What Does Stop-Loss Order Mean?
In simple words, Stop-Loss Order is an order placed with a broker to sell a share/security when it reaches a certain price as per the risk taking capacity of the investor. A stop-loss order is designed to limit an investor’s loss on a security position. It is solely decided as per the investors choice.

It is also known as a “stop order” or “stop-market order”.

Stop-Loss Order Explained:
Taking an example here, you set a Stop-loss order of 10% on a share. Now, setting a stop-loss order for 10% below the price you paid for the stock will limit your loss to 10% as the share will be sold at the stop-loss price as set by you. This strategy allows investors to determine their loss limit in advance, preventing emotional decision-making and repending later.

For example, let’s say you just purchased shares for Mahindra Satyam at Rs.120 per share. Right after buying the stock you enter a stop-loss order for Rs.100. This means that if the stock falls below Rs.100, your shares will then be sold at the prevailing market price.

When the stock fall considerably even below this set stop-loss order, you can again enter into the stock and make fresh positions. This is a very wise decision to make as here, losing some amount of money once, gives you a chance to earn even more. This not only covers your initial loss that you incurred in the very first instance but in addition, earns a good profit for you.

Positives and Negatives
The advantage of a stop order is that you don’t have to monitor on a daily basis how a stock is performing. This is especially handy when you are on vacation or in a situation that prevents you from watching your stocks for an extended period of time. In this case, you simply place a stop-loss order with the broker and when the stock price reaches this limit, it will be sold by the system on your behalf, minimizing your losses to a certain limit.

The disadvantage is that the stop price could be activated by a short-term fluctuation in a stock’s price. The key to this is picking a stop-loss percentage that allows a stock to fluctuate day to day while preventing as much downside risk as possible. Setting a 5% stop loss on a stock that has a history of fluctuating 10% or more in a week is not the best strategy. You’ll most likely just lose money on the commissions generated from the execution of your stop-loss orders.

There are no hard and fast rules for the level at which stops should be placed. This totally depends on your individual investing style: an active trader might use 5% while a long-term investor might choose 15% or more.

Another thing to keep in mind is that once your stop-loss price is reached, your stop order becomes a market order and the price at which you sell may be much different from the stop price. This is especially true in a fast-moving market where stock prices can change rapidly.

A last restriction with the stop-loss order is that many brokers do not allow you to place a stop order on certain securities.

Advantages of the Stop-Loss Order
First of all, the beauty of the stop-loss order is that it costs nothing to implement. Your regular commission is charged only once the stop-loss price has been reached and the stock must be sold. You can think of it as a free insurance policy.

Most importantly, a stop loss allows decision making to be free from any emotional influences. People tend to fall in love with stocks, believing that if they give a stock another chance, it will come around. This causes procrastination and delay, giving the stock yet another chance. In the meantime, the losses mount.

No matter what type of investor you are, you should know why you own a stock. A value investor’s criteria will be different from that of a growth investor, which will be different still from an active trader. Any one strategy may work, but only if you stick to the strategy. This also means that if you are a hardcore buy-and-hold investor, your stop-loss orders are next to useless.

The point here is to be confident in your strategy and carry through with your plan. Stop-loss orders can help you stay on track without clouding your judgment with emotion.

Finally, it’s important to realize that stop-loss orders do not guarantee you’ll make money in the stock market; you still have to make intelligent investment decisions. If you don’t, you’ll lose just as much money as you would without a stop loss, only at a much slower rate.

Conclusion
A stop-loss order is a simple tool, yet so many investors fail to use it. Whether to prevent excessive losses or to lock in profits, nearly all investing styles can benefit from this trade. Think of a stop loss as an insurance policy: you hope you never have to use it, but it’s good to know you have the protection should you need it.

For Further Reading:

1. GE extends Mah Satyam’s multi-billion dollar order by 3 yrs
2. Stock Picks for 24th July 2009
3. Man Infra gets IPO grade of 3/5 from CRISIL
4. Market Outlook and Tips for 7th Sept 2009

In addition to the technical terms like Stocks, Shares, Mutual Funds, IPOs, P/E Ratio, EPS, Dividends, and so on…, you must have many a times came across yet another term every other day in the NewsPapers, News, TV Channels called “Futures and Options” But what is this term about? What are the technical aspects and how can we make use of Futures and Options to make the most using them

This article will answer all your queries about the Futures and Options.

Futures and options represent two of the most common form of what is called as “Derivatives”. Derivatives are financial instruments that derive their value from an ‘underlying’. The underlying can be a stock issued by a company, a currency, Gold etc. The derivative instrument can be traded independently of the underlying asset.

In simple words, Futures and options are forms of exchange-regulated forward trading in which you enter into a transaction today, the settlement of which is scheduled to take place at a future date. The settlement date is called the expiry of the contract.

The value of the instrument called derivative changes according to the changes in the value of the underlying.

Derivatives are of two types — exchange traded and over the counter.

Exchange traded derivatives, as the name signifies are traded through organized exchanges around the world. These instruments can be bought and sold through these exchanges, just like the stock market. Some of the common exchange traded derivative instruments are futures and options.

Over the counter (popularly known as OTC) derivatives are not traded through the exchanges. They are not standardized and have varied features. Some of the popular OTC instruments are forwards, swaps, swaptions etc.

Now, as this article focuses mainly on the instruments called Futures and Options, we will discuss these in detail below.

Futures
A ‘Future’ is a contract to buy or sell the underlying asset for a specific price at a pre-determined time. If you buy a futures contract, it means that you promise to pay the price of the asset at a specified time. If you sell a future, you effectively make a promise to transfer the asset to the buyer of the future at a specified price at a particular time. Every futures contract has the following features:

• Buyer
• Seller
• Price
• Expiry

Some of the most popular assets on which futures contracts are available are equity stocks, indices, commodities and currency.

The difference between the price of the underlying asset in the spot market and the futures market is called ‘Basis’. (As ‘spot market’ is a market for immediate delivery) The basis is usually negative, which means that the price of the asset in the futures market is more than the price in the spot market. This is because of the interest cost, storage cost, insurance premium etc., That is, if you buy the asset in the spot market, you will be incurring all these expenses, which are not needed if you buy a futures contract. This condition of basis being negative is called as ‘Contango’.

Sometimes it is more profitable to hold the asset in physical form than in the form of futures. For eg: if you hold equity shares in your account you will receive dividends, whereas if you hold equity futures you will not be eligible for any dividend.

When these benefits overshadow the expenses associated with the holding of the asset, the basis becomes positive (i.e., the price of the asset in the spot market is more than in the futures market). This condition is called ‘Backwardation’. Backwardation generally happens if the price of the asset is expected to fall.

It is common that, as the futures contract approaches maturity, the futures price and the spot price tend to close in the gap between them ie., the basis slowly becomes zero.

Options
Options contracts are instruments that give the holder of the instrument the right to buy or sell the underlying asset at a predetermined price. An option can be a ‘call’ option or a ‘put’ option.

A call option gives the buyer, the right to buy the asset at a given price. This ‘given price’ is called ‘strike price’. It should be noted that while the holder of the call option has a right to demand sale of asset from the seller, the seller has only the obligation and not the right. For eg: if the buyer wants to buy the asset, the seller has to sell it. He does not have a right.

Similarly a ‘put’ option gives the buyer a right to sell the asset at the ‘strike price’ to the buyer. Here the buyer has the right to sell and the seller has the obligation to buy.

So in any options contract, the right to exercise the option is vested with the buyer of the contract. The seller of the contract has only the obligation and no right. As the seller of the contract bears the obligation, he is paid a price called as ‘premium’. Therefore the price that is paid for buying an option contract is called as premium.

The buyer of a call option will not exercise his option (to buy) if, on expiry, the price of the asset in the spot market is less than the strike price of the call. For eg: A bought a call at a strike price of Rs 500. On expiry the price of the asset is Rs 450. A will not exercise his call. Because he can buy the same asset from the market at Rs 450, rather than paying Rs 500 to the seller of the option.

The buyer of a put option will not exercise his option (to sell) if, on expiry, the price of the asset in the spot market is more than the strike price of the call. For eg: B bought a put at a strike price of Rs 600. On expiry the price of the asset is Rs 619. A will not exercise his put option. Because he can sell the same asset in the market at Rs 619, rather than giving it to the seller of the put option for Rs 600.

I hope that this article would be helpful to you and improve your understanding for “Futures and Options”. In case you have any views or inputs to add to the topic, please comment below.

For Further Reading:

1. Market Outlook and Tips for 27th Aug 2009
2. How to Short Sell: Earn in the Falling Markets?
3. Tata Capital NCD: Should you invest?
4. What is an IPO Green Shoe Option | Over-allotment Option?

This isn’t a type of Shoe Brand that I am going to talk about. With full respect to the genre of this investment tips finance blog, Green Shoe is a kind of option which is primarily used at the time of IPO or listing of any stock to ensure a successful opening price.

A green shoe option means that an underwriter of a security can choose to sell more stocks of the company going for IPO if the demand of the stocks exceeds the number of stocks made available for the offerring.

Any company when decides to go public generally prefers the IPO route, which it does with the help of big investment bankers also known in the financial market place as UNDERWRITERS. This sounds remotely like an UNDERTAKER but fortunately these underwriters are the guys responsible for making the issue successful and find the buyers for company’s shares. The company after making the decision to go public zeroes in to select their underwriters to find the buyers for their issue. These Underwriters also sometime help the Corporate in determining the issue price and the kind of equity dilution i.e. how many shares will be made available for the public.

But with the turbulent times prevailing in the market place, it is however quite possible that the IPO undersubscribed and trades below its issue price.

This is where these Underwriters invoke the Green shoe option to stabilize the issue.Green shoe option derives its name from the Green Shoe company of US which used it for the first time.

Green Shoe Option technically speaking or rather Wikipedia Speaking is,

A Green Shoe, also known by its legal title as an “over-allotment option” (the only way it can be referred to in a prospectus), gives underwriters the right to sell additional shares in a registered securities offering if demand for the securities is in excess of the original amount offered. The Green Shoe can vary in size up to 15% of the original number of shares offered.

This option is also called the over-allotment option.

If you find this information useful, you would also like subscribe to the EquiTipz Blog Feed here or enter you email address to get the daily tips in your inbox

For Further Reading:

1. NHPC IPO : Basis of Allotment
2. Indiabulls Power IPO to open on Oct 12
3. What is an IPO? :: What, How and Why of an IPO
4. IPO Fever: Godrej Properties IPO in November

Compound Annual Growth Rate (CAGR) is one of those typical investing technical terms that we are unable to understand until somebody quotes an example for us. It?s a bit strange because the explanation undermines the simplicity of the calculation of the growth rate in question.

Simply put, CAGR is the the fixed rate of return that will give you the exact same growth of the investment that is being talked about. Let me explaing this by taking a simple example:

A portfolio with Rs. 10,000 becomes Rs.12,000 by year one, Rs.15,000 by year two, and Rs.25,000 by year three. The CAGR is simply 0.3572, or in other words, the portfolio enjoyed a 35.72% return annually.

Below is the formula so that you can calculate CAGR on your own without any hassle:

CAGR = ((ending value / beginning value) ^ 1/compound period)) ? 1

Where CAGR is Used?
This growth rate is used often when comparing growth of two entities because this measure reduces the effects of volatility. It is also used in business to report on a specific part of its operations, like revenue, subscriber growth etc.

What This Means to Us?
With the information about CAGR, you can easily compare two different investments? historic returns. Also, it is a great tool to use in calculating your own portfolio returns to see how fast it?s growing.

In your own investment portfolio, remember though that you have most likely made deposits or withdrawal. Therefore, don?t be alarmed when you see a 80% CAGR and do not falsely believe in your investment genius!

If you find this information useful, you would surely like to subscribe to the EquiTipz Blog Feed here or enter you email address hereto get the daily tips in your inbox

For Further Reading:

1. PEG (Price to future growth ratio!) and what it tells you!
2. The Basics of Fundamental Analysis
3. How "Inflation" eats your money silently!
4. Should I buy Aqua Logistics IPO? : Angel Broking Report

If there is one number that people look at than more any other number, it is the “Price to Earning Ratio (P/E)”. The P/E is a ratio that investors throw around with confidence as if it told the complete story. Of course, it doesn’t tell the whole story (if it did, we wouldn’t need all the other numbers.) The P/E looks at the relationship between the stock price and the company’s earnings.

P/E = Stock Price / EPS

For example: A company with a share price of Rs.40 and an EPS of 8 would have a P/E of: (40 / = 5

In conclusion, the P/E tells you what the market thinks of a stock. It tells you whether the market likes or dislikes the stock. If things are vague and unclear to you, do not worry. The next ratio will make everything you read till now make sense.

For Further Reading:

1. Earnings per share (EPS) ratio & what it means!
2. PEG (Price to future growth ratio!) and what it tells you!
3. Thinksoft IPO Price band reduced
4. OIL IPO Price fixed at Rs. 1050 per share

The market is usually more concerned about the future than the present, it is always looking for some way to figure out what is going to happen in the companies future. A ratio that will help you look at future earnings growth is called the PEG ratio. You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings. PEG = (P/E) / (projected growth in earnings) For example, a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 30 / 15 = 2.

Important note:

For Further Reading:

1. Price to earning (P/E) ratio & what it means?
2. Earnings per share (EPS) ratio & what it means!
3. What is CAGR (Compound Annual Growth Rate)?
4. Thinksoft IPO Price band reduced

Even comparing the earnings of one company to another really doesn’t make any sense, if you think about it.

Earnings will tell you nothing about how many shares the company has. Because you do not know how many shares a company has, you do not know how many parts that companies earnings have to be divided into. If the company has more shares, the earnings will be divided into more parts.

For example, companies A and B both earn Rs.100, but company A has 10 shares outstanding, so each share holder has in effect earned Rs.10.On the other hand, if company B has 50 shares outstanding and they too have earned Rs.100 then each shareholder has earned Rs.2. So you see it is important to know what is the total number of outstanding shares are as well as the earnings.

Thus it makes more sense to look at earnings per share (EPS), as a comparison tool. You calculate earnings per share by taking the net earnings and divide by the outstanding shares. EPS = Net Earnings / Outstanding Shares So looking at the EPS ratio, you should go buy Company A with an EPS of 10, right? EPS is not the only basis of comparing two companies, but it is one of the methods used. Note that there are three types of EPS numbers:

Trailing EPS – last year’s numbers and the only actual EPS
Current EPS – this year’s numbers, which are still projections
Forward EPS – future numbers, which are obviously projections

EPS doesn’t tell you whether it’s a good stock to buy or what the market thinks of it. For that information, we need to look at some other ratios next….
Next – Price to earnings ratio (P/E) ratio & what is it? >>
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For Further Reading:

1. Price to earning (P/E) ratio & what it means?
2. PEG (Price to future growth ratio!) and what it tells you!
3. Factors affecting the share prices
4. OIL IPO Price fixed at Rs. 1050 per share

The Sensex is an “index”. What is an index? An index is basically an indicator. It gives you a general idea about whether most of the stocks have gone up or most of the stocks have gone down.

The Sensex is an indicator of all the major companies of the BSE.

The Nifty is an indicator of all the major companies of the NSE.

If the Sensex goes up, it means that the prices of the stocks of most of the major companies on the BSE have gone up. If the Sensex goes down, this tells you that the stock price of most of the major stocks on the BSE have gone down.

Just like the Sensex represents the top stocks of the BSE, the Nifty represents the top stocks of the NSE.

Just in case you are confused, the BSE, is the Bombay Stock Exchange and the NSE is the National Stock Exchange. The BSE is situated at Bombay and the NSE is situated at Delhi. These are the major stock exchanges in the country. There are other stock exchanges like the Calcutta Stock Exchange etc. but they are not as popular as the BSE and the NSE.Most of the stock trading in the country is done though the BSE & the NSE.

Besides Sensex and the Nifty there are many other indexes. There is an index that gives you an idea about whether the mid-cap stocks go up and down. This is called the “BSE Mid-cap Index”. There are many other types of indexes.

There is an index for the metal stocks. There is an index for the FMCG stocks. There is an index for the automobile stocks etc. If you are interested in knowing how the SENSEX is actually calculated…you must check-out our “How to calculate BSE SENSEX?” article!

But, before we go ahead and try to understand “How to make money in the stock market?” you MUST read the next page….

Next – 3 things every stock investor MUST remember >>

For Further Reading:

1. Markets Surge: Sensex and Nifty hit new 2009 Highs
2. Week Starts with Panic Monday; Nifty below 4400
3. Nifty Crosses 4700; makes a new 52-week High
4. Sensex closes flat; Reliance, ONGC plunge