash flow, to determine the true value of a company. However, a company does not always trade around its intrinsic value due to factors like momentum and macroeconomics. For example, AliBaba, one of the world’s largest online commerce companies, is fundamentally valued at a much higher price than the share price it is currently trading at. This is because the company is facing pressure from the government and this causes uncertainty about the future performance of the company. 

### Methods:

Dividend discount model - the price of a stock is equal to the next year’s dividend divided by the difference between the cost of equity and constant growth rate. 

Discounted cash flow - calculates the sum of the present value of all expected future cash flows, discounted at the weighted average cost of capital to determine the enterprise value of a company and eventually its stock price. 

Residual income model - the price of a stock is equal to the present value of future residual flows discounted at the cost of equity. 

Asset-based model - calculates the net asset value of a company based on the difference between the market value of its assets and liabilities. 

## Relative Valuation

As the title says, these methods value a company based on the valuation of similar companies in the same industry. This involves calculating ratios and multiples for several companies and then comparing them to each other. An example of a ratio is the price-to-earnings ratio(P/E) which measures its current share price relative to the earnings per share (EPS). For example, Ford’s P/E ratio is 16.00 but General Motors P/E ratio is only 5.91. This indicates that General Motors, relative to Ford Motor Company, is undervalued. This method of comparing ratios is much quicker and easier than any of the absolute valuation methods. 

When analyzing an equity, the best way to start is by seeing the relative valuation of your company versus its comparables. If you want to take it step further, then use an absolute valuation method to estimate the intrinsic value and share price of your company. 

Valuing equity securities

Before you get into trading, you need to understand the basics. This includes concepts and frequently used terminology in the equities market. You can’t call yourself a true “trader” till you speak the lingo. 

**Beta** - measure of a stock’s volatility relative to the overall market. A large equity index, like the S&P 500, is used as a benchmark and given a Beta value of 1.0. Therefore the Beta value of a stock is a relative measure to the movement of the overall market. If a stock has a higher volatility than the overall market, its Beta value will be greater than 1. If the stock swings less than the market does, its Beta value will be less than 1. Stocks with a high Beta value carry higher risk, but also the potential for a higher return, and vice versa for stocks with a lower Beta value. 

**Shares outstanding** - refers to the total number of shares issued by a company when they went public, including restricted shares (shares that cannot be publicly traded). This value can change if the company chooses to repurchase shares or or sell additional shares. Additionally, if the company has issued any stock options, this number can change in the future too. 

**Volume** - refers to the number of shares or contracts traded for a specific security during market open hours. This measure is used in all the different markets for different asset classes. This is a good measure of an asset’s trading activity and hence liquidity during market hours. 

**Market Capitalization** - refers to the total monetary value of a company’s shares, calculated as number of outstanding shares * per share market price. Essentially, market cap explains the market value of a company. It is also used to describe the size of a public company, relative to other publicly traded companies. Companies can be segmented into the following categories based on their market capitalization: small-cap ($300M - $2B), medium-cap ($2B - $10B), large-cap ($10B - $300B) and mega-cap ($300B and more). Examples of mega-cap companies include Amazon and Apple. 

**Range** - market prices fluctuate throughout the day, month and year. One way to observe price volatility is through the range, either daily or 52 week range (price movement over the last year). The range is calculated for different horizons by taking that specific horizon’s high minus the low. The low price is called the support price and the high price is called the resistance level because if either price is hit, this will cause a large move in the price, down or up. One type of investing (range-bound trading) focuses on trading a security between a defined range over time. 

**Earnings date** - scheduled date for the company to announce quarterly earnings. The markets react based on if earnings expectations will be met, beat or missed. 

Equity due diligence

Stock and Equity

## TL;DR

- How much do you want to invest? 
- Which brokerage do you want to open an account with?
- What are you investing in?
- What is your investment style? 

## How do I start?

Now that you’ve decided to start investing, the first thing you need to do is decide how much to invest. If you’re earning a monthly salary, how much do you want to allocate to your investments every month? If your employer offers to match your 401(k), how much will you contribute? Consider your investment horizon and goal, then walk backwards to calculate how much to invest monthly or annually. As a rule of thumb, you should invest at least 10% of your annual income. 

After you’ve allocated your funds, it’s time to open an investment account. There are a lot of different brokerages which you can use but you should consider the best one for your needs. If you’re starting from scratch, Robinhood might be a good place to start because of its easy user interface. If you’re more experienced, then Interactive Brokers might be the correct brokerage for you. It really depends on you. Make sure to research the brokerage’s fee structure. Once you’ve decided your brokerage, set up an account and connect your bank account to the platform. 

Now you have a brokerage account with some money - this is where the fun starts. It’s time to choose what you want to invest in. Based on your risk profile and characteristics, choose investments which you are comfortable and passionate about. Once you know what you want to invest in, you have to think about your investing style. If you’re investing for the long term, then accumulate a good amount of investments. But if you’re investing for a short time, the maximum time you’ll hold an investment may be 1 month. Again, it really depends on you. 

Once you are able to answer all the above questions, you’re ready to dive into the exciting world of investing. 

Starting to trade

## TL;DR

- Different investors have different styles of trading
- Long term investors prefer passive trading while swing traders prefer active trading 
- Both strategies have their own advantages and disadvantages

## Passive Trading

A strategy used by investors who believe that returns are positive in the long run and seek to stay invested throughout the years. 

This involves buying and holding assets over long investment horizons with minimal trading. An example of a passive investment strategy is indexing, where an investor purchases an index linked to a benchmark (like the S&P 500) and holds it for a while. 

With less frequent trading, passive investing is a cheaper strategy because of fewer fees and less time commitment. As previously mentioned, your characteristics should determine the type of investor you can be and for someone with not so much time, passive investing is a great strategy to build their wealth. This strategy also provides better after-tax results as investments held for longer periods of time are taxed less than ones held over a short term. 

## Active Trading

On the other hand, active investing involves frequent trades and more time commitment. 

Active investors continuously buy and sell assets in hopes to exploit as many profitable trade opportunities. Since these investors are looking at short term profits, their analysis revolves around price movements and finding arbitrage opportunities. 

The benefit of constant rebalancing is that your portfolio stays up to date with current market conditions and hence risk may be lower. However, with so many trades occurring, fees to maintain these orders are high and lots of brokerages require high initial investment to allow active trades. For example, Robinhood requires investors to have at least $25,000 in their trading account to trade the same security more than once in a day. 

Passive vs active investing

**Market order** - an order to buy or sell shares at the market’s current trading price. This kind of order usually ensures execution, but the price is not guaranteed. For example, a trader may get his/her order executed, but pay a few cents more per share than what was reported when the trade was executed. This kind of order is appropriate when an investor wants to execute a trade immediately, no matter the small difference in cents of the share price. Market orders can only be placed during market hours. If a market order is placed after markets are closed, it will only execute when the market opens next, which will result in the share price being different from the previous day’s market close price. 

**Limit order** - an order to buy or sell shares with a limit on the maximum price an investor is willing to pay or the minimum price a seller is willing to accept (“limit price”). When buying a share, an order could be executed below the limit price and for a seller, the order could be executed above the limit price. For the order to be filled, the investor must input the specific number of shares and the price. However, there is no guarantee of execution. For example, if the stock reaches your inputted limit price, your order may not be filled if orders ahead of yours limit the availability of shares at the limit price. Thus, orders are executed on a first come, first served basis. A limit order is appropriate when an investor believes they can enter a position at a price lower than - or exit a position at a price higher than - the current market price. 

**Stop order** - an order to buy or sell shares at a specified price once the share has traded at or through the stop price. First, the investor must input the order with the amount of shares and the stop price. If the share reaches the stop price, the order becomes a market order and gets executed at the next available market price. If the share does not reach the stop price, then the order is not executed. Sometimes referred to as a “stop-loss,” this kind of order protects an investor’s unrealized gains or minimizes their potential losses. After entering a position, an investor can choose to put a stop loss above the market price (to protect their gains) or a stop loss under the market price (to minimize their losses). By doing this, an investor protects their position and reduces their volatility risk (explained later). 

**Pop Quiz!**

Kate works at a jewelry company and trades TSLA shares on the side. She wants to enter an order that will allow her to exit her position without needing to constantly look at her brokerage account. What order is most appropriate? 

1. Stop order
2. Limit order
3. Market order 

_Answer: Kate would want to input stop losses on her position so that her brokerage account can automatically exit her TSLA position once she makes an unrealized gain or to minimize her losses should the share price crash._ 


Trading orders

Trading

Constructing portfolios is fun. Your portfolio expresses your investing views, your beliefs and even your ethical views.

- Maybe you believe tech stocks will continue to revolutionize the world and want a heavy exposure to them.
- Or you really care about certain sustainability goals and only want to invest in companies that help further those goals.
- Maybe you are working towards FIRE and seek income-producing assets. 
- Or you are an active option trader, and your portfolio is a high-risk/high-gain basket of call and put options
- Whatever is your style, portfolio construction helps you express who you are through a basket of assets.

## Here are 4 steps to building and maintaining a successful portfolio:

1. Decide how much you are investing
2. Selecting in what you wish to invest 
3. Determining how to allocate your capital
4. Maintenance


### Decide how much you are investing

The first step of building any portfolio is to understand how much capital you want to invest, and why you are investing.

On the one hand of the spectrum, if you’re investing for the long run you will probably add to your capital a portion of your savings each month, and invest in a balanced portfolio.

On the other hand, you might decide to invest a portion of your assets that you can afford to lose in high risk / high return assets - knowing you could lose it all.	

Choosing how much money to invest depends on your investment profile (your age, income, investment goals), which also has an effect on your risk tolerance. 

In terms of character, an investor who aims to earn an income versus an investor who trades as a hobby would have very different risk appetites and hence, asset allocations. The former would look at lower risk-lower return assets (like bonds and exchange traded funds) while the latter, investing as a hobby, would be willing to invest in high risk-high return assets (like equities and cryptocurrencies). Therefore one must carefully study their present situation and future financial goals before investing their money. 

### Selecting in what you wish to invest 

Based on an investor’s strategy, their choice of assets and capital allocation will look different. Different assets carry different amounts of risk: assets like bonds carry less risk than equities, because of their hierarchy in the repayment line, if a bankruptcy were to occur. Additionally, a lot of bonds are backed by the guarantee of governments and large corporations. 

You can further break down asset classes into different subclasses, based on their different risk and return profiles. For example, equities can be classified based on different industries (which carry different risk) and bonds can be classified based on time horizon (short term vs long term). Remember to analyze the different factors (risk-return profiles) before allocating capital to assets. 

### Deciding how to allocate your capital 

An asset’s weight in the portfolio is defined by the amount of capital invested in a specific asset divided by the total amount of capital invested. 

The choice of portfolio weights is one of the major decisions in portfolio construction. And it is not a one-off action: over time these weights will have to be reassessed and rebalanced due to changes in the investing environment as well as in your future financial goals or risk appetite. 

For example, a salary promotion or an inheritance might provide you with a cushion and decrease your risk aversion , motivating you to increase allocation in stocks for the long term. 

Rebalancing simply means bringing the weights of the portfolio in line with your desired levels. 

### Maintenance

Once you’ve decided which asset classes to rebalance, it’s time to dive into the asset classes and decide which specific assets to rebalance. As mentioned before, asset classes are divided into subclasses, which hold different risk-return characteristics. If you choose to reduce your risk exposure in equities, maybe you choose to reduce your allocation in pharmaceutical companies and increase your allocation in high-dividend paying utilities. In terms of bonds, you may switch between corporate bonds and government bonds for more financial security. 

How to construct a portfolio

## How can you mitigate risk? 

Question time: if you put together a portfolio with 2 stocks, each with a volatility of 20%, what’s the average volatility of your portfolio?

_Answer: the vol of the portfolio will be lower than 20%. This is because using two stocks brings diversification to the portfolio. Maybe when one is dropping, the other rallies and therefore the mix of the two is less risky than each separately_

This is the core of how diversification works. Read more about it here.

## What is diversification in portfolio management? (aka not putting all your eggs in one basket) 

One of the ways to reduce your exposure to the different risks in the market is by diversifying your portfolio, so that you are not heavily affected by one industry or company. Not only can you diversify your equities by investing in different markets, but you can diversify your entire portfolio by investing in different asset classes. By doing this, you reduce your overall portfolio risk. For example, many investors hold commodities in their portfolios as these assets are hedged against inflation. 

For example: 

_Romain (an equity investor) diversifies his equity portfolio and reduces his overall portfolio risk by investing in technology, tourism and agricultural stocks. Specifically in each industry, he invests in a few companies, rather than one, to reduce his exposure to a single company._

_Euri (a macroeconomic investor) diversifies her portfolio and overall risk by investing in different countries. In the case that one country faces negative returns, her portfolio won’t be as heavily affected because she has investments in other countries which have positive returns._

Essentially, by not putting all your eggs in one basket, your wins are able to offset your losses, reducing your overall loss and portfolio risk. 

Diversification

## TL;DR

- Monitor your portfolio performance
- Pay attention to risk and rebalance if necessary
- Regularly invest
- Focus on your financial goals 

## How to manage your portfolio? 

### Monitor your portfolio performance

Apps like robinhood, through notifications, encourage investors to constantly monitor their portfolios and worry about short term results. However, this is wrong. It’s okay to check on your portfolio performance sometimes but focusing on the short-term results will lead you to make irrational decisions. For example, during the Great Recession, a large market selloff occurred and a lot of investors thought they were smart by exiting their position before losing anymore money. However, the investors who held onto their positions, regained all their losses and made profit. Financial loss may be painful but it is only temporary. 

Rather than comparing your portfolio performance to someone else’s, compare your performance to major benchmarks like the S&P 500 or Nasdaq, to understand how your portfolio compares to the overall market performance. If you find that your portfolio is constantly lagging behind its benchmark, then it’s time to invest in other securities. The best way to do this is through diversification. 

### Pay attention to risk and rebalance, if necessary	

Let’s say you wanted to invest 50% of your capital in stocks and 50% in bonds but your equity assets yielded a much higher return than your fixed income assets this year. As a result of this, your exposure to equities increases because the market value of your equities is now greater than the market value of your fixed assets. To return back to your 50/50 asset allocation, you would either have to buy more bonds or move some money from your equities to your fixed asset. If you fail to rebalance, you could find your portfolio risk skyrocket and stray away from your risk tolerance. 

In addition to this, global events have a large impact on your portfolio. For example, during the COVID-19 pandemic, we saw a dramatic fall in equity ownership as investors moved their money into fixed income securities and commodities. This was because the future was unknown, the economy was unstable and investors wanted to make sure their money didn’t vanish. As lockdowns eased and vaccinations accelerated, the equity market started to boom, eventually reaching an all time high in Aug 2020. Hence, you must rebalance your portfolio as the environment and your risk tolerance changes.

### Regularly invest

Morgan Housel wrote in “The Psychology of Money” that Warren Buffet’s skill was investing but his secret was time. He had started investing as a young man, building up his portfolio from the first chance he got. Making small regular investments is the best way of meeting a big financial goal. The sooner you start investing, the more time your investments will get to grow and the more experience you will develop. The more you learn, the more return you potentially earn. 

One of the benefits of regularly investing is dollar cost averaging. By regularly purchasing shares, the variety of prices at which they have been bought, will cause the average cost of shares to decrease. Note: always buy more shares when the market price is lower than your average cost as this will bring down your average cost further and increase your holding value. For example, buying 100 shares at $100 and then 100 shares at $80 will cause the average cost of your 200 shares to be $90. 

### Focus on your financial goals 

At the end of the day, the objective of investing is to meet your financial goals: generating passive income, saving for college or retirement. The beauty of investing is being able to take your financial goals into your own hands. If you need to save up for college/retirement and you only have a limited amount of time, invest in riskier assets in hopes of gaining a higher return. However, if you’ve started investing early, then balance your portfolio in terms of asset allocation. At the end of the day, your portfolio should reflect your financial goals and characteristics. 

Managing your portfolio

Investing

## TL:DR

- A stock represents part ownership in a company 
- It carries two fundamental rights: the right to dividends, and the right to vote
- Shares can be traded on public exchanges or privately. 
- Why buy stock: capital appreciation, dividends (if applicable) and shareholder rights
- Types of shares: common shares and preferred shares
- Large potential for capital appreciation but high risk present too 


## What is a stock? 

A stock is a financial security that represents part ownership of a company. 
ALT: A stock represents part ownership of a company, and is also known as a financial security.

This gives the holder of the stock the right to own a certain amount of a company’s assets and profits, based on the number of “shares” they own. The owner of a share is called a shareholder and his/her ownership depends on the number of shares they own versus the total number of company shares (aka shares outstanding). 

For example: _Giuseppe owns 1,000 shares of Amazon stock. Amazon has a total of 50,000 shares outstanding. That means Giuseppe owns and has a 2.0% (1,000/50,000 * 100) claim to the company’s assets and earnings. 
_

All publicly traded company shares are transacted on exchanges like NYSE and Nasdaq, but private companies can only sell shares privately to individual investors. Companies issue shares in order to raise funds to operate and maintain the business. There are two types of shares: common and preferred shares. 

The transactions must follow regulations set forth by the SEC in order to protect investors buying private shares (which can be risky). Historically, stocks have outperformed all other asset classes over the long run. 

## Why do people buy stocks?

There are 3 reasons why an investor buys stocks: 

- Capital appreciation: growth of investment amount as the price of a stock rises
- Dividends: some companies directly pay their shareholders a portion of its earnings 
- Rights: by holding a company’s stock, some shareholders can vote and have an influence on company decisions

## Why does a company issue stock?

The main reason a company issues stock to the public is to raise money to fund operations. This includes activities like paying off debt, supporting research & development projects to grow the business or simply maintaining business operations. 

Money raised from selling shares on the public market is called equity. A company’s market value of equity (total amount of equity) is equal to the number of shares outstanding * current stock price. Major companies are funded through equity and debt (explained later). 

## What kind of stocks can you invest in?

The two main types of stocks are, common stock and preferred stock.

Common stock: most common form of equity ownership which gives the owner the right to vote at shareholder meetings and receive dividends if they are offered. 

Preferred stock: alternative form of equity ownership where the owner does not have voting rights, but has preference over common stockholders in order of receiving dividend payments and repayment if the company goes bankrupt. 

## Advantages and disadvantages of trading stocks: 

Stocks provide investors with an opportunity for large capital appreciation. As mentioned above, stocks have outperformed all other asset classes over the long term. However, in the shorter term, stock prices move down as well. 

If a company goes bankrupt and all its assets are liquidated, common shareholders (the most common form of stockholders) are last in line to receive any repayment. The hierarchy of repayment in such a situation starts with bond holders, preferred shareholders and then common shareholders are left with residual value. Hence, common shareholders are at the highest risk of losing most/all of their investment. 

If a company is not bankrupt and faced with negative information (like missing earnings expectations, strict government regulation, bad press), this will result in the price of the stock going down. As a result, common shareholders will be in a loss, if the market price crosses their average cost. 

This risk can be managed through investing in different stocks, so that the correlation of your assets is lower. Essentially, if one stock price goes down due to bad information, the other stocks in your portfolio will not be affected (if the news is on a micro scale). This will be explained further in the “diversification” article. 



## TL;DR

- Instrument used to track a basket of securities covering the overall market or a specific industry 
- Popular broad equity-based indexes: S&P500, Dow Jones Industrial Average, Nasdaq Composite 

## What is an index? 

An index is used to measure the performance of a basket of securities, mimicking the performance of an entire market or a specific industry. For example, the Standards and Poors 500 (S&P500) index is used to measure the performance of the US equities market as it encompasses all the largest capitalization assets trading on the US market. Indexes are used as a benchmark for investors to track how their portfolio performs in comparison to the overall market. 

A popular investment strategy called “indexing” involves an investor replicating an index (like the S&P) so that they don’t have to constantly monitor their investments and try to outperform the market. An investor may also replicate the performance of the overall bond market by investing in bonds similar to those in the Bloomberg Barclays US Aggregate Bond Index. Through indexing, portfolio management is minimal but returns are also smaller over the short term. 



What is an equity index? 

## TL;DR

- Fixed Income refers to fixed income encompasses securities that pay a fixed amount of interest at a fixed time - such as government and corporate bonds, and includes the broad class of interest-bearing securities like swaps
- Fixed Income instruments provide known future cash flows at a specific date (maturity). 
- Such investments are less risky but also provide a lower return

## What is Fixed Income? 

As the term says, fixed income encompasses securities that pay a fixed amount of interest at a fixed time to an investor/holder of a fixed income security. The investment horizon of a fixed income security is called “time to maturity” and at maturity, investors are repaid their entire initial investment, in addition to the interest they received on the initial investment. Unlike equity, where the future payments are unknown, fixed income securities provide a steady flow of fixed cash flows based on interest rates or dividends, which are both known in advance. 

In the event of a bankruptcy, fixed income investors receive priority over common stockholders for repayment. Hence, investing in fixed income securities are less risky but provide a lower return than equity investments. The most common types of fixed incomes securities are government and corporate bonds. 

## What is a Bond? 

Similar to how a company introduces equity to aid their business operations, companies and governments issue debt securities to finance operations. A bond is a debt security and type of fixed income security that pays the holder their initial investment amount, with interest, on the maturity date. 

_Example: Armenak buys a corporate bond from ABZ Bank. They issue a $10,000 bond with a 10 year maturity at 5% “coupon rate.” So Armenak must first pay the bank $10,000 to buy the bond. After that, he will be paid interest payments overtime (aka coupon payments), on an annual basis and calculated like this: $10,000 * 5% = $500 every year for 10 years. At the maturity date, Armenak will receive his initial $10,000 investment. Therefore, in total, Armenak would have made $5,000 from 10 yearly coupon payments of $500 each and the repayment of his initial investment._

Seeing as the above mentioned example is in regards to a corporate bond, Armenak received a higher coupon rate than if he would have bought a government issue bond. This is because a corporate bond entails some risk and therefore investors must be compensated extra for that additional risk. On the other hand, a government bond is backed by the guarantee of repayment by the government (pretty credible source right). 

On top of the difference in cash flows, another difference between a bond and stock is that a bond does not entail any form of ownership in the parent company. 

What is fixed income?

## TL;DR

- Currencies are...well, just that: cash, for any given country
- FX refers to the exchange rate between two currencies, like EUR vs USD
- The currency market (aka foreign exchange) is known as the largest and most liquid financial market in the world.
- Foreign exchange markets run 24 hours a day 

## What is currency and FX? 

A currency is the official means of payment in a country (USD in the United States) and the currency market entails the exchange of global currencies. Each currency has an exchange rate: its value relative to another currency. For example: the current exchange rate between the Indian rupee and the US dollar is 0.014. That means 1 Indian Rupee is the equivalent of 0.014 USD. The USD is the most commonly used benchmark currency, so the majority of currencies around the world are quoted against the US Dollar. 

FX refers to the foreign exchange market, a global over-the-counter market for trading global currencies. If you want to take a trip to India from the US, you must exchange USD to INR through a currency house which will buy your USD and give you INR, based on the currency exchange rate. Now if you scale this into the millions of other transactions occurring at the same time, you’ll understand why the daily volume for forex is in the TRILLIONS - facilitating global trade and business. 

An investor can gain a profit through the forex trade by making the difference between currency interest rates in different economies. An investor can buy the currency with the higher interest rate and short the currency with the lower interest rate. 

What are currencies? 

## TL;DR

- Type of security that tracks another asset but can be traded on stock exchanges
- ETFs can contain one asset or thousands of assets from different industries
- Good source of diversification - low risk, lower return
- Thematic ETFS are popular today 

## What is an ETF?

An Exchange Traded Fund (ETF) is a security that tracks another asset (index, commodity, industry) and can be traded on the stock exchange like any public equity. ETFs can track individual commodities (like gold or timber) but also a large collection of securities (space exploration stocks). Since an ETF has more than one underlying asset, it can be a good source of diversification as an ETF can include hundreds to thousands of stocks. As a result, ETFs have lower risk and a lower expected return. 

A well known ETF is the SPDR S&P 500 ETF which tracks the performance of the S&P 500. Not only can an ETF include commodities and stocks, but also bonds, real estate or other investment securities. Its defining factor is that an ETF can easily trade on a stock exchange since it is a marketable security; hence affected by price fluctuations everyday.  

## Thematic ETFs

Today, a lot of the ETFs trading on American stock exchanges are thematic ETFs: focused on a specific industry or trend. As a result, an investor does not need to do any due diligence and is simplifying buying a trend. By buying one share of an ETF, you are taking a stake in all the companies in the fund and gaining exposure to the overall theme. For example, Cathie Wood’s ARK fund released a lot of thematic ETFs based on a trend such as ARKX. ARKX is a thematic ETF focused on growing space exploration companies like Trimble and Lockheed Martin. As an investor, by owning one share of ARKX, you are fractionally exposed to all the companies in the fund. 

## Benefits and Drawbacks 

The benefit of being exposed to so many companies by purchasing 1 share allows investors to face lower average costs, since they only need to execute one transaction to increase/reduce their exposure to so many companies. Compared to individually investing in each company in the ETF, with only one trade, brokerage fees are also fewer. 

However, the above benefit is valid if an ETF is not being as frequently rebalanced. In the case that you invest in actively managed ETFS, fees are much higher as more trades occur. Additionally, if a thematic ETF is focused on one industry like space exploration, diversification is not as great compared to investing in different asset classes. Lastly, liquidity for ETFs are not as high as common stock since they are less frequently traded. 

What is an ETF?

## TL;DR

- Type of contract that gives the holder the right, but not obligation, to transact an asset in the future at a specified price and time. 
- Types of options: calls and puts 

## What is an option? 

An option is a contract between two parties.

This contract gives the holder the right to buy and sell an asset at a specific price by a specific date. Each contract consists of 100 shares of the underlying asset. However, the holder of the contract is not obligated to exercise their contract but has the right to whenever after they purchase the contract. The date chosen for the contract is the expiration date before the option gets exercised and the chosen price is the price you plan to exercise your contract at. Since options grant holders the right to transact but not obligation to trade their contracts, they must pay a premium for these rights. Based on the risk connected with your specific expiration date and strike price, the premium will fluctuate. As the price of a contract goes up or down, so does the premium associated with the contract. There are 2 types of options: calls and puts. However, there are different types of option orders which can be made. Let’s break down the basics first. 

## Calls

If you think the price of an asset is going to rise, you would bet on the price going up and buy a call option. This allows the holder to buy that asset at the stated price by a specific date. For example: Lei is confident that NIO shares will skyrocket as the company increases its global presence. If the stock is currently trading at $38.70, Lei believes that the asset could go higher by the end of the year. He therefore buys 1 $40 call expiring by the end of 2021. With this contract, Lei has bought the right to buy 100 shares of NIO at $40 each before the end of 2021. If the price of NIO skyrockets past $40 before the end of the year, Lei’s option contract will be “in the money:” he can either choose to sell his option and make the difference in the premium amount or he can exercise the option, buy 100 shares of NIO at $40 and make the difference between the trading and strike price. 

## Puts

If you think the price of an asset is going to fall, you would bet on the price going down and buy a put option. Similar to a call option, a put option is bought with a strike price and expiration date in mind. However, unlike a call option, a put option gives the holder the right to sell shares of an asset. Just like Lei chose a strike price higher than the current trading price because he was bullish about the asset, he would do the opposite with a put option. For example: if NIO was currently trading at $38.70 and Lei was bearish about NIO, he would buy a put option for $35 for the end of the year. The only way he makes money is if NIO’s price starts to decrease towards $35 and he either sells the contract to make the difference in the premium or he exercises it and makes the difference between the trading and strike price. Options “in the money” have strike prices lower than the current trading price. 

## Benefits and Drawbacks 

Since options can be thought of as contracts rather than securities, an option holder does not actually own the asset. The advantage of this is that the cost of owning an option contract (100 shares) is much cheaper than actually buying 100 shares. This is because the only cost for buying an option contract is the premium amount. As a result, risk is much lower since you are paying less and therefore your potential losses are also lower. Lastly, combining options can create a strategic position for an investor who is able to hedge their positions. For example, an investor can buy both a call option and put option, to hedge their risk, in case the asset price moves in an unexpected direction. 

Compared to trading common shares, options are traded less frequently and tougher for investors to enter/exit positions quickly. In addition to this, not all stocks listed on public markets have option contracts. Some brokerages also require higher commission fees to trade options. Lastly, due to time decay, the value of your option premium will decrease everyday no matter the movement of the underlying asset. Therefore, trading options can be extremely profitable but requires experience to avoid large losses. 

What are options? 

## TL;DR

- Cryptocurrencies are a type of digital currency, originally created with the goal of buying and selling goods, and ultimately replace real currencies. 
- Cryptos work with the help of blockchain technology. 

## What is a cryptocurrency? 

You can think of a cryptocurrency as a virtual currency which can be used to buy and sell goods, and which carries a unique feature: a long list of ALL transactions ever made with that coin. . 

This feature is implemented through the eponymous blockchain, which is a digital public ledger of transactions that is very difficult to hack - because everybody keeps a copy of it. 

This allows users to securely transact with one another - and in peer-to-peer fashion, this limits the interference of the government, banks or any other third party. The major appeal of digital currencies is that it is anonymous and independent of oversight.

Example; _when you go to a theme park, you pay for a special currency that can only be used for goods and services within the theme park._ Similarly with cryptocurrencies, you’ll need to use real currency to purchase cryptos like Bitcoin, which are then used to access relevant goods and services, like non-fungible tokens. At its peak, the total value of all cryptocurrencies in the market was approximately $2.2 TRILLION. 

## Benefits and Drawbacks

Crypto currencies remove central banks from the picture. By doing this, the supply and value of the token is not modified in times of stress and hence, cryptos are hedged against inflation. In theory makes cryptocurrencies the perfect asset for diversification since it has little to no correlation with the USD - albeit in practice speculative trading adds back some correlation to traditional currencies and equity markets.

The technology behind crypto currencies is also highly complex and makes blockchains more secure than traditional payment systems. 

With anonymity, comes the risk of money laundering. Crypto currencies are frequently used for black market activity since they are unregulated. For example, the Silk Road on the dark web (the amazon for narcotics) only allows transactions with bitcoin so that no transaction can be traced by law enforcement. As a result, cryptocurrencies face regulatory challenges because of their ability to facilitate illegal activities under the radar. 

Finally, the crypto market can be very volatile - whilst this can help investors achieve high returns, the potential for losses are equally higher. 

What are cryptocurrencies?

## TL;DR

- Raw materials which can be consumed (like food) or used to create other products, and traded in financial markets
- Spot commodities and derivative commodities markets 
- Hard commodities and soft commodities 

## What are commodities? 

Commodities are raw materials such as copper or coffee, that can be bought and sold. These commodities can be traded on the commodity market: a place where buyers and sellers of raw materials come together to transact. These people come together to ensure present production through current orders or future orders for later consumption. The commodity market can be split into 2: spot orders that involve immediate delivery or derivative orders that involve future delivery. Investors can get directly involved in the commodities market through a range of investment vehicles. 

There are 2 categories of commodities: hard and soft. Hard commodities refer to natural resources that are extracted from our planet, like coal or gold. On the other hand, soft commodities are usually products used in our food (agricultural or livestock) like corn or chicken. Since prices of commodities move opposite to stock prices, investors rely on commodities for diversification and hedging their portfolio against inflation risk. For example, the value of the dollar is dependent on monetary policy and fiscal policy but precious metals like gold derive their value from different factors, isolating them from inflation. 

## Types of Commodity Markets

Commodities either trade in the spot or derivatives markets. The spot market is where buyers and sellers trade physical commodities and these will be delivered to the respective party immediately.

Derivatives markets involve derivative securities: forwards, futures and options. Forwards and futures are contracts to transact at a future date with a predetermined price. Forwards and future contracts are the same except forwards can be customized and traded over the counter. On the other hand, futures are standardized and only traded on exchanges, guaranteeing the transaction with a clearinghouse. 

## Benefits and drawbacks

Investing in commodities provides exposure to growth opportunities with good potential returns. For example, this year, lumber saw its price rise as high as 370% as homeowners used money saved up from the COVID pandemic for home renovations. As mentioned earlier, commodity prices also have a low correlation with stocks and therefore great to diversify one’s portfolio - reducing their risk. Essentially, this hedges an investor’s portfolio against inflation. 

On the other hand, while prices can drastically rise, prices can dramatically fall too. It is said that investing in commodities is twice as volatile as investing in stocks. At the start of the COVID pandemic, when lockdowns began and demand for oil vanished, oil producers had no one to sell their supply to. As a result, production continued, storage filled up but nothing was being sold. No one wanted to buy oil when the future was so uncertain. As a result, in April 2020, oil prices went negative, forcing sellers to pay people to take oil. Lastly, unlike stocks that generate income in capital or dividend gains, commodities do not provide investors with any income. 



What are commodities? 

## TL;DR

- Investments that don’t qualify as a traditional long-only investment like a stock. 
- Private Equity, Venture Capital, Real Estate, Hedge Funds are all examples of alternative investments 

## What are alternative investments? 

Alternative investments differ from traditional investments by offering investors exposure to streams of return that go beyond traditional “long-only” market exposure.

Alternative investments offer low correlation to traditional investments, providing portfolios with a great source of diversification. 

Real estate and antique investments are also classified as alternative investments. 

Most alternative instruments are held by large institutions or high-net individual investors who can understand the complexity and risk involved. The reasons for this complexity are that alternative investments are not registered under the SEC or regulated under the Dodd-Frank act. 

Hence, investors must conduct their own due diligence before investing in this field. In terms of risk, the initial investment for such assets is much higher than traditional investments and therefore the potential for loss is also higher. As a result, alternative investments are primarily issued to investors who can bear such high risk (net worth higher than $1 million). 

## Types of Alternative Investments

As mentioned above, alternative investments encompass assets that go against traditional long-only investments. This includes: hedge funds, venture capital, private equity, real estate, commodities, and even antiques. Usually these strategies are expressed via funds which are actively managed, carrying higher fees overall. 

To provide one example of alternative strategy, look at so-called “equity long-short” hedge funds. These managers are able to bet on the rise of an asset’s price, as much as on it’s fall. By doing this, they are hedging their position against opposite movement in the price of an asset.

For another example, Venture Capital, which involves investing in early stage companies, pre-profit or -revenue, in hopes of getting a high return on investment as these companies grow explosively.

Both these strategies involve risk and a higher level of understanding, before any investment decisions can be made. 

## Benefits and Drawbacks 

The primary benefits of investing in alternative investments are lack of correlation to traditional investments, protection against inflation and potential for high returns. 

Since alternative investments move (or should move) with low correlation to the stock or bond market, they provide a good source of portfolio and return diversification. In specific cases like hard commodity assets like gold or real estate, investors also get a hedge against inflation. Lastly, these assets come with a lot of risk in terms of initial investment and liquidity. 

The amount of money required by funds to invest in alternative investments is high (the investor must earn at least $200,00 a year). On top of this, alternative investments are very illiquid, making it tough for investors to exit an alternative investment position. For example, it’s more difficult to sell an antique vase than some shares of Amazon. However, with so much risk, investors are compensated with a much higher return and fees are also lower since fewer transactions take place. 

Essentially, these investments can only be directly invested in by institutional investors and high net worth individuals because of its unregulated, complex and risky nature. If you, a retail investor, are interested in alternative investments, you can invest in them through alternative mutual funds and ETFs. E.g. ProShares UltraPro Short ETF trades on the Nasdaq (SQQQ), which is a 3x inverse leveraged ETF covering nonfinancial stocks. The ETF produces returns when the Nasdaq falls and amplifies the return by 3x. If the Nasdaq rises, the holder would face 3x the loss. This is what leverage implies. 

What are alternative instruments?

## TL;DR

- Options, forwards, futures and swaps are types of derivative instruments 
- Derivative contracts track the performance of an “underlying” asset. 
- Majority trade in the OTC markets but some trade on standardized exchanges 
- Good source of return and portfolio diversification 
- High risk and highly unregulated 

## What are derivative contracts? 

Derivative contracts began in the agricultural industry where one party to a contract agreed to sell goods to the other party at a specified price on a specific date. 

Derivative contracts allow parties to transact an option of a security, either immediately or at a later date. The security is referred to as the “underlying” as it drives the value of the derivative contract. This allows holders to hedge risk (in terms of price fluctuations) and accelerate returns. Similar to alternative investments, derivative contracts are also leveraged, so as high as the gains can be, the losses can be deep too. 

Most derivatives are traded in the over-the-counter market but as mentioned above, some options and futures are traded only on standardized exchanges. This allows the clearing house to guarantee the transaction occurs. 

## Benefits and drawbacks 

By investing in derivative contracts, the holder can “hedge” against the underlying asset i.e. gain protection against the price moves of the asset.

For example, if a producer of sugar likes the price today and is worried that it would go down in a few months, he can hedge his position by selling sugar at today’s price, thus effectively betting that the price would fall tomorrow. This transaction would protect the producer from any fluctuation in price in the future. A speculative trader would take the other side of the bet if she believed that the price of sugar would instead increase in the future.

In another example, interest rate swaps allow users to lock in favorable rates relative to the interest rate from directly borrowing. 

Did you know that credit-default swaps, a type of derivative contract, led to the collapse of financial institutions and eventually the Global Financial Crisis? The volatility involved in trading derivatives is very high, exposing investors to potentially large losses. The unregulated nature of derivatives also make them very complex and difficult to fairly value. As a result, these contracts are made available only to institutional or experienced investors. In addition to downside risk, there is a chance that the counter-party you are doing business with might default on their payment. 



What are derivative contracts?

Types of Assets

## TL;DR

- Bull and bear markets are lingo expressions that made it to the mainstream
- Bull market is when prices go up
- Bear market is when prices go down

**Bull market** - When a bull strikes, it thrusts its horns up. Similarly with the stock market, a bull market is defined as a period of time when prices are rising and expected to continue rising. Characterized by optimism and investor confidence, this period can last from anywhere between a few months to a few years. Note that a bull market can refer to more than just the stock market but also the bond, real estate or commodities market. A period can be said to be a “bull market” if stocks rise by 20% after two declines of 20% each. In order to gain the most benefit from a bull market, an investor should enter a position early in order to take advantage of rising prices and exit their position when the asset has reached a peak. 

**Bear market** - On the other hand, when a bear strikes, it swipes its paws down. Contrary to a bull market, a bear market is defined as a period of time when prices are falling and expected to continue falling. Characterized by pessimism and investor fear, this period can also last from anywhere between a few months to a few years. Similarly, a bull market can refer to more than just the stock market. In order to take advantage of falling prices, investors can use alternative strategies such as put options (explained later) to benefit from an asset’s falling price. 

Bull & Bear market

## TL;DR

- Short sellers are people betting against the stock
- High demand for an asset causes its price to skyrocket for a brief period
- The most famous short squeeze occurred in 2008 with Volkswagen

## What is a short squeeze? 

A short squeeze occurs when a lot of demand for an asset causes the price of the asset to skyrocket for a short period of time. This occurs when a lot of investors bet an asset price will go down but the price actually shoots up, causing all the short sellers (people betting against the asset) to buy back the stock to prevent them from losing more money. The sudden surge of people buying the asset causes a short squeeze to occur, a short period of extremely inflated prices.

An important metric to consider when discussing short squeezes is the short interest ratio. This is the number of days it takes for short sellers (people betting against the stock) to cover their positions (repurchase their borrowed shares). It’s calculated by dividing the number of shares trading short by the average trading volume, over 30 days. This metric measures the number of shares that are short and have not been closed out yet. Usually, a position is closed out once the option is in the money. However, if the option is not the money, then an investor will continue to hold the option. Therefore, a stock with a high short interest ratio could imply a potential squeeze because if the price of the asset keeps rising, this will force short sellers to buy back the stock, raising the price of the asset even more, eventually squeezing to an extremely high number. 

## Example

The most well-known short squeeze in financial history is probably the GameStop squeeze that peaked on January 27th 2021. When a large number of retail traders from a group called WallStreetBets saw how high the short interest ratio for GME was, they decided to buy a ton of shares and hold onto them. By doing this, this was increasing the price of the stock. This became a war between retail and institutional traders, and as more retail traders bought shares and held for dear life, the price continued to rise. On January 20th 2021, GME had reached $40 a share. Almost a week later, GME was trading at $400 a share. The constant purchase of shares by retail traders kept driving up the price of the stock, forcing short sellers (big institutional funds) to buy back shares at higher prices, sending the stock even higher. It is said that institutions like hedge funds and private banks lost upwards of billions of dollars just shorting GME stock. One London hedge fund, White Star Capital, lost so much money going short on GME that it shutdown after amounting losses in the double digits. 

Another very famous short squeeze occurred in 2008 with Volkswagen stock. When short sellers realized that Porsche had bought a major stake in Volkswagen and there would not be enough shares for short sellers to cover their positions, panic occurred. This caused the asset price to rise as high as €999, making Volkswagen one of the largest companies in the world for a short period of time. 

However, once peak asset prices are hit and people sell their shares, more shares become available for short sellers to purchase, causing the price of the asset to return close to its intrinsic value. 

Short Squeeze

The term “meme stock” has been recently coined after the market witnessed how extreme retail interest in a stock could meteorically increase its price. 

The term was established after the GameStop short squeeze, proving that a mob of individual traders could together propel the price of an asset up by orders of magnitude, by “holding for dear life” and refusing to sell/ 

Such stocks have seen an increase in demand and volume after being hyped up on social media forums like Reddit. Examples of meme stocks include Gamestop, AMC Entertainment and Blackberry. While all three companies have performed poorly over the last few years, their share prices reflect a different story after massive hikes in the price over 2021. AMC’s price increased by 10 times but gamestop saw its share price increasing by hundreds of dollars in just a few days. 

The birth of meme stocks can be credited to the internet, social media and the speed at which word spreads. Since the price hikes are not fundamentally driven, usually after a rise in the price of a meme stock, we inevitably see a corresponding crash in the price. 

Heavily shorted stocks (stocks with a high short interest ratio) are usually the best candidates to become meme stocks because they have the highest chance of squeezing out to ridiculously high prices over a very short period of time. 

It can be very exciting for the prospect to increase your money by 50 times, but the risk involved in investing in such companies is also very high since involvement of retail traders can cause extreme volatility. 

Meme stocks

## TL;DR 

- Measure of how many investors are invested in a particular trade, with particular focus on investors with short-term trading horizons
- Assessing whether a trade is crowded is a very common part of professional commentary for asset managers
- Positioning data can be used to predict a potential "short squeeze" 

Positioning of a security to measure how many investors are in the same position for the same reason - in jargon, how “crowded” is the trade. Positioning is usually referred to with a specific focus on speculative investors that might decide to unwind their positions all at the same time.

Positioning is meant to alert you of the risk of a sharp price move against the prevalent speculative trend in a security. It shows that a lot of “impatient” money has recently been invested in a security and might decide to rush out of the trade at the first sign of adverse news. Professional investors are very interested in positioning data, because they fear to be caught in a trade along with many others who came in for the same reason - and might decide to leave all at the same time causing sharp drawdowns.

The most universally accepted measure comes from the [Commodity Futures Trading Commission](https://www.cftc.gov/) in the US - CFTC for short. The Commission produces a weekly report of all positions in major futures traded in US exchanges, and one thing in particular makes their reports very useful: they separate positions between “hedging” and “speculative”.

The latter part of the report allows market participants to assess how much money is long or short an asset and whether this measure changed abruptly. Here’s a nice example for ES, the ever-popular e-mini future on S&P 500.

![S&P 500 speculative net future positioning](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/Screen_Shot_2022_02_07_at_9_57_33_AM_1a10c1cd7e/Screen_Shot_2022_02_07_at_9_57_33_AM_1a10c1cd7e.png)

This chart is quite telling: it shows how in mid-2020 the market reached an extreme short position in the market - i.e. investors were betting hard that the market would fall. 

**How do I use positioning data?**

The data is used to assess whether you are taking a very popular position, which might lead you to suffer when your peers unwind the position ahead of you - what’s called a “squeeze”.

Let’s look at this assuming investors believe a stock should fall. When a number of short-term investors all take in a one-sided short position in this stock, there is little selling pressure left (as they all have their desired position) and in fact some of them are even forced to trim their positions for risk-management reasons.

This means they need to buy the stock, adding upward pressure to prices which then forces other speculators to buy the stock...and this goes on until the squeeze is complete and all spec positions are “flattened” (i.e. closed).

**Can you show me an example of a positioning squeeze?**

The chart above about S&P 500 is a great one as it allows us to show a classic example of a “short squeeze”. Let’s add the chart of S&P 500 itself and zoom in:

![SPX speculative net futures positioning vs price](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/Screen_Shot_2022_02_07_at_10_09_56_AM_17636af9fc/Screen_Shot_2022_02_07_at_10_09_56_AM_17636af9fc.png)

Here you can see the textbook evolution of a short squeeze.

1. **The emergence of a short thesis**: at the beginning of the second quarter of 2020, the market was reeling from the impact of the sharpest economic slowdown ever experienced. With VIX higher than during the financial crisis, market participants forecast a deep recession
2. **Build-up of short positions**: as the belief in a prolonged recession became shared, market participants became more bearish about the market and began to add short positions - that is the Short Accumulation phase shown in blue. The more markets rallied, the more the short thesis appeared compelling to investors, who piled in to sell e-mini contracts (and their related options).
4. **Short squeeze**: except...markets kept going higher - thanks both to Tech stocks and short covering: speculators were forced to cover massive positions, often at significant losses, thus propelling the market higher

The latter part of this chart shows how some investors choose to use positioning data: for an investor who believed that markets were overpriced and wanted to express a short position, the end of this chart (late Aug 2020) would have been in fact the ideal moment.

Without the noise generated by speculative trading, this investor’s short thesis would have had a better chance to affect the market (if the investor was right, of course). And in any case, the risk to be squeezed for this investor would have been much reduced.

**This is in essence the role of positioning analysis** - ensuring that deeper fundamental views can take hold of the market, once the short-term fluctuations of speculators are over.


Positioning analysis

Commonly used unit of measurement to track interest rates and changes in other financial percentages. Basis points are frequently expressed as “bps.”

One basis point = 0.01% - it’s 1/100th of 1%

Consequently: 1% = 100 bps

The term comes from the move from one percentage to another or the spread between interest rates. Since small percentage changes can have a larger outcome, the “base” move is a fraction of a percentage change. This measurement is mostly used for interest rates, equity indices and fixed-income securities (bond pricing).

Pop Quiz:

If the price of the S&P 500 index rises by 20 bps, what percentage change has occurred?

- 0.2%
- 0.02%
- 2%

Basis Points

Common Investment Concepts

ETFs are known for being safer instruments but can also generate good returns without much expense for the investor. For every investment, you will be charged an expense amount, determined by the expense ratio. This is usually much lower relative to investing in other instruments. 

Don’t forget that there are 2 types of ETFs: passive and active ETFs. Passive investments (aka index funds) track a stock index, like the S&P 500, but an active ETF requires manpower for monitoring and rebalancing the underlying securities. As a result, this is more expensive than a passive ETF investment as the expense includes portfolio management fees. 

Unlike mutual funds, ETFs don’t have a minimum investment requirement as they can trade on a per-share/fractional basis. 

## Here are the steps for investing in ETFs:

### Open a brokerage account

You will first need to choose where you want to open a brokerage account. The majority of online brokerages offer commission-free stock and ETF investing. However, it’s good to compare the features of each platform. For example, if you’re a new investor, it might be a good idea to open an account with a brokerage like E*Trade, which offers a wide range of educational materials. 

### Choose your ETFs

Now that you’ve opened your brokerage account, it’s time to invest in some ETFs. As a beginner, investing in passive funds is a good idea as they are cheaper than actively managed ETFs. Additionally, actively managed ETFs don’t always beat their benchmark. 

The most popular ETFs are issued by Vanguard and Charles Schwab as both companies focus on connecting people to the stock market at the lowest cost and ETFs are an efficient way for people to get involved in investing. Some examples are Vanguard S&P 500 ETF, which covers large US companies and Schwab US Mid-cap ETF, which covers mid-sized US companies. 

### Let the ETFs do the rest

ETFs are known for being safe investments that require minimal maintenance. The best thing to do after investing in ETFs is to leave them and let them do the work for you. One of the main reasons why investors underperform against the market over time is because of over-trading. So stop checking your portfolio and let your ETFs produce returns at their own pace. 

How to invest in ETFs

After the “ETF Rule” passed in September 2019 by the SEC, ETF issuers have been able to bring new strategies to the market much easier than before. This has caused the ETF market to increase by 50%, equivalent to a $3.9 trillion ETF industry. This market has seen an increase in popularity because of its simplicity, cost efficiency and diversification. Especially after the pandemic, investors are looking for safer investments to diversify their portfolios with and further growth may be ahead. 

Dave Nadig, CIO at ETF trends believes that ETFs are likely to surpass mutual fund assets in the US over the next five years. He believes that with the integration of technology into the asset management space, investors will lean more towards ETFs because of their efficient nature. 

The standout feature of an ETF is that it can be traded on public exchanges like a stock. This allows easy and cheap investment for all types of investors. Additionally, this kind of investment provides risk diversification. 

The rise in popularity of ETFs has led to some of the largest financial institutions offering their own products: iShares, Vanguard, Charles Schwab, Proshares. 

As an investor, you can choose what type of ETF you want to invest in as there are thousands to pick from. If you are looking for a longer-term investment, you may choose an ETF that tracks mega-cap stocks but if you’re investing on the short term, you may be interested in an ETF that tracks startups with a high growth potential. 

How have ETFs become so popular?

It depends. In general they are more liquid than mutual funds, but in most cases they are still not as liquid as single securities (with important exceptions like SPY). ETFs not only provide the same diversification benefits as mutual funds but they can also be traded during market hours, unlike mutual funds which wait till the end of the day to be priced. This makes ETFs a convenient investment vehicle as investors can access cash flow whenever needed. 

The primary factors of an ETF’s liquidity are the composition of assets and the trading volume of the individual assets within the ETF. For example, an ETF will have low liquidity if its underlying assets are not frequently traded or if the assets are too correlated. As a result, ETFs that hold mega-cap equities are the most liquid as trading volume is high for the underlying securities. 

The secondary factors that determine an ETF’s liquidity include its own trading volume and the general macroeconomic environment. Trading activity is dependent on the supply and demand of financial securities, therefore the trading environment will affect an ETFs liquidity. 

However, companies that issue ETFs have the ability to generate additional shares, which solves the liquidity problem in a short period of time. 

Essentially, ETFs have different levels of liquidity based on the securities it holds, the trading volume of those securities, the trading volume of the ETF and the trading environment. 

The most actively traded ETFs are the S&P 500 SPDR (SPY), Invesco QQQ (QQQ) and Financial Select SPDR (XLF), which only covers the financial sector of the S&P 500. 

How liquid are ETFs? 

ETFs are known for being inexpensive investments but they do entail certain costs: the most prominent is the operating expense ratio (OER). The expense ratio is the annual cost for the fund to cover portfolio management, administration and others relating to the assets you hold. This ratio depends on the number of assets and how long you hold the ETF for. For example, the OER is more relevant for long-term ETF holders than short term investors. Most recently, a lot of issuers have launched similar ETFs, which track the same market index, with a lower OER. 

Other costs include commission, bid/ask spread and discounts to NAV. Commission costs have become less significant with brokers like Charles Schwab offering commission-free trading however this cost is based on your broker. Essentially, the more you trade, the more you’ll pay in commission costs. You can think of the bid/ask spread as a commission cost too as the larger the spread and the more frequently you trade, the more significant this cost becomes. 

If you bought shares of an ETF when it was trading at a premium to the NAV but then it drops to a discount, the difference between the two values is the cost to you. For example: if the ETF was bought at 0.5% premium and then drops to a 0.5% discount, you incur a 1% cost. As an investor, you should be aware of the risks involved, even if it’s just a small loss. 

Fee structure of ETFs

Along with low fees, ETFs are a good addition to your portfolio because of their tax efficiency. Rather than individually investing in a basket of securities and getting taxed on each capital gain, by investing in ETFs, you only get taxed on the gains you earn from the ETF. 

Even if you choose to hold your ETF forever, you can still earn capital gains at the end of the year if the fund manager decides to sell the underlying securities. This is calculated by taking the gains from the year and subtracting the losses - the difference is distributed to shareholders as capital gains. Since most ETFs track an index like the S&P 500 or the Nasdaq, a manager only sells underlying securities if there is a change in the index’s holdings, which rarely happens. As a result, there are fewer capital gains to report at tax time, especially compared to active funds which aim to beat an index. 

Essentially, the more you trade, the more potential capital gains but the higher taxes you will have to pay. As a result, investing in passive ETFs and holding these investments for a long term provides you with the highest tax efficiency, unless you’re using an IRA account to trade. 

The amount you will have to pay in taxes depends on the tax rate and how long you hold a security for. If you hold a security for longer than 1 year, you will be charged a lower tax rate versus holding a security for less than a year. 

For institutional investors, shares of an ETF can be redeemed in exchange for a basket of securities held by the fund. As a result, the fund never has to sell shares of its underlying securities to generate cash and this avoids generating taxable gains since these events are not considered as “taxable.” 

Tax structure of ETFs

Pooled investment funds aggregate many individual investments into one large investment, allowing investors to benefit from economies of scale. This allows individual investors to gain wide exposure by bundling securities together and managers benefit from decreased transaction costs through large transactions with pooled capital. Mutual funds, hedge funds, ETFs and pension funds are all examples of pooled investments. 

The pooled fund is professionally managed by experienced financial professionals who try to deliver the highest potential return for their investors. The most common pooled investment fund is a mutual fund, which is actively managed and contains a large number of securities.

Unlike mutual funds, ETFs can be traded on the stock market like shares but mutual funds can only be purchased after the market shuts, based on the calculated price. As a result,, EtFs are viewed as more liquid than mutual funds. ETFs are also passively managed, meaning that their performance is pegged to a specific market index. Some people prefer mutual funds because they are actively managed and investors can rely on the professional manager to build a sound portfolio, rather than following a market index. 

Mutual funds are known for having higher fees and expenses than ETFs because of the higher costs associated with managing an active fund such as manpower and trading fees. ETFs on the other hand are passive investments which require less rebalancing and less labor hours. 

ETFs offer tax advantages to investors too since passively managed portfolios realize fewer capital gains than actively managed mutual funds. 

ETFs vs pooled investments

Exchange Traded Funds (ETFs)

One of the reasons why option trading is so scary for new investors is because of the plethora of options available, in terms of type of strategy, expiration date and strike price. One option could send your value to the moon, while the other could drive it straight into the ground. Therefore, finding the right option is essential to maximizing your success and profit. So which option is the right one to trade? 

Here are seven steps to help you identify the right option:
1. Choose the underlying asset
2. Understand your investment objective
3. Decide your risk-reward payoff
4. Figure out the volatility
5. Identify events
6. Plan a strategy
7. Establish option details

## Choose the underlying

Before you can buy an option contract, you need to choose which asset you want to buy a contract for. Is it a stock, commodity, ETF? Everyone has their own way and resources to screen for the right asset (smart investors use [www.toggle.ai](www.toggle.ai)). 

_Kate is a big fan of healthy eating and buys 1000 shares of Sweetgreen (NYSE:SG) at $29.24 per share._

## Understand your investment objective

Once you know what underlying asset you want to trade, you need to know your objective so that you can decide the option strategy. Are you speculating on a large bullish or bearish move? Or are you trying to hedge a current position? 

Do you want to earn a profit from selling the option premium or do you want to buy/sell an underlying asset? Different traders use options for different reasons: some want to make an income but others use options to speculate or hedge. Therefore, you must decide the objective of the trade before you can jump into the next step. 

_Kate is worried that the price of SG might fall by 5% over the next few months because Cava ( a competitor) has been performing very well._

## Decide your risk-reward payoff

Dependent on your appetite for risk, your option strategy will be different. If you are a risk averse investor, then you might want to stick with leap call options. These are longer term options (more than 9 months till expiry) that carry similar risk to buying the underlying stock, except for cheaper since you’re not actually paying to buy the stock, but only the right. If you’re a riskier investor, you might want to write puts or enter deep out of the money positions, in hopes of a higher profit. Remember, the riskier the position, the higher the potential profit, but the higher chance of loss too. 

_Kate does not mind a little risk but wants to protect her stock position from downside risk_ 

## Figure out the volatility 

As previously mentioned, the implied volatility of an option determines its price. The best strategy is to compare a stock’s implied volatility with its historical volatility and the the volatility in the general market - this will give you an idea of the stock’s implied volatility relative to the asset and rest of the market.

The implied volatility tells you whether other traders are expecting a large swing in the stock. A high implied volatility will result in a higher premium for the option, making it more attractive as traders think the volatility won’t increase anymore. A low implied volatility means that the premium is lower, which is cheaper to buy if a trader thinks the stock will swing soon. The aim is to buy an option with a low premium (and volatility), in hopes for the volatility to increase, causing the premium to increase too. 

_Implied volatility on in-the-money put options (strike price of $30) is 17.38% for one-month puts and 16.40% for three-month puts. Market volatility is currently 13.08%_

## Identify events

Events can have a large impact on the implied volatility, even before it actually occurs. There are 2 categories of events: market-wide and stock-specific. 

For example,Omicron outbreaks and accelerated tapering are market-wide events while an Astra rocket hitting orbit for the first time is a stock-specific event. Such events cause a spike in asset volatility and hence, the value of the option. 

You should identify events which could have a large impact on the underlying, as this influences your decision about the right time frame and expiration date for the option trade.

_Cava’s earnings report comes out in just under 2 months, which means the put option should extend to 3 months out, to protect Kate from downside Sweetgreen could see after Cava’s earnings report._

## Plan a strategy 

Depending on your investment objective, risk-reward payoff, level of volatility and key events, you can make an easier decision on which specific option strategy you want to use.

For conservative investors who just want to trade on the option premium, a covered call would be a good strategy as it involves writing calls on stocks already in your portfolio.

On the riskier hand, if you think the market is headed for a decline, you might want to buy puts on the major market indices.

Each strategy is dependent on you. 

_Kate buys puts to hedge the risk of a decline in Sweetgreen stock’s price._

## Establish option details 

Now that you know which option you want to purchase, all that remains is deciding the details of the option: expiration date, strike price and option deltas. For example, if you want to buy an option at the lowest cost, you would look at a call with the longest expiration which will be deep out-of-the-money. 

_$30 strike-price puts with a 3M expiration, available for $1.19 each._

**_Continued Example_**

_For Kate to hedge her Sweetgreen position, she must purchase 10 put contracts (each containing 100 shares). Her total cost for the put position is $1.19 * 1000 = $1,190_

_If the price of the stock drops, the hedge kicks in, as the gain from the put option offsets the loss from the stock position. If the stock stays unchanged at $28.24, the value of the put option would be $0.76 ($30 - $29.24), which means Kate gets back $760 out of the $1190 she invested, when she closes her position._

_If Sweetgreen’s price goes above $30, Kate would receive profit on the increase in her stock position but would have to forfeit the $1190 paid for the put position._


A brief introduction into option trading

Calls and puts

The price of an option changes when the price of its underlying asset changes - as it’s intuitive.

However, this relationship is affected by other factors such as time and how pricey options are today in general.

The Greeks are parameters that tell us how sensitive an option is to these factors: to time-value decay, to changes in implied volatility and and to movements in the price of the underlying asset.

These factors encompass the various risk measures and price movements, which drive the value of an option. 

The 4 Greeks are an option’s delta, gamma, theta, and vega. . 

**Delta (Δ) - measures the change in an option’s value when a change in the underlying asset occurs**

Delta is the simplest of the Greeks to understand. If delta is for example 50%, it means that if the price of the underlying asset changes by $1, then the price of the option changes by $0.5.

For puts, the delta ranges from -100 to 0 and for calls, the delta ranges from 0 to 100. Delta for puts are negative because they have an inverse relationship with the underlying - the value of the put falls when the underlying rises and vice versa. On the other hand, if the underlying price rises, the value of the call option increases, as long as there is no change in the other greeks. Options that are likely to expire in-the-money will have a higher delta and tend to be more expensive since they’re more likely to expire profitable. 

**Gamma (Γ) - measures the rate of delta’s change over time**

Suppose 2 similar options have different gamma values: one higher and one lower. The option with the higher gamma might see the largest change in delta if the underlying changes - so you thought you had a 50-delta option, but prices rally and all of a sudden your delta is 70!. Gamma is higher close to a strike, lower away from it. If delta represents the probability of an option expiring in the money, gamma represents the stability of that probability. 

**Theta (θ) - measures the price decay of an option as time passes**

As time progresses, the chance of an option expiring in-the-money (profitable) decreases and as the expiration date gets closer, theta starts to accelerate as there is less time to earn a profit from trading the option. The value of the option starts linearly diminishing as soon as it’s been purchased and starts to exponentially diminish as the expiration date nears.

**Vega (ν) - measures the risk of changes in implied volatility, affecting the price forecast of an asset**

Investors use an asset’s implied volatility as a measure to forecast future movements in the price of a security and its option value: when volatility is expected to increase means the implied volatility is rising, which will cause the value of the option to likely increase as well since there’s a great chance of hitting the strike price. Vega decreases as the option nears expiration as the likelihood of hitting the strike price decreases. 

We know that a call option holder will profit when the underlying asset price is higher than their option strike price (and vice versa for put option holders). Therefore, the following table shows you the influence each factor has on the price of a call or put option and hence, your potential profit. Remember that results would differ based on if a trader was long or short. 

![investopedia option table](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/investopedia_option_table_ac7241c3e1/investopedia_option_table_ac7241c3e1.png)

*kudos to Investopedia for this great table 

4 option greeks

Hedging is an investment strategy that aims to offset the potential loss accumulated from another investment. This usually consists of taking an opposite/offsetting position by investing in a different security or the same security in the opposite direction. The aim is to limit your risk in your investments. 

You can think of hedging like purchasing an insurance policy: this mitigates potential future risks by creating a safety net. Similar to purchasing an insurance policy, hedging is not free and the investor must find the right risk-reward tradeoff. The perfect hedge is a strategy which eliminates 100% of the risk in a position or portfolio but this isn’t that easy.

The most common way to hedge a position is through derivatives. If you remember from our previous article, derivatives track the performance of one or more under underlying assets. These include swaps, options, futures, forward contracts and the underlying asset can be almost any instrument (including interest rates). A derivative can be set up that gains a profit when a loss in another investment occurs. 

For example, if you have long shares of AMZN stock, you can buy a put option to mitigate the downside risk. However, by purchasing the put, your potential profit decreases. In the event that the stock goes up, you lose out on profit equal to the premium paid for the put. However, if the stock goes to the ground, the profit you make from the put offsets the losses you make from the long shares, protecting you from losing your entire investment. The greater the downside risk, the greater the cost of the hedge. So, after a point, it becomes inexplicable to purchase additional protection because of the risk-reward tradeoff. 

The effectiveness of a hedge can be measured using the “hedge ratio,” which measures the amount a derivative’s value moves per $1 move in the price of the underlying. 

**Other ways to Hedge**

A more familiar method of hedging investments is through diversification. Since hedging with derivatives can be complicated and requires a decent amount of capital, diversification is simple and provides price protection too. However, there is no guarantee that the diversified assets will move in the opposite direction. For example, during March 2020, diversification in different sectors would not matter since the entire market crashed. 

For retail traders, even though they may not take part in hedging activities, it’s good to understand the topic since large corporations engage in it on a regular basis and if you’re involved with these financial institutions, you most likely will be affected by their actions. Remember, hedging will rarely result in an investor making money. The objective of hedging is only to prevent losses. 

Hedging your risk

Options

## TL;DR

- Fixed Income refers to fixed income encompasses securities that pay a fixed amount of interest at a fixed time - such as government and corporate bonds, and includes the broad class of interest-bearing securities like swaps
- Fixed Income instruments provide known future cash flows at a specific date (maturity). 
- Such investments are less risky but also provide a lower return

## What is Fixed Income? 

As the term says, fixed income encompasses securities that pay a fixed amount of interest at a fixed time to an investor/holder of a fixed income security. The investment horizon of a fixed income security is called “time to maturity” and at maturity, investors are repaid their entire initial investment, in addition to the interest they received on the initial investment. Unlike equity, where the future payments are unknown, fixed income securities provide a steady flow of fixed cash flows based on interest rates or dividends, which are both known in advance. 

In the event of a bankruptcy, fixed income investors receive priority over common stockholders for repayment. Hence, investing in fixed income securities are less risky but provide a lower return than equity investments. The most common types of fixed incomes securities are government and corporate bonds. 

## What is a Bond? 

Similar to how a company introduces equity to aid their business operations, companies and governments issue debt securities to finance operations. A bond is a debt security and type of fixed income security that pays the holder their initial investment amount, with interest, on the maturity date. 

Example: _Armenak buys a corporate bond from ABZ Bank. They issue a $10,000 bond with a 10 year maturity at 5% “coupon rate.” So Armenak must first pay the bank $10,000 to buy the bond. After that, he will be paid interest payments overtime (aka coupon payments), on an annual basis and calculated like this: $10,000 * 5% = $500 every year for 10 years. At the maturity date, Armenak will receive his initial $10,000 investment. Therefore, in total, Armenak would have made $5,000 from 10 yearly coupon payments of $500 each and the repayment of his initial investment._

Seeing as the above mentioned example is in regards to a corporate bond, Armenak received a higher coupon rate than if he would have bought a government issue bond. This is because a corporate bond entails some risk and therefore investors must be compensated extra for that additional risk. On the other hand, a government bond is backed by the guarantee of repayment by the government (pretty credible source right). 

On top of the difference in cash flows, another difference between a bond and stock is that a bond does not entail any form of ownership in the parent company. 

Fixed Income Basics

Now that you know what fixed income securities are, here are some key terms to familiarize yourself with. The following concepts are important in valuing fixed income securities - is it worth your investment?


**Coupon**

The coupon is the promised payment by the bond issuer to the bond holder (usually on a semi-annual basis) until the bond expires. The coupon is calculated with the coupon rate, which can be thought of as the interest rate and is expressed as an annual percentage of the bond’s face value. 


Example: A corporate bond with a 4% coupon rate will pay $40 per $1000 of the bond’s face value, per year. 


**Maturity**

The bonds “expiration date” - the date on which the bond issuer owes the bond holder the principal amount (initial payment) and any final coupon payment. 


Example: A bond with a 5% coupon rate, $1000 face value and 5 years to maturity. This means that the bondholder will receive a total of (5*2) 9 semi-annual payments and they will receive their 10th payment with their principal amount on the date of maturity. This is defined in the bond’s indenture before a deal is signed. 


**Price**

The two key values in bond pricing are the market price and the par value (aka face value). The market price is the current quoted price for the bond (the market value). On the other hand, the par value is the price at which the bond is issued and this is usually $1000. The principal payment received at maturity is the par value. 


In practice, bond prices are quoted as a percentage of the par value. For example if the bond price is 100.00, then the bond is trading at the par value. If the bond price is 99.00, then the bond is trading at a discount to par value. If the bond price was 103.00, then the bond is trading at a premium to the par value. 


-  _Market Price > Par Value : Premium_
-  _Market Price = Par Value: Par_
-  _Market Price < Par Value: Discount_ 


**Yield (Yield to Maturity)**

The expected annual return on an investment and takes into account all the bond’s characteristics. A bond’s yield is inversely proportional to its price - so when the yield of a bond increases, its market price decreases and vice versa. For example: a bond with a 5% yield will be priced lower than a bond with a 4% yield. 


You can compare the yield of a bond to its coupon rate to determine how the bond is trading, relative to its par value. 


- _Coupon Rate > YTM : Premium_
- _Coupon Rate = YTM : Par_
- _Coupon Rate < YTM : Discount_ 


**Credit Risk**

The possibility that the bond issuer might not be able to pay the bond holder the coupon payments or the final principal payment. This is known as default risk. To inform investors about the potential for default, a bond’s degree of risk is expressed through its credit rating. Companies like Standards and Poors and Moodys are in charge of rating bonds based on their creditworthiness. Bonds can be split into two categories; investment grade bonds and junk bonds. Investment grade bonds range from AAA to BBB- and junk bonds range from BB+ to D (for default). The bonds are rated on the capacity for the issuer to repay its bondholders. 


**Duration**

This measures how sensitive a bond’s price is to changes in interest rates. Unlike time to maturity, the duration measure is non-linear and accelerates as the maturity date approaches. The higher a bond’s duration, the more sensitive the bond’s price is to changes in the interest rate, and the more the bond’s price will fall as interest rates rise. 

With a longer maturity, a bond will have a greater duration because it is exposed to greater interest rate risk. On the other hand, the higher the bond’s coupon rate, the lesser the duration and interest rate risk. 



Fixed income concepts

**Bonds - Corporate & Government (treasury) & Municipal**

Bonds vary in maturity and risk. 

Corporate bonds encompass investment grade bonds with a rating between AAA to BBB. Compared to government bonds, corporate bonds carry additional risk and hence, additional return to compensate the investor for taking on that risk. These kinds of bonds are issued by large corporations and maintain a level of safety but still provide higher returns than government bonds. 

Shorter term bonds like Treasury notes are government bonds with lower yields because of their lower interest rate risk and higher liquidity. Longer duration bonds like Treasury bills are exposed to more interest rates move and hence more interest rate risk. However, interest rates on government bonds are expected to decrease as the economy weakens so there may be too little income to be gained here. 

Municipal bonds are issued by branches of the government - a city, state or government agency. These bonds are usually tax-free and investors buy them for their tax benefits. However, the market is dominated by small investors which makes the municipal bonds market not as efficient as other bond markets. 

**Fixed income ETFs or Mutual Funds**

By investing in bond ETFs and mutual funds, the investor does not have to choose a single government or corporate bond. By purchasing ETFs and mutual funds, investors skip paying premiums and even get a discount for buying a large number of bonds. The Vanguard Long-Term Bond ETF provides investors with broad exposure, potentially higher returns and lesser risk. 

**High-yield bonds**

A high-yield bond is described by its higher yield and higher risk than a normal fixed-income bond. It’s also known as a junk bond because its credit rating classifies it as non-investment grade. Investors purchase this asset to gain a competitive expected rate of return, similar to investing in the equity market but with lesser volatility. However, these bonds come with a high default risk as they are issued by companies with high debt ratios. Sometimes these bonds may just be from companies which lost good credit ratings due to previous defaults. 

**Preferred Stock (kinda)**

Preferred stock contains characteristics that would classify it as both an equity and fixed income security. On top of that, preferred stocks are impacted by changes in interest rates. For example, when interest rates fall, the value of preferred stock increases and continues to provide dividend payments, almost in a coupon payment form. Preferred stock is also issued by larger-scale companies like insurance companies and banks - so they carry more guarantee of performance than buying common stock in a small capitalization asset. 



Types of fixed income instruments

**Tldr:**

- Interest is the extra amount of money a borrower has to pay on top of the loaned amount
- Interest rate is the rate of interest paid over the borrowed amount
- Interest rates can be thought of as “the cost of borrowing” 
- Entire economies are affected by changes in interest rates 

The talk of the town…a topic that once would have resulted in you being a loner now seems to be on the tip of every investor’s tongue. So what are interest rates?

Rates is a broad term that encompassess a lot of instruments that have to do with paying interest.

The three main categories of rates-based products include Government Bonds, Interest Rates Swaps and Corporate Bonds.

Whilst conceptually different, these types of securities have one key point in common: one party agrees to borrow money for X time and give it back at the end, whilst paying interest in between.

So at the end of the day all rates products are similar to borrowing a personal loan from the bank, paying interest and then giving them back the amount borrowed.

The key metric for these products is the interest rate, which can be thought of as the “cost of borrowing,” aka, the amount you would have to pay on top of the amount you want to borrow.

_For example, if you wanted to borrow $100 and the interest rate was 5%, you would have to pay back $105. As the borrower, the interest rate is the cost of debt and for the lender, it’s their rate of return. The lender requires compensation for lending money because they are losing out on investing that money somewhere else (opportunity cost)._

On a larger scale, companies need to borrow money from banks to fund projects and hence, interest rates determine how much the company can afford to borrow. As market interest rates increase, it becomes more expensive to borrow money. As a result, it becomes tougher for firms to borrow money and build those projects which accelerate their value. Without growth, profits are falling which is causing the market value of companies to fall too. The opposite is true too (as you may have noticed post March 2020). With interest rates at almost zero, the market saw a boom in growth as it became very cheap to borrow money, hence allowing the economy to easily grow. 

Another catalyst for lowering stock prices when interest rates rise is the increase in demand for fixed income instruments like bonds (because of their less risky nature), which lowers the demand for stocks. 

So how are interest rates determined? The central bank (in the US’ case, the Federal Reserve) sets interest rates by taking into account the state of the economy. It is one of the tools used by the government to control people’s spending/saving habits, growth of the economy and overall inflation. 

To combat inflation, the FED might increase the reserve requirement for banks which limits the amount of money that can be loaned out and increases the demand for credit. When interest rates are high, people would rather grow their money by saving compared to when interest rates are low, stocks promise better returns than the savings rate (helping boost the economy). 

While everyone prefers lower interest rates, this leads to a disequilibrium as demand exceeds supply, and causes inflation. Coupled with a pandemic, this leads to further hiccups in the global supply chain, affecting the entire economy. 

Interest rates

Bonds and Fixed Income

The profitability of a publicly traded company drives the value of its equity as investors primarily care about the profits their investments generate. For example, the most common ratio is the Net Profit Margin - of the revenue generated, how much is profits? Additionally, Return on Investment measures the amount of profit made on an investment. Both these ratios are important for investors prior to investing because they can understand the profitability of a company or the cost structure (the inverse of profit).

Additionally, profitability ratios can be used to understand what percentage of the revenue is available to cover expenses. This is calculated using the Gross Profit Margin, which looks at how much money is generated to cover expenses after the cost of goods are subtracted from the revenue.

Net Profit Margin =Net Income/Revenue

Return on Investment = Profit/Investment

Gross Profit Margin = Gross Profit/Revenue

_You can find these values on the company’s balance sheet/income statement_

Profitability 

Liquidity ratios focus on the company’s ability to meet its short term obligations and this varies by industry. Investors prefer companies with high liquidity ratios but larger companies can get away with lower liquidity ratios because of greater funding sources, compared to smaller companies. During the peak of the pandemic, the US federal government pumped liquidity into the economy with interest-free loans to institutions and stimulus payments to individuals.

Current Ratio = Current Assets/Current Liabilities

A higher ratio is preferred because it indicates a company has liquidity, more capacity to take on debt and meet its short-term obligations.

Another helpful measure is the cash conversion cycle, which calculates the number of days it takes for a company to collect cash. Operations with a lower cash conversion cycle will have greater cash on hand and hence liquidity.

The defensive interval ratio measures how long a company can pay its daily cash expenditures with only existing liquid assets (no additional cash flows).

Defensive Interval Ratio = Cash + Short Term Marketable Securities + Receivables Daily Cash Expenditures

Liquidity

On the other hand, solvency ratios focus on a company’s ability to meet its long term obligations such as debt. The amount and type of debt a company holds will influence their future risk and return. This measure is known as leverage and there are 2 kinds. Operating leverage comes from fixed costs like building rent and financial leverage arises from financing costs like interest expenses.

A commonly used measure is the debt-capital ratio which measures what percentage of a company’s total capital is financed by debt.

Debt-to-Capital Ratio = Total DebtTotal Debt + Shareholder's Equity

On the financial leverage side, the interest coverage ratio (aka Times Earned Ratio) represents how many times earnings before interest and taxes (EBIT) can cover the interest payments.

Interest Coverage = EBIT/Interest Payment

Solvency

This metric looks at the relationship between the market value of a company and a financial metric like earnings. The aim is to show you the price you are paying for some future stream of revenue/cash flow. For example, if you pay $100 for a company that expects to generate $200 a year, then the company is cheap because the P/E ratio is 0.5x (the S&P 500’s P/E ~18x). Essentially, valuation ratios are based on estimates of future streams of cash flows/earnings.

Since these ratios are forward looking, you will have to make an estimate about what you and the rest of the market believe this company could potentially generate. Analyst expectations about future earnings can easily be found online and play a role in the movement of an asset’s price.

The most commonly used measure is the Price - Earnings ratio (also known as P/E or PE ratio) which looks at how much an investor pays for a single dollar of earnings. This ratio is also beneficial to compare competitors within the same industry.

## Price/Earnings Ratio

The price/earnings ratio is a major relative valuation method used to compare performance between similar companies or compare periodic performance within a company. This ratio is calculated as the current share price divided by the earnings per share (EPS). Sometimes referred to as the earnings multiple, investors use this ratio to observe the relative value of a company’s shares.

A high P/E could indicate that a company is overvalued or analysts expect high future growth rates. There are 2 types of P/E ratios - forward and trailing P/E. Trailing means that these are real earnings that the company has produced in the last 12m or last fiscal year. Forward refers to the expected earnings per share of a company, based on the mean/median earnings estimated by the analysts that cover the company. The two measures each have their own drawbacks. Trailing earnings are backward looking, and forward earnings are usually just a lagging indicator based on market performance.

Another major valuation ratio is a company’s enterprise value to its earnings before interest, tax, depreciation and amortization (EBITDA). A company’s enterprise value measures the total value of a company and is calculated by adding debt and subtracting cash from a company’s market value. Overall, the ratio tells you how many times a company’s EBITDA covers the value of the business.

Valuation & P/E ratio

Fundamental Valuation Ratios

The ERP measures the excess return granted for owning a stock, when compared to a risk-free asset like a government bond.

The ERP is a measure of cross-asset valuation. It tells you if equities are cheap relative to bonds. High means value, low means cheap.

The ERP is a cross-asset valuation measure comparing the return available for equities with that available for bonds. It applies to single stocks and by extension to equity indexes, and works well for most industries with some relevant exceptions.

The ratio is calculated as the ratio between the share price and the earnings per share. The latter can be trailing earnings or forward earnings.

The chart below shows the trailing PE for SPX in the last 40 years.

Remembering that “low = expensive” you can see that during the 80s and 90s, all the way up to the dot.com bubble, the market was expensive if compared to bonds. For context, this was a period of high PE ratios combined with very attractive Treasury yields in the 6-8% range on the 10y bond. Conversely, the picture shifted in favour of Equities in the age of Quantitative Easing. During the period from 2011 onwards, equities have become meaningfully cheaper than bonds.

![spx equity risk premium on forward EPS](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/spx_erp_d180b65e65/spx_erp_d180b65e65.png)

Equity Risk Premium

Financial Analysts from banks and research houses cover companies and the evolution of their business. In this process, they issue estimates about the EPS and Sales of a company, and often about other measures as well: dividends, cash flow, ebitda etc.

The Analyst Revision Bias measures how many analysts have reviewed their estimates up or down in the last month. A reading of +100% means that all analysts have increased their estimates, a reading of -75% means most analysts have decreased them.

Analyst revisions help gauge consensus and understand whether the research community for this stock actually has predictive power or - as sometimes happens - is more of a contrarian indicator: in some cases, when all analysts are one-sided on the trade, it’s a sign to do the opposite.

Analyst Revisions Bias 

Financial Analysts from banks and research houses cover companies and the evolution of their business. In this process, they issue estimates about the EPS and Sales of a company for the next 12 months, and these can be compared with the realized metrics for the company for the past 12 months to gauge what kind of growth the analyst community is expecting for the stock.

Analyst Expected Growth helps gauge the views of the analyst community on the growth potential for the stock. This can either have predictive power or - as sometimes happens - be more of a contrarian indicator: in some cases, when all analysts are one-sided on the trade, it’s a sign to do the opposite.

Discounted cash flows, an absolute valuation method, rely on growth expectations to predict future cash flows and hence potential stock prices. Investors can use analyst expected growth as a benchmark for their own growth expectations.

Analyst Expected Growth 

The return an investor can make on an equity position is divided into two sections: capital and dividend gain.

Capital gain encompasses the appreciation in the price of the asset, compared to when it was first bought. The difference between those two values is the capital gained by the investor, after selling. This value can be expressed as a percentage by dividing the difference by the initial cost amount.

Some equities pay investors a dividend: a portion of the profits to thank shareholders for owning the asset. This is not mandatory but facilitates a healthy relationship between the company and its shareholders. If an asset pays a dividend, this is included in the return yield. The dividend yield can be calculated as the annual dividend per share divided by the current share price.



Return Yield

In short, earnings are the profit of a company: revenues minus costs and taxes.

The after-tax net income earned by a company (found on the income statement) is referred to earnings. Analysts frequently refer to this value to understand a company’s financial structure and forecast growth. This value is calculated by subtracting a company’s costs and taxes from its revenue, every quarter or fiscal year.

Earnings per share (EPS) measures a company’s earnings divided by the number of shares outstanding: measuring how much a company earns per share. EPS is a relative valuation metric which can be used to compare performance between similar companies. A company with a higher EPS, compared to a competitor, is said to be of higher value. Analysts predict quarterly EPS for a company and the company’s share price reacts based on if the forecasted EPS value is either met, missed or beat.

Earnings, EPS and Basis Points 

Fundamental Valuation Indicators

The Relative Strength Index is a measurement of the speed and magnitude of price movements. It was developed in 1978 by J. Wilder, a mechanical engineer and real-estate developer with an interest in the stock market who developed several foundational technical indicators. Since then, many different ways to use and interpret RSI have been developed, but his indicators have stood the test of time.

This simple indicator is what is called an oscillator, meaning it moves within a range. In the case of RSI, between zero and 100. You can think of it as a spring that can be compressed and expanded within certain limits. Without any external force, it will return to its natural state in the middle.  

What RSI measures is a stock's momentum, meaning it looks at how fast a stock is moving and in what direction. This is similar to measuring the average acceleration of a car as it speeds up and slows down. 

Combining momentum and direction together gives you a momentum oscillator that acts as a leading indicator, a measure that is designed to move before the price of a stock and indicate what will likely happen to that stock's price. This is similar to how someone's face may turn green before they get sick, letting you know that something is going to happen before it actually does. 

**Overbought/ Oversold:**

The most common RSI signals are overbought and oversold, generally considered to be a level of 70 and 30, respectively. When the RSI exceeds 70 it means that the stock is likely overheating and is due for a pullback. When the RSI dips below 30 it indicates that the stock may be oversold and due for a rebound. 

![relative strength index](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/rsi_754add9129/rsi_754add9129.png)

**Divergences:**

Divergences are less common than Overbought/Oversold signals, and arguably more reliable. When a divergence takes place, a few specific price and RSI movements must occur in tandem. 

A bullish divergence begins with the stock price and RSI both having recent lows in a specific period before rebounding together. The stock must then fall again to a price lower than the first dip. If this occurs and the RSI remains higher than the previous low, you have a bullish divergence.

![rsi divergence](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/rsi_divergence_ce4ad9a8bf/rsi_divergence_ce4ad9a8bf.webp)

Similarly, a bearish divergence begins with the stock and RSI breaking recent highs before falling together. The stock must then rise again to a price higher than the first peak. If this occurs and the RSI remains lower than the previous high you have a bearish divergence. 

Relative Strength Index 

When an index like the S&P 500 or Dow Jones moves in one direction, not all the assets which it covers move up too. The price of an index may be rising even though the majority of its stocks are falling since a small number of those assets are posting very large gains, bringing the whole index higher.

Taking the performance of the current S&P 500 index, the price of the asset seems to be hitting new all-time highs even if the majority of its underlying stocks are falling. This is largely due to the performance of companies like TSLA and APPL, whose disparate returns are literally carrying the index.

Such an indicator allows investors to assess how strong or weak the underlying assets of an index are, as well as gain insight into where the index might be heading next. Looking at the balance between rising and falling stocks (stocks hitting new highs and lows) can provide insight about an index’s potential future trajectory.



Market Breadth

Momentum measures the percentage change in a stock price over a certain period of time. For example: “S&P 500 fell 10% this week”

Momentum is a highly significant measure for market participants. It helps gauge the size of a move, and provides psychological benchmarks. For example, when the market falls 20% it is considered to be in a “bear market”.

Momentum is used to gauge entry points and the strength of a trend

Momentum is the measure of percentage change in price over a certain period of time, from a day to a year or more.

The chart below shows the trailing PE for SPX in the last 40 years.

| ![trailing PE for SPX in the last 40 years!](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/trailing_PE_for_SPX_b2f3b0b4c4/trailing_PE_for_SPX_b2f3b0b4c4.png) ||:--:|| Trailing PE for SPX in the last 40 years|


Momentum is used to gauge whether the market is trending or conversely has reached overextended levels.

Momentum

The KD Stochastic is a popular indicator in the oscillator family, which is one of the largest tools in the technical analysis toolkit. The Stochastic indicator tells you the position of a security within its recent range in % terms: 1% means it’s at the lowest 1% of the recent range, and 99% conversely that the security is the top of the price range of the last few days. The KD spread is the spread between a short stochastic (D is the 3 days stochastic) and a longer one (K is the 14 days one)


Oscillators are used to gauge bottoms/tops and inversions. The theory is that if the oscillator is close to the bottom of its range, then so is the stock and vice versa.

Stochastic Indicator

This indicator belongs broadly to the category of Technical Analysis Indicators, and is used to monitor extreme short-term rallies or drops in a simple way: it counts the number of consecutive days during which the stock moved in the same direction.

So if a stock rallied for three days the indicator will be set at 3, and conversely if a currency fell for six trading days in a row the indicator will be set at -6.

Like most oscillators, this is used mostly for 1d reversion plays: look at the S&P 500 example below, which shows that in the last 5 years SPX never managed to rally more than 5 days before falling. The implication is that, by monitoring these opportunities, one can play a reversion with a degree of confidence.

![spx consecutive days](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/spx_consecutive_days_ab9b79c5b1/spx_consecutive_days_ab9b79c5b1.png)

Consecutive Days Move Counter Indicator

The Sharpe Ratio for a security is a measure of its return divided by its volatility. It normalizes the size of the move by comparing it to recent history, so that it’s easier for traders to gauge the significance of the move itself. When you hear in the media that “the market fell 2 standard deviations” they refer to the Sharpe Ratio of the security.

The indicator is an oscillator of sorts, allowing investors to answer questions like “What happened the last 10 times that S&P 500 fell 2 standard deviations?”. It is usually used as a mean reversion guide.

The indicator is named after Nobel prize-winner William F. Sharpe, who developed it in 1966. Originally the calculation subtracted the risk-free rate from the return calculation.



Sharpe Ratio

The Surprise Move of a security is a modified version of the Sharpe Ratio: whereas the latter indicator measures the return of a security divided by the volatility of the security during the move, the Surprise Move divides the return of a security by the risk regime before the move took place.

This modification of the Sharpe Ratio allows the indicator to highlight how a relatively small move was quite large within the context of a pre-existing low-volatility environment, and conversely a large rebound was not so out of the ordinary, if seen under the light of a tumultuous high-vol regime that maybe came after a large drop.

The indicator is an oscillator of sorts, allowing investors to answer questions like “What happened the last 10 times that S&P 500 fell 2 standard deviations?”. It is usually used as a mean reversion guide.

Surprise Move Indicator

The MACD is possibly one of the most well known Technical Indicators. The acronym means Moving Average Convergence Divergence and the indicator is calculated as the difference between a shorter and a longer moving averages.

Moving averages are used to gauge trends. The basic assumption is that a moving average helps identify a trend, and therefore when a short-term one diverges or converges to a longer term moving average, the trend is meant to continue or invert. Generally, when one moving average crosses the other traders assume the trend will invert.

MACDs are defined by the windows of the two moving averages, for example one can have 1 month vs. 3 months, 12 weeks vs. 24 weeks, and so on.

Possibly the most well known MACD combo is the 50 days vs. 200 days one, which gives rise to two colorfully named inversion events: the Golden Cross and the Death Cross. These are, respectively, the occurrence of the 50D average crossing above the 200D one, and the mirror event when the shorter average crosses below.

MacD Indicator

Financial indicator based on the assumption that security prices go through predictable changes within the same period of every year: a quarter, month, holiday period, peak period.This indicator is mostly used to predict movements in the price of commodities, such as soybeans.

On the equity side, the seasonality indicator is justified by fundamental reasons: earnings, tax season. Over the last few years, seasonal patterns in the stock market have been detected based on human behavior. For example, around Christmas, the market seems to rally upwards due to the holiday spirit and investment into the market, starting the year on a clean slate. Other patterns include liquidations at the end of each month to pay for month-end costs and fund managers selling losing positions to improve end of month performance metrics.

Investors can use this data to predict price movements in a specific period of time, based on an asset’s historical performance. However, investors should be aware of the macroeconomic environment as this can have an effect on price movements predicted by past performance.

Seasonality Indicator

Technical Indicators 

PMIs are surveys that ask companies “_How is business going compared to last month, better or worse?_” via a questionnaire made of several questions - how is business, are you hiring, are prices rising, etc….The acronym means “Purchasing Manager Index”.

The PMI for each question is expressed as the % of companies that reply “better”. New Orders PMIs in particular are the index built around the question “Is new business coming in better or worse than last month?” and are oftentimes leading the rest of the PMI complex.

New Order PMIs are the fastest gauge of trend for an industry or a whole economy. Since they are released at the beginning of the month for the previous month, they provide a much timelier alternative to GDP.

Generally high New Orders mean an economy that is doing well and low new orders mean an economy that is doing poorly.

New Orders PMIs

PMIs are surveys of companies that ask how business is doing. They are quality leading macro data and should be observed carefully. PMI stands for Purchasing Managers' Index.

The companies who produce PMIs, such as ISM in the US, send out questionnaires to large groups of companies, asking questions like “_are inventories higher or lower than last month?_”.

The results are published as a percentage of positive responses. So if the Inventory PMI is at 60, it means that 60% of companies queried have higher inventories compared to last month.

PMI surveys have many questions but the most important one, the one you should focus on, is New Orders: “_is business better or worse than last month?_”.

New Orders are among the earliest gauge of macro growth available. Keep an eye on them in the first days of each month.

So in conclusion you should decompose ‘US ISM Manufacturing New Orders PMI’ like so:

-🇺🇸 US: The Land of the Free and Home of the Brave – this implies that you can have China or Japan or Italy PMIs as well
-📦 ISM: Institute for Supply Management, a non-profit organization that conducts the survey – other institutions do the same job across the world, IHS-Markit being one of the key ones
-🏭 Manufacturing: the mega-sector aggregate of all manufacturing industries (as opposed to “service”) - you can have PMIs for any sector
-🧾 New Orders: new orders placed with a manufacturer - this is one of the survey questions, and the full list includes Inventories, Input Prices, Output Prices, Employment Costs, and much more
-🙋 PMI: an index based on a survey – PMIs as a whole are a vast category of data



US ISM Manufacturing New Orders PMI

Citi Economic Surprises is a long-standing series published by Citi’s FX research department to gauge whether the economy is “beating expectations” of economic forecasters - this is very much the concept of a company beating analyst expectations, applied to a whole economy.

Several economic indicators are included in the basket and the weights are based on the impact that economic surprises have on FX crosses.

Economic surprises are meant to be used mostly in FX trading, but most investors use them to gauge whether the economy is on an uptrend or downtrend for broader economic allocation.

![citi economic surprises](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/citi_economic_surprises_7aba9e4091/citi_economic_surprises_7aba9e4091.png)

Citi Economic Surprises

Citi Inflation Surprises is a long-standing series published by Citi’s FX research department to gauge whether inflation is “beating expectations” of economic forecasters - this is very much the concept of a company beating analyst expectations, applied to a whole economy.

Inflation surprises provide a gauge of inflation’s trend and are regarded by Currency and Treasury traders as a way to build expectations for Central Bank actions.

![citi inflation surprise](https://storage.googleapis.com/toggle-webcm/https://storage.googleapis.com/toggle-webcm/citi_inflation_surprise_36928bcdbd/citi_inflation_surprise_36928bcdbd.png)

Citi Inflation Surprises

Economic Indicators

Investing in cryptos is becoming as easy as investing in equity shares thanks to technology and the rise in demand. Bitcoin, Ethereum and Dogecoin are just a few of the crypto currencies available to be traded by investors like you and me. But how can one jump into the world of cryptocurrencies? Here’s how:

1. Choose which crypto exchange you want to use 
2. Set up a broker account with the crypto exchange 
3. Put cash into the account
4. Invest 
5. Store your coins 

**Choose your crypto exchange**

There are a number of exchanges which you can trade crypto on but each person has their own preferences. Similar to an equity exchange, a crypto exchange is a platform where buyers and sellers can transact cryptocurrencies. Some of the most well known exchanges are Binance and Coinbase. These exchanges are popular because they offer users convenience to buy and sell crypto with US dollars. Some exchanges only allow you to purchase cryptocurrencies with other cryptocurrencies. For example, buying 1 bitcoin with 13.24 ethereum coins. However, convenience costs money and usually the most beginner friendly platforms charge the highest through fees. 

Another issue with using standard trading platforms like Robinhood is that after you purchase a coin, you don’t really own the crypto. This is because you cannot transfer these assets from your trading account to a hard wallet. Some owners prefer holding their coins in crypto wallets for extra security. This way they never face an issue if Robinhood crashes or puts a halt on trading. Some advanced crypto investors hold wallets that do not connect to the internet for additional security. 


**Set up a broker account with the crypto exchange**

After you decide which crypto exchange you want to use, it’s time to set up your account. This usually involves verifying your identity to prevent fraud and ensure you meet federal regulations. This includes sending in a copy of your international identification and a selfie to verify your identity. You will not be able to transact any crypto till you complete the identity verification process. 

**Put cash into the account**

In order to start purchasing crypto currencies, you will have to fund your account by either directly connecting your bank account or adding a debit card. This usually takes a few days to approve but once it’s connected, you will be able to instantly use funds to trade any cryptos.

Watch out though! Connecting a credit card to your account will cause you to pay unnecessary charges. For example, crypto transactions usually involve paying a higher interest rate than regular purchases. In addition, the brokerage may charge you additional fees just because you’re using a credit card. So make sure to either connect your bank account or use a debit card only. 

**Invest**

Look at you - you’re ready to place your first crypto currency order! You can choose from a wide range of cryptos - ranging from big names like Bitcoin to interesting cryptos like TrumpCoin. As an investor, make sure to purchase coins whose projects mean something to you and you believe in. When purchasing a cryptocurrency, you fortunately can buy fractional shares. This means that you don’t need to spend ~ $43,000 to invest in Bitcoin. You can buy as much as you want and receive the prorated amount. For example, if you want to invest $1,000, you will only receive ~ 0.023 Bitcoin. 

The 10 current largest crypto currencies by market capitalization are: 

1. Bitcoin (BTC)
2. Ethereum (ETH)
3. Cardano (ADA)
4. Tether (USDT)
5. Binance Coin (BNB)
6. XRP (XRP)
7. Solana (SOL)
8. USD Coin (USDC)
9. Polkadot (DOT)
10. Dogecoin (DOGE)

Fun fact: dogecoin was previously in the top 5 cryptocurrencies by market capitalization however has fallen after a lack of demand (or hype in this case). 

**Store your coins**

One of the reasons why advanced crypto investors choose to store their coins on an offline wallet is because exchanges are not backed by the FDIC and at a high risk of theft through hacking. Previously, billions of dollars worth of Bitcoin have been lost after people have forgotten their keys to access their accounts. For example, [Stefan Thomas forgot the password to access his account holding crypto worth approximately $200 million](https://www.nytimes.com/2021/01/12/technology/bitcoin-passwords-wallets-fortunes.html). 

If you’re buying crypto through a broker like Robinhood, you currently don’t have a choice how your coins are stored. If you don’t want to store your crypto in your exchange wallet, you can transfer them to a hot or cold wallet. Depending on the transfer, you may have to pay a fee. Hot wallets are stored online while cold wallets are stored offline. Both are secure but cold wallets provide extra security since they are not connected to the internet. This is usually stored in a hard drive, but if you forget the key, you could end up like Stefan Thomas. 

How to invest in cryptocurrencies

**Crypto Exchange - Traded Funds (ETFs)**

ETFs allow investors to invest in a pool of assets by purchasing a single security. This can be related to a sector, index or category of assets. This provides the holder with diversification and lowers their risk, compared to investing in individual assets. There are no public investments yet but as of June 2021, the SEC is reviewing potential cryptocurrency ETF applications. 

**Crypto - Connected Companies**

Rather than directly investing in cryptocurrencies, you can invest in companies that use cryptocurrencies or the technology that powers them (blockchain). Companies include Nvidia (NVDA), PayPal (PYPL) and Square (SQ). Nvidia produces the graphics cards necessary to mine cryptocurrency, Paypal allows users to transact cryptocurrencies with their account and Square literally owns millions of dollars worth of Bitcoin. 

As mentioned, make sure you understand your current and future financial goals before investing in a risky asset like cryptocurrencies. Just like dogecoin’s market cap vanished with a few tweets, it only takes a few words to make the price of a crypto react. By investing through alternatives, this reduces your risk but you’re still exposed. 

Alternative methods to investing in crypto

When Satoshi Nakamoto created Bitcoin in 2008, he made sure that there would only be a total of 21 million bitcoins ever in circulation. This ensured that the Bitcoin system avoided inflation since the Bitcoin supply was fixed. 

However, not all those Bitcoins are currently in circulation. This is because the rest need to be “mined” - but not by someone in a cave digging for Bitcoin. Instead, a miner is a small computer that’s made to solve mathematical problems. Once the problem is solved, the answer is inputted into the bitcoin network and in return, the miner gets an award. The reward is given for securing the network and chain of transactions. What started initially as a reward of 50 bitcoins for every solution, today the reward is only 6.25 bitcoins. This is due to the growing number of miners and fixed supply of Bitcoins. 

To get the reward, a miner must try to crack a cryptographic puzzle by dedicating as much computational power to add a block of transactions to the public ledger. Of everyone who tries to mine a coin, only one account will be awarded. The computer with the most power has the highest chance of winning but that requires a lot of power. A miner requires 17 megajoules of energy to mine $1 worth of Bitcoin. That’s double the amount of energy needed during the gold rush for a miner to extract $1 of gold. As more miners try to extract Bitcoin, this makes the puzzles more challenging and more computational power is needed to be the fastest miner to solve the puzzle. Today’s S19 miner is able to handle 110 trillion computations in a second and uses ~3000 watts of power. The number of computations a miner can complete in a second is called the hash rate. 

Today, Rockdale Texas is home to the largest crypto mining hub in North America. Riot Blockchain is a Bitcoin mining company that owns Whinstone, a Rockdale-based company running 30,000 miners every single day and this is just one of the many Bitcoin mines in Texas. This is because Texas is home to some of the lowest kilowatt hour prices in the region due to the deregulated energy market. This allows industry participants to compete to secure big crypto mining clients like Whinstone. In addition, investors from [China are pouring investment in Texas mining facilities](https://www.coindesk.com/markets/2021/05/20/chinese-bitcoin-mining-company-invests-25m-in-new-facility-in-texas/) after the government banned cryptocurrencies in the country. 

The demand for Bitcoin continues to grow as companies mine for the limited supply but the energy consumption poses the greatest risk to this industry. In the long term, 73 trillion watt hours annually is not sustainable when the reward is only making a few rich. In addition, natural resources like lakes and our atmosphere are being damaged to facilitate this process. With an S19 miner, you can make ~ 30 USD/day but is that worth the environmental cost bitcoin mining has on our planet? 