What is Trading on Equity and How to Do it Properly
Trading on equity is a common term used widely in both the Forex and Accounting industry. It's also one of the easier of phrases to define. But when it comes to putting it into practice, many incorrectly believe it difficult.
Here we look at trading on equity in further detail and attempt to highlight its many advantages. Greater knowledge of this term further enhances your chances in the trading arena.
What Does Trading on Equity Mean?
There are a couple of ways used to define trading on equity. Some people refer to it as using borrowed capital. A more common interpretation of it is financial leverage.
Whatever term you prefer, the concept is the same here. Trading on equity occurs when a business works to increase its earnings on its common stock. They do this using bonds, preferred stocks, and other debts.
How Trading on Equity Is Used on The Stock Market
In the stock market, trading on equity refers to the buying and selling of company stock shares. This is done so with the idea of investing such shares at a higher rate of interest.
The result of trading on equity here means earnings are increased. Returns are more significant as a result.
Example of How Trading on Equity is Treated
To highlight how trading on equity works in action, let’s assume that a company purchases assets using a long term debt. These assets expect to earn more than the interest on the debt.
Those earnings that are in excess of the new debts interest expense are of concern here. These are responsible for increasing the earnings for the business’ common stockholders. This increase tells us that the business was successful when trading on its equity.
However, there is a negative side to this. This one suggests a possible decrease in the common stockholders’ earnings. This decrease comes about when the newly purchased assets earn significantly less than the interest expense of the new debt.
How to Trade on Equity Properly for The Best Results
Now that you have a little more understanding of trading on equity, now’s the time to put it into practice. But how do you do this properly? More so, how can you ensure you get those better results each time you trade on equity?
First things first, is understanding the market you’re trading in. This usually involves public stocks or privately traded stocks. Those trades which are public stocks are the ones that are listed on the stock exchange. The private of traded stocks are generally done through dealers, referred to as over the counter.
Trading on Equity in the Equity Market
As an investor in this marketplace, you’ll bid for stocks. This means the seller will ask for a specific price and you’ll offer a certain price. In this case, many investors will be bidding on the same stock. So, if this is the case, the investor who’s first to place the bid will be first to get the stock.
For those buyers who pay any price for this stock, they’re buying at market value. Likewise, the seller taking any price for their stock is also selling at market value.
Those companies offering stock like this on the market are publicly traded ones. This means each stock will represent a piece of their ownership. Thus, it's worth noting here that when the companies do well, its investors are rewarded as the value of their stocks rise.
The risk of such a venture here is when the company isn’t doing so well. This leads to its stock falling.
The best way to trade equity on such markets as this is to understand when to buy and sell quickly and easily. Look toward the activity that surrounds the company. When there’s a high investment demand in the company, stock prices will tend to rise. When multiple investors look at selling their stock, the value will then tend to go down.
Trading on Equity in the Stock Market
As an investor on the stock exchange, here you will trade in stock on the equity market. Whether a physical stock exchange - or the more popular of choices an online stock exchange, these exist all around the world.
When trading stocks electronically, you will do so through a network of computers. This will usually involve accessing a market maker. Market makers act as the broker-dealer company. They will look to both buying and selling stocks for you to facilitate trading.
This means you’ll need to make sure that the market maker you hire here is licensed. They should be registered to operate and approved and regulated to perform this role. The ability to trade smoothly is a significant benefit. This is why more people use electronic trading as opposed to physical trading.
When trading physically, exchanges are made on the trading floor. This is done via a floor broker who is effectively doing the work for you. This broker will be paid commission on the stocks that they work.
Once again, it is essential to ensure that the broker you select here has the appropriate licensing and regulation. This ensures they’re able to trade correctly for you.
Trading Equity and Doing it Properly Alone
You may be one of the many people who trade by themselves. This can be done using the many automation and electronic services widely available. Once you’ve opened a trading account, you're ready to start buying or selling stocks, instantly.
But, before beginning trading on equity, we recommend you consider the following advice:
- Gather as much detailed information as you can before you enter into any trading activity
- Devise a methodical system to work on
- Develop a sense of discipline as you trade
- Don’t expect quick fixes
- Attempt to trial your trading efforts through a test trading platform
- Consider using fundamental analysis or technical analysis when making investments and trading decisions
Fundamental analysis refers to being aware of any events, whether big or small, which could impact a company’s bottom line. News regarding a company’s performance is so often a powerful indicator. Therefore, it pays to keep abreast of those companies you have stocks and shares in at all times.
The fundamental analysis covers all those financial aspects regularly made available for public viewing. This is in the form of an annual statement as well as quarterly reports.
You should also keep a close eye on other sources of information here. This includes news events, overall economic dates, and even the executive management team’s quality. Basically, this involves anything here that could impact company performance.
Technical analysis is the most popular method in the trading arena. This is because many traders feel able to access this with ease and thus make preferred investment decisions.
When applying technical analysis, you can gather a more detailed examination of those stock orders present on the charts. This includes the crucial aspect of the price representation of what traders are willing to pay, as opposed to what they think!
Technical analysis will provide a variety of helpful items, two of which including support and resistance as well as trend lines.
Final Thoughts on Trading on Equity and Doing it Properly
As well as working on the above advice, when it comes to equity trading, make sure you find your own place within the markets:
- Work on building up a portfolio. This helps you become accustomed to stocks from the same sector, rather than grasping to follow all the stocks on the market. Therefore, you get to familiarize yourself with their industry while concentrating on one area.
- Make a list of the events for the upcoming week. Aim to do this every weekend when the markets close on Friday. This can mean listing potential news events for a small number of your stocks. By doing this, you give yourself a chance to react to events that could impact your positions. You’ll also know what to be aware of when trading such securities.
- Be scrupulous when it comes to money management. This refers to being cautious when it comes to leverage. When trading as a beginner, it's advised that you don’t aim to risk anything more than 1% of your total cash on any trade. If you do deal with brokerage firms, you may experience them throwing money at you in the form of leverage. We strongly advise resisting the urge here.
Hopefully, you're now clearer about the term trading on equity. You may also feel it is indeed one of the simpler of trading terms after all!
Exercise a good deal of caution alongside common sense with your next trading endeavors. Thus, you’ll be assured of trading on equity more effectively. You'll also be aware of potential risk, maintaining a hold on the bigger picture as you trade.