Insider Trading

Security analysts gather and compile information, talk to corporate officers and other insiders, and issue recommendations to traders. Thus their activities may easily cross legal lines if they are not especially careful.
The CFA Institute in its code of ethics states that analysts should make every effort to make all reports available to all the broker's clients on a timely basis.

Analysts should never report material nonpublic information, except in an effort to make that information available to the general public. Nevertheless, analysts' reports may contain a variety of information that is "pieced together" without violating insider trading laws, under the mosaic theory.

This information may include non-material nonpublic information as well as material public information, which may increase in value when properly compiled and documented.

In May 2007, a bill entitled the

"Stop Trading on Congressional Knowledge Act, or STOCK Act"

was introduced that would hold congressional and federal employees liable for stock trades they made using information they gained through their jobs and also regulate analysts or "Political Intelligence" firms that research government activities.

The bill has not passed.

Traders

Since insiders are required to report their trades, others often track these traders, and there is a school of investing which follows the lead of insiders.

This is of course subject to the risk that an insider is making a buy specifically to increase investor confidence, or making a sell for reasons unrelated to the health of the company (e.g. a desire to diversify or pay a personal expense).

As of December 2005 companies are required to announce times to their employees as to when they can safely trade without being accused of trading on inside information.

Trading on Information in General

Not all trading on information is illegal inside trading, however.

For example;
While dining at a restaurant, you hear the CEO of Company A at the next table telling the CFO that the company will be taken over, and then you buy the stock, you might not be guilty of insider trading unless there was some closer connection between you, the company, or the company officers.

Illegal Insider Trading

Rules against insider trading on material non-public information exist in most jurisdictions around the world, though the details and the efforts to enforce them vary considerably. The United States is generally viewed as having the strictest laws against illegal insider trading, and makes the most serious efforts to enforce them.

For example;
Illegal insider trading would occur if the chief executive officer of Company A learned (prior to a public announcement) that Company A will be taken over, and bought shares in Company A knowing that the share price would likely rise.

Legal Insider Trading

Legal trades by insiders are common, as employees of publicly-traded corporations often have stock or stock options. These trades are made public in the US through SEC filings, mainly Form Prior to 2001, US law restricted trading such that insiders mainly traded during windows when their inside information was public, such as soon after earnings releases.

SEC Rule 10b5-I clarified that the U.S. prohibition against insider trading does not require proof that an insider actually used material nonpublic information when conducting a trade; possession of such information alone is sufficient to violate the provision, and the SEC would impute an insider in possession of material nonpublic information uses this information when conducting a trade.

However, Rule 10b5-I also created for insiders an affirmative defense if the insider can demonstrate that the trades conducted on behalf of the insider were conducted as part of a preexisting contract or written, binding plan for trading in the future.

For example;
if a corporate insider plans on retiring after a period of time and, as part of his or her retirement planning, adopts a written, binding plan to sell a specific amount of the company's stock every month for the next two years, and during this period the insider comes into possession of material nonpublic information about the company, any subsequent trades based on the original plan might not constitute prohibited insider trading.

Leverage

In finance, leverage (or gearing) is borrowing money to supplement existing funds for investment in such a way that the potential positive or negative outcome is magnified and/or enhanced.

It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity.

Deleveraging is the action of reducing borrowings.

Casual Trading and Floor Trading

The principal differences between casual trading and floor trading are in the traders' experience, volume and location. Professional traders usually carry out their trades from the trading floor and carry large volumes.

Casual traders do not trade as a profession but as an addition to their everyday lives. They usually trade from their own homes or "day job" offices using an Internet connection and a trading platform software day trading software, which is monitored and regulated by the National Futures Association (NFA).

General Trading Markets

There are three major markets in casual trading. They are -- stocks, foreign exchange (forex) and commodities.

Stock market stock trading or (equity trading) is trading of company stock and derivatives of company stock at an agreed price. Both of these are securities listed on a stock exchange as well as those only traded privately.

In foreign exchange (currency or forex or FX), market traders select a currency pair in which one currency is traded for another. It is by far the largest financial market in the world, with the average daily trade in the global forex and related markets estimated at US$ 3 trillion.

In forex, it is common to use leveraging which enables traders to generate large profits but which is considered quite risky for the inexperienced trader.

Commodities are things for which there is demand, but which are supplied without qualitative differentiation across a given market. Characteristic of commodities is that their prices are determined as a function of their market as a whole.

Generally, these are basic resources and agricultural products such as iron ore, crude oil, coal, etc

Casual Trading

Casual trading is a newly developed variant of financial trading. It consists of the same principles carried out in trading rooms but involves the use of trading platforms that can be operated from the trader's residence.

Casual trading is a general name for all trading actions that are carried out by individuals without the use of a mediator. They can be found in stock exchange, foreign exchange, commodities and other markets.

Magic Formula Investing

The Little Book That Beats The Market
by: Joel Greenblatt

It was a milestone book in value investing. In a short 155 pages that can be read in 2 hours and understood by anyone, Mr. Greenblatt concisely lays out a simple investment strategy where stocks are picked by only 2 factors: pre-tax return on tangible capital (ROTC), and earnings yield. A high ROTC is a sign of a good company. A high earnings yield is a sign of a cheap stock. The "Magic Formula" simply ranks all U.S. stocks by both metrics, adds them together, and buys the highest ranked stocks.

Simple, right? And to simplify things even more, Mr. Greenblatt advises to buy 5-7 stocks every few months, holding them for a year and then selling, replacing with new picks. He even created a website, www.magicformulainvesting.com, that lists all the current stocks by his rankings.


Magic Formula Investing is a term that refers to an investment technique outlined by Joel Greenblatt that uses the principles of value investing.

1. Establish a minimum market capitalization (usually greater than $50 million).
2. Exclude utility and financial stocks
3. Exclude foreign companies (American Depositary Receipts)
4. Determine company's earnings yield = EBIT / enterprise value.
5. Determine company's return on capital = EBIT / (Net fixed assets + working capital)
6. Rank all companies above chosen market capitalization by highest earnings yield andhighest return on capital (ranked as percentages).
7. Invest in 20-30 highest ranked companies, accumulating 2-3 positions per month over a 12-month period.
8. Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark.
9. Continue over long-term (3-5 year) period.

Barbell Strategy

In finance, a Barbell strategy is formed when a Trader invests in Long and Short duration bonds but does not invest in the intermediate duration bonds.

The Short Duration Bond Portfolio strategy invests in high-quality short- and ultra short-term bond funds, floating rate high-income funds, intermediate bond funds, intermediate government income bond funds, and mortgage-backed securities funds.

Bond volatility and risk is managed by using fundamental, technical, and cyclical analysis. Careful monitoring of the money supply and the direction of interest rates is essential for reading developing economic trends and how that might influence bonds. Relative strength comparisons between high-grade bond funds and high-yield bond funds are helpful in identifying dominant trends. Oscillators are especially useful in identifying cyclical influences.

This strategy is ideal for defensive investors focused on capital preservation during difficult economic times. This strategy provides lower volatility risk relative to the U.S. stock market. Consequently, in a weak economic environment, high-grade bonds will rally in value.


The opposite is Bullet strategy.

ECNs and the Stock Market

For stock, ECNs exist as a class of SEC-permitted Alternative Trading Systems (ATS). As an ATS, ECNs exclude broker-dealers' internal crossing networks – i.e., systems that match orders at the broker-dealer using prices from an exchange, without actually sending the order to a public venue.

ECNs and the Currency Market

FX ECNs, like Baxter-FX, provides access to an electronic trading network, supplied with streaming quotes from the top tier banks in the world. The matching engine performs limit check and matches orders in less than 100 milliseconds per trade.

The matching is quote driven and these are the prices that match against all orders. Spreads are discretionary but in general multibank competition creates 1-2 ticks on Majors and Euro Crosses.

The order book is not a routing system that sends orders to individual market makers. It is a live exchange type book working against the best bid/offer of all quotes.

By trading through an ECN, a currency trader generally benefits from greater price transparency, faster processing, increased liquidity and more availability in the marketplace.

The banks also reduce their costs as there is less manual..

Electronic Communication Network

An electronic communication network (ECN) is the term used in financial circles for a type of computer system that facilitates trading of financial products outside of stock exchanges.

The primary products that are traded on ECNs are stocks and currencies. ECNs came into existence in 1998 when the SEC authorized their creation.

ECNs increase competition among trading firms by lowering transaction costs, giving clients full access to their order books, and offering order matching outside of traditional exchange hours.

Selling Strategy Indices

These indices have been sold under the following premises which need not be always true,

1. They offer a new asset class that is uncorrelated to conventional asset classes such as equities, bonds and commodities.

2. Compared to hedgefunds and mutual funds, these strategies are very transparent and the client can buy them only if they like the idea behind the strategy.

3. Some types of strategies also benefit from accounting reasons, for instance, in Germany, Notes linked to interest rates can be issued in the Schuldshein format. This enables interest rate linked strategies to be issued as Schuldsheins.

Developing and Trading Strategies Indices

Strategy Indices are indices that track the performance of an algorithmic trading strategy. The algorithm clearly and transparently specifies all the actions that need to be taken. The following are examples of algorithms that strategies can be based on.

1) Pairs Trading Strategy. This strategy examines pairs of instruments that are known to be statistically correlated. For example, consider Shell and Exxon. Both are oil stocks and are likely to move together. Knowledge of this trend creates an opportunity for profit, as on the occasions when these stocks break correlation for an instant, the trader may buy one and sell the other at a premium.

2) Fed Funds Curve Strategy This strategy takes a view on the shape of the curve based on the actions of the Fed. In this strategy, one puts on a steepener or flattener, based on whether the Federal Reserve has cut the benchmark rate or raised it. This is based on the conventional wisdom that the curve steepens when the rate is expected to be cut and vice versa.

3) Implied Volatility against Realized Volatility In a number of markets such as commodities and rates, the implied volatility, as implied by straddle prices is higher than the realized volatility of the underlying forward. One way to 'exploit' this is to sell a short expiry straddle on day 1 and delta-hedge the straddle every day. The strategy makes money if at expiry, the premium received, the final value of the straddle and the final value of the forwards is greater than zero.

Correlation Trading

In finance, correlation trading is a strategy in which the investor gets exposure to the average correlation of an index.

The key to correlation trading is understanding the principle of diversification -- that the volatility of a portfolio of securities is less than (or equal to) the volatility of a single security in that portfolio.

The lower the correlation among the individual securities, the lower the overall volatility of the entire portfolio.

To buy correlation, investors can:
a. buy a portfolio of options on the index and sell a portfolio of options on the individual constituents of the index.
b. buy a variance swap on the index and sell the variance swaps on the individual constituents.

Equity Risk

Equity risk is the risk that one's investments will depreciate because of stock market dynamics causing one to lose money.

The measure of risk used in the equity markets is typically the standard deviation of a security's price over a number of periods.

The standard deviation will delineate the normal fluctuations one can expect in that particular security above and below the mean, or average.

However, since most investors would not consider fluctuations above the average return as "risk", some economists prefer other means of measuring it.

Equity Premium Puzzle

The equity premium puzzle is a term coined in 1985 by economists Rajnish Mehra and Edward C. Prescott. It is based on the observation that in order to reconcile the much higher return on equity stock compared to government bonds in the United States, individuals must have implausibly high risk aversion according to standard economics models.

Similar situations prevail in many other industrialized countries. The puzzle has led to an extensive research effort in both macroeconomics and finance. So far a range of useful theoretical tools and several plausible explanations have been presented, but a solution generally accepted by the economics profession remains elusive.

In addition to explanations of the puzzle, some deny that there is an equity premium at all; notably, following the stock market crashes of the late 2000s recession, there has been no global equity premium over the 30-year period 1979–2009, as observed by Bloomberg.

In the United States, the observed "equity premium" - the risk premium (in fact the historical outperformance) on equity in stocks vs. government bonds - over the past century was approximately 6% per annum.

However, over any one decade, the outperformance had great variability - from over 19% in the 1950s to 0.3% in the 1970s. It is this gap that is much larger than would be predicted on the basis of standard models of financial markets and assumptions about risk attitudes.

To quantify the level of risk aversion implied if these figures represented the expected outperformance of equities over bonds, investors would have to be indifferent between a bet equally likely to pay $50,000 or $100,000 (an expected value of $75,000) and a certain payoff of $51,209 (Mankiw and Zeldes, 1991).

Equity investment

Equity investment generally refers to the buying and holding of shares of stock on a stock market by individuals and funds in anticipation of income from dividends and capital gain as the value of the stock rises.

It also sometimes refers to the acquisition of equity (ownership) participation in a private (unlisted) company or a startup (a company being created or newly created).

When the investment is in infant companies, it is referred to as venture capital investing and is generally understood to be higher risk than investment in listed going-concern situations.

Financial statements

Generally, the call will begin with a company official reading a safe harbor statement to limit the company's liability should the future prove different from that stated in the discussion. Then one or more company officials, often including the Chief executive officer and Chief financial officer will discuss the operational results and financial statements for the period just ended and their outlook for the future.

The teleconference will then be opened for questions by investors, financial analysts, and other call participants. Management will answer many of these questions, although if the data is not available to them they may decline or defer response. Depending on the size and complexity of the company, the difference between actual and expected results, and other factors, the length of the call will vary.

There is no general requirement for how far in advance notice of a call must be given. However, keeping the investor and analyst communities happy is part of management's job, so the call will generally be announced a few days or weeks in advance. If the company has a website, there will probably be a section titled Investor Relations or Investors - this is the most likely part of their website to contain both call schedules and archived past calls.

Many companies are tracked by financial analysts that publish estimates of earnings per share. The company may also provide guidance as to what earnings per share are likely to be. If management knows that its results are going to be significiantly different from its guidance or from analyst expectations, it may choose to make a preannouncement of differing results.

Income Statement - earnings per share

Earnings Calls are a teleconference in which a public company discusses the financial results of a reporting period. The name comes from the bottom line numbers in the income statement - earnings per share.

The U.S. based National Investor Relations Institute says that 92% of companies represented by their members conduct earnings calls and that virtually all of these are webcast.

Transcripts of calls may be made available either by the company or a third party.
The calls are usually preceded or accompanied by a press release containing a summary of the financial results, and possibly also by a more detailed filing under securities law.

Earnings calls usually happen, or at least begin, while the stock market on which the company's shares are traded is closed to trading, so that all investors will have had a chance to hear management's presentation before trading in the stock resumes.

Electronic trading

Electronic trading, sometimes called etrading, is a method of trading securities (such as stocks, and bonds), foreign currency, and exchange traded derivatives electronically.

It uses information technology to bring together buyers and sellers through electronic media to create a virtual market place. NASDAQ, NYSE Arca and Globex are examples of electronic market places.

Exchanges that facilitate electronic trading in the United States are regulated by either the Securities and Exchange Commission or [[CFTC, and are generally called electronic communications networks or ECNs.

Etrading is widely believed to be more reliable than older methods of trade processing, but glitches and cancelled trades do occur.

In modern times, financial institutions are facing unprecedented challenge in the form of exponential growth in trading volumes, order handling, trade routing and other trade applications. Scalable, cutting edge, feature rich Electronic Trading software solutions that include robust architectures are required to address these challenges. Financial industry participants trade with FIX and other related protocols, to ensure that their trading practices enhance their abilities to achieve the optimum level of straight through processing capabilities and comply with the stipulated regulatory norms. .

Direct public offering

A company pursues a direct public offering (DPO) to raise capital by marketing its shares directly to its own customers, employees, suppliers, distributors and friends in the community.

DPOs are an alternative to underwritten public offerings by securities broker-dealer firms where a company's shares are sold to the broker's customers and prospects.

Direct public offerings are considerably less expensive than traditional underwritten offerings. Additionally, they don't have the restrictions that are usually associated with bank and venture capital financing.

On the other hand, a DPO will typically raise much less than a traditional offering.

Direct access trading

Direct access trading is a technology which allows stock traders to trade directly with market makers or specialists, rather than trading through stock brokers.

Direct access trading systems use front-end trading software and high-speed computer links to stock exchanges such as NASDAQ, NYSE and the various Electronic Communications Networks.

Direct access trading system transactions are executed in a fraction of a second and their confirmations are instantly displayed on the trader's computer screen.

This is in contrast to a typical conventional online trader who requires seconds or minutes to execute a trade.

After-hours trading

After-hours trading is stock trading that occurs outside the traditional trading hours of the major exchanges, such as the New York Stock Exchange and the Nasdaq Stock Market.

Since 1985 the regular trading hours have been from 9:30 a.m. to 4:00 p.m. Eastern Time.
Trading outside these regular hours is not a new phenomenon, but it has generally been limited to high net-worth investors and institutional investors, such as mutual funds.

The emergence of private trading systems, known as electronic communication networks, or ECNs, has allowed individual investors to participate in after-hours trading.

After Hours trading on a day with a normal session is 4:15 - 8 p.m. EST

Automated trading system

An automated trading system (ATS) is a computer trading program that automatically submits trades to an exchange.

An example of an early ATS is Instinet.
This allows traders to input trades invisibly to the market, with a crossing price determined by a VWAP measure. Instinet also enables anonymous conversations and negotiations to take place between bidders, and so reduces informational costs to the participants.

Automated trading platform

An automated trading platform is used both by trading system publishers, and the investors who subscribe to them. Using it, traders can track marked-to-market performance using several different metrics for verifiability.

1. In addition to tracking performance of these "black box" systems, the automated trading platform also provides a venue to permit the system's buy/sell signals to be executed to the subscriber's brokerage account automatically. Some of the automated trading platforms are completely broker-agnostic and permit an interface with almost any brokerage firm.
The immediate benefit to investors is that it allows them to have insight into various trading systems that are on offer, which may make claims of profitability.

The platform "allows people or institutions that believe they can outperform the market to prove to the public in a verifiable way that they indeed can do so."

2. In the second stage of use, traders subscribe to one or more of these trading methodologies, and have the trades that are specified by the system executed automatically in a brokerage account.
Although turning over decisions and execution to a "black box" system requires the investor to give up an element of control, the automated trading platform does serve the purpose of allowing the trader to spend more time on strategy and on studying trends, rather than executing those strategies manually.