Goals Information and Trading

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1 Information and Trading Economics 71a Gitman/Madura Chapter 16 Lecture notes 9 Information sources Information Sources Web Private Free and subscription Government Federal Reserve Information Sources Key publications Economic information Federal reserve bulletins (economic info) Firm/investment data Value Line Survey Standard and Poor s Handbook Security firm reports Firm annual reports

2 Value Line Investment Survey Subscription information service Very complete Both financial data, and proprietary estimates See both page 503 and the value line website Insider Trading Information Inside Information Information about a firm not provided to the public Insiders (managers) are not supposed to trade on inside information Must reveal trades to Securities and Exchange Commission These trades then are made public Might still signal confidence or lack of confidence by management team Analyst Information Firms reveal information to analysts Analysts recommend (buy, sell, hold) Problems: Firms often are biased in what they tell analysts Other Information Events Dividends Earnings surprises Acquisitions Secondary stock offerings Often negative reaction Firm thinks price high Dilutes current share holders Stock repurchases Often positive Firm thinks stock overvalued

3 Information sources Securities Exchanges NYSE AMEX/NASDAQ Floor (AMEX) Electronic dealers (NASDAQ) Foreign markets Foreign investments in US ADR s (American depositary receipts) WEBS (World equity benchmarks) Information sources Market Orders Limit Orders Stop Orders Transactions

4 Market Order Buy or sell at the current market price No restrictions Buy 50 shares at market Limit Orders Buy when price drops below a limit Sell when price moves above a limit Example Limit buy at 50 (price at 60) Stock moves to 55 (nothing happens) Stock moves to 49 (order executed) Advantage Might end up with a better price Disadvantage Order might end up unfilled Stop Orders Buy if price reaches a certain level Going up Sell if price reaches a certain level Going down Kind of reverse of limit orders Costs of Trading Commissions Electronic trading cheap/simple Ameritrade /Etrade ($8) Discount brokers Full service brokers Bid/ask spread Buy at the ask Sell at the bid

5 Example: Ask 88.5, Bid = 88 Spreads may change Bid/ask Spread Over time Over stocks Reveal the ease of trading a stock Margins Short Sales Other Transactions Margins Borrowing money to buy stock, price = $5 Example: 50% margin, 10% interest Own funds = 100, borrowed = 100 Total shares = 200/5 = 40 Case A: Stock goes to $10 Sell for $400 Pay back loan -$110 Value at end = $290 = (more than doubled) Case B: Stock goes to $4 Sell for $160 Pay back loan $-110 Value at end = = 50 Margins Magnify gains and losses Can get in big trouble with losses Lose more than 100% of your starting value Previous example: price = $1 Ending value = -70

6 Short Sales Holding negative stock Sell stock you don t have Buy it back later Pay dividends yourself in between Key issue Make money on a price fall Lose money on a rise Betting against a stock The Mechanics of a Short Tell broker you want to sell 100 shares of IBM short (price = $50) Broker borrows shares of 100 shares of IBM owned by another client (Sam) Sells it to someone for 50*100=5000, and pays this to you When dividends are to be paid, you pay broker, and broker pays Sam The Mechanics of a Short Oddities About Shorts IBM goes down to $40 per share You buy your 100 shares to take you back to zero, pay broker 40*100=4000. Broker buys at market, and puts the shares back in Sam s account You make = 1000 (less dividends) Make money when price falls Lose money when prices rises Can lose unbounded amounts of money Normally only lose what you put in With short price can go up forever, and your losses keep increases Also, broker can get in trouble if you default Other customer could lose original shares Often insured for this Amount of shorts is interesting information on a stock (How many pessimists?)

7 Information sources Day trading Day Trading Trade by computer Trade at high frequency Several to many times per day Hope to make money off short term trends and patterns in prices Similar to other trading behavior, but now more generally available Day Trading (SEC report) May incur large losses High costs from trades Stressful/full-time Lots of margin buying Magnify small gains (and losses) Claims of easy profits exaggerated Don t believe classes Information sources

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