Short selling is an arbitrage strategy, which involves the selling of an asset that is not owned by an investor. Investors use short-selling when they believe that a company’s sales are slowing and earnings will drop. However, this strategy is addressed to risk-takers and not to risk-adverse investors. The reason is that, historically, the stock market rises in value over time, but short-selling moves in the opposite direction of the market. Therefore, it requires precise timing, which is a difficult feat.  

We assume that an investor instructs his broker to short sell the shares of company X. The broker will carry out the instructions by borrowing the shares from another client and selling them in the market at the current market price. If the stock’s market price declines, the investor covers the short position by buying back the shares, which are then returned to the lender. The difference between the price the investor sells the security and the price he pays to buy it back, minus commissions and expenses for borrowing the stock is the investor’s profit. If the stock’s market price increases there are unlimited potential losses. 

Example

To illustrate the example with numbers, we assume that an investor holds 400 shares of company X and decides to short them in February when the share price is $100. The short position is closed by buying the shares back in June when the price per share is $80. We also assume a dividend of $2 is paid in April. Since the price per share declined, the investor will receive profit. 

To calculate the net gain we need to calculate the difference between the cost of buying the shares in February and the return received from selling the shares in June, minus the dividend paid in April. Therefore, the net gain is: 

(400 x $100) – (400 x $80) – (400 x $2) = $40,000 – $32,000 – $800 = $7,200 

Illustration of closing the sort position 

Purchase of shares

February: Purchase of 400 shares for $100 = 400 x $100 = – $40,000

April: Dividend $2 per share = 400 x $2 = $800

June: Sell 400 shares for $80 = 400 x $80 = $32,000

Net gain = $32,000 + $800 – $40,000 = -$7,200 

Short Selling of shares

February: Borrow 400 shares and sell them for $100 = 400 x $100 = $40,000

April: Pay Dividend $2 per share = 400 x $2 = – $800

June: Buy 400 shares for $80 to close the position = 400 x $80 = -$32,000

Net gain = $40,000 – $800 – $32,000 = $7,200 

Implications from short-selling

Short-selling concerns typically rise when markets decline. The most popular targets of short-sellers are firms with small capitalization, which have been driven by momentum investors or firms with high P/E ratios and growth rates such as banks. The recent example of the collapse of Bear Stearns is a typical example of short-selling which occurred several months before the company collapsed and led other institutions to stop doing business with it, fearing it might be in trouble.  

Another implication of short-selling is the allegations about the motives of short-sellers. Short-sellers are accused of driving down the stocks of several firms, by creating collusion and spreading rumours. 

Conclusively, short selling is a particularly risk hedge strategy and it is far from being a financial panacea. It is a complicated strategy to execute, because in the long run stock markets tend to rise.  

I work as a financial and investment advisor but my passion is writing, music and photography. Writing mostly about finance, business and music, being an amateur photographer and a professional dj, I am inspired from life.

Being a strong advocate of simplicity in life, I love my family, my partner and all the people that have stood by me with or without knowing. And I hope that someday, human nature will cease to be greedy and demanding realizing that the more we have the more we want and the more we satisfy our needs the more needs we create. And this is so needless after all.

Article Source:http://www.articlesbase.com/investing-articles/a-look-at-short-selling-stock-854209.html

Investors observe the markets within a rational expectations framework in which they exploit current available information to predict future stock returns. Taking into consideration accounting-related attributes such as price to book (P/B), price to earnings (P/E), and price to cash flow (P/CF), but also market-related attributes such as firm size, trading volume, and market returns, expectation analysis considers the beliefs of the investors and speculators to best estimate the future direction of stock prices. 

Expectation analysis is an investment analysis that enables analysts to forecast the economy’s future direction based on current fundamentals or trends. Given that the accuracy of the estimates cannot be measured when estimates are measured, economic forecasts have to be scientific, that is formulated by verifiable predictions based on explicitly stated statistical method that can be checked or reproduced. Or else, the validity of the forecasts is at stake and the forecast reliability is an unstable basis for further scientific progress. Considering the current financial environment and the assumptions behind the estimates, expectation analysis constantly monitors the data produced in the form of information available to investors in order to identify any changes in the environment or violation of the analyst’s assumptions.  

Expectation analysis is concluded in four stages.  

(1) In the first stage, expectation analysis forecasts the broader economic, political and demographic trends. This stage includes assumptions about monetary and fiscal policy, political conditions and initiatives, trade partnerships and others.  

(2) In the second stage, expectation analysis relates the macroeconomic forecasts to certain sectors of the economy aiming to identify how GDP components – such as government spending, consumption, investment, and net exports – change over time.  

(3) In the third stage, expectation analysis relates the macro and sector forecasts from the previous stages to industry analysis. The microeconomic analysis estimates price elasticity, competitive positioning and other micro and macro trends that are particularly relevant to the industry specialization. 

(4) In the fourth stage, expectation analysis adapts economic and industry analysis to the individual firm. Within this context, analysts use the Porter’s Five Forces Model which identifies the bargaining power of suppliers, the bargaining power of buyers, the threat of new entrants, the potential substitutes and the current rivalry as the five forces that may affect the competitive structure of the firm. 

After each stage of expectation analysis is concluded, relevant variables are produced in order to be monitored in relation to the forecasts made. In this context, expectation analysis tracks the relationship between the analysts’ estimates and the expected industry performance aiming to weigh the implications of new information on industry analysis and economic outlook. In case of violation of the analysts’ assumptions, estimates are reviewed and adjusted to the new market realities so that investors receive accurate information on the state of the economy and rebuild their rational expectations framework for future stock-market performance.

I work as a financial and investment advisor but my passion is writing, music and photography. Writing mostly about finance, business and music, being an amateur photographer and a professional dj, I am inspired from life.

Being a strong advocate of simplicity in life, I love my family, my partner and all the people that have stood by me with or without knowing. And I hope that someday, human nature will cease to be greedy and demanding realizing that the more we have the more we want and the more we satisfy our needs the more needs we create. And this is so needless after all.

Article Source:http://www.articlesbase.com/investing-articles/expectation-analysis-on-expected-stock-returns-854216.html

The main characteristic of U.S. stock exchange was mass speculation throughout the late 1920′s. In 1929 alone, a record volume of 1,124 billion shares were traded on the New York Stock Exchange, while in less than one year Dow Jones Industrial average rose from 191 to 381. This situation intrigued investors, who became uninterested in corporate results and focused on the potential profits from the constant increase in the stock prices. Moreover, investors were buying stocks on margin by borrowing from their brokers as they didn’t actually have the money to purchase them. This led to an absurd increase of market performance and incurred huge profits for the investors. In the 1930s, the total of outstanding brokers’ loans was $8.5 billion, while interest rates for broker’s loans were skyrocketing reaching even 20%.  

In this speculative environment, the stock prices had begun declining since September 3, 1929, but on October 21 a free fall of prices panicked mostly the average investors, who started selling quickly in the fear of even greater losses. Although the prices stabilized the next two, on October 24 the system collapsed collectively as institutional and major investors lost confidence in the market. Big banking corporations tried to stop the crash, but it was obvious that the market’s correction mechanisms could not work under these panicky conditions. On Tuesday, October 29, 1929 Dow Jones recorded a decline of 13% and 16.4 million shares changes hands. 

Black Tuesday of October 29, 1929 is broadly considered as the beginning of the Great Depression Era for the United States, but also for the economic system around the globe. However, it is a fact that, since September 1929 the U.S. stock exchange had declined by nearly 40% in less than five weeks. It is also a fact that since the beginning of 1920s, capitalist systems had experienced periods of panic and depressions as a result of ineffective economic policies and practices, both governmental and private. In this turbulent environment, investors had lost their confidence to the market before 1929, but they kept on investing being captured by extreme profitability from margin investing.  

Therefore, Black Tuesday did not exactly caused the Great Depression. It was actually a correction of the market considering the 13% losses of that day compared to the average of 40% of the previous weeks. However, as market mechanisms were unable to reverse the situation and force required correction of errors, stock exchange ultimately collapsed.

I work as a financial and investment advisor but my passion is writing, music and photography. Writing mostly about finance, business and music, being an amateur photographer and a professional dj, I am inspired from life.

Being a strong advocate of simplicity in life, I love my family, my partner and all the people that have stood by me with or without knowing. And I hope that someday, human nature will cease to be greedy and demanding realizing that the more we have the more we want and the more we satisfy our needs the more needs we create. And this is so needless after all.

Article Source:http://www.articlesbase.com/investing-articles/a-look-at-the-black-tuesday-crash-of-the-new-york-stock-exchange-and-if-it-caused-the-great-depression-854213.html