I have previously explained wash trading, which is an illegal and prohibited practice for a long time now. However, there is a similar stock trading activity that is legal in some situations and practiced all the time, it is called a wash sale. A wash sale is the process by which someone sells his losing shares for tax deduction purpose, only to buy them back in the new year.

For example, let’s assume that someone bought a 1,000 shares of BAC at the beginning of the year when they were trading around $15. Assuming BAC closes the year 2011 at around $8, that individual will be left with a loss of $7,000. What that person does is that he sells these stocks at the end of the year, claiming an unrealized loss on his taxes, and then buys the 1,000 shares again in January, thinking that BAC will recover. As you probably would have guessed, a wash sale is the main reason behind the January effect. It is important to note that in the US, an investor cannot claim an unrealized loss from this transaction if he buys back the same securities in less than a month after he sells them. However, he’s able to add the loss, per share, to the price of each share he buys back. Let me explain, say the investor above buys back the stock at $9 in January of next year, if, at one point in 2012, the investor sells his BAC shares at $20 each, then he will only have to report gains (for tax purposes) based on the stock price of $16 ($9 price of the stock when he purchased it the second time plus $7 his loss from his first purchase). I know what most people will think right now, that a wash sale is essentially useless. Maybe, I wouldn’t care about doing it myself as I personally don’t see the point…

You can clearly see that a wash sale is completely different from a wash trade, where in the latter case, an investor buys and sells the same security in order to artificially inflate the volume and attract other investors.

More and more investors are suddenly finding the company they have shares in going private. What does that mean for the stock and the investors?

Before answering the question, let’s briefly discuss why companies go private. Companies go private for three reasons:

- They believe they have reached a certain level of prosperity that allows them to buy back the debt from the “little” investors so that “big” investors make a ridiculous amount of money.
- They have valid reasons to believe that their stock is being (negatively) manipulated in the public market.
- The main investor(s) want(s) to have full control over the company.

In all cases, going private is not a gesture of love and appreciation to small investors, it’s just a way that big investors can make a lot money.

Companies buy back shares from investors in the following ways:

- They buy them through the cash reserves they have and/or
- They buy them by getting a loan from a bank to finance the buyout of the shares.

When the company uses solely the second method, it generally means that the main investors in the company believe that the stock is negatively manipulated in the public market (otherwise what’s the point of getting a loan to pay back money that bears no interest, unless, of course, there is a plan for a scam), so they decide to get a loan from the bank and buy back the stock at a higher price either to limit their losses or to make some profit.

Now let’s answer the original question, what will happen to the stock and to the investors?

Here’s a step-by-step explanation of what will happen:

- The company decides to go private and decides on the price it will buy back the shares at, usually the company gives a premium of at least 20% over the price of the last trading day.
- Shareholders are given a few days to sell their shares through their broker at the specified price.
- After a few days, the stock will no longer trade on the public market (meaning that the company will delist itself).
- Once the stock is delisted, shareholders are no longer allowed to sell their shares through their broker. The company will then “buy them out” forcefully, which means that the company will contact them and send them a check/cash/wire totaling the price of their shares at the specified price.
- Large investors (those possessing at least 1% of the total shares) may enter into negotiations with the company to own a stake in the company.

This article (as well as all other articles on this website) is an intellectual property and copyright of Fadi El-Eter and can only appear on fadi.el-eter.com.

September 3, 2011 | In: Opinion

Is Stock Trading a Sin?

Most people that don’t trade stocks, especially those with not-so-great-education or in developing countries, believe that stock trading a sin. They think it’s a form of gambling, because one has a chance of winning and has a chance of losing.

However, here’s why I don’t think it’s a form of gambling (or a sin):

- When you do anything in life that is worth doing, you’re taking a risk. When you’re doing a trade in the normal, non-stock world (for example, you’re buying and selling apples), there is a chance that you will make money, and there is also a chance that you lose (if, for example, the market is suddenly flooded with apples, then the price of the apples will be less than you bought them, and now you have to sell them at a loss). How come buying and selling apples is not a sin, while buying and selling stocks is?

- Most investors pick stocks after doing their due diligence. They study the company, the trend of the stock, and other technical details before deciding on a stock. Compare that with gambling, where picking numbers is completely random, and luck is heavily involved.

- At one point, most people make money with their stocks, if they are patient and they don’t panic and they’re not greedy. Not selling at the right time is the reason why most people lose money on a stock. Compare that with gambling, where either you win or lose.

- Stock movement is not controlled by luck, it is controlled by known factors (such as company news, technical details of the stock, political news, economical news). Gambling consists of pure luck, bluffing, and some intelligence.

Can stock trading turn into gambling? Yes it can, this usually happens when someone does not accept loss as part of the game, this person starts doing the same thing over and over again in hope that one day he will make money, but instead, keeps losing and losing money. I’ll give you an example of this: Someone buys 1,000 shares of BAC at the current price of $7.25 in hope that the stock will reach the $10 level again in a few days. The stock drops to $6 early next week. The person panics and gets out of the stock. The stock then moves up to $10 2 weeks after, the person buys a thousand shares again, at $10,000, thinking that the stock will go up again. Immediately after he buys the stock drops to $8 because BofA was penalized for another mortgage related scandal. The guys sells again, and then buys, and then sells – all at a loss. That person is no longer trading, he’s gambling, he’s obsessed with making money just to satisfy his ego, just to demonstrate (to himself maybe) that he was right the first time. In stock trading there is no right or wrong, there is something called learning from your mistakes. Losing is part of the game… Note that the SEC admits that stock trading can become gambling on its website (I can’t find the link right now, but I remember that line “if you’re gambling in our markets…”).

Note that in many countries where gambling is not allowed, stock trading is allowed and encouraged…

September 2, 2011 | In: General

What Is Wash Trading?

I have written this article on one of my other financial websites. Since I have now decided to deprecate the other website, I thought the article can be of good use here.

Wash trading is an illegal practice where an investor buys and sells the same stocks simultaneously in order to inflate the stock price. According to the SEC, “a wash trade is a securities transaction which involves no change in the beneficial ownership of the security.”

How It Works

Wash trading is about creating hype. The most common (and obvious) technique of wash trading is selling stocks from a company through a brokerage firm, and buying the same stocks of the same company through another brokerage firm. This will inflate the volume and will draw the attention of other investors, who will look into buying the stock, thinking the high movements are real. This usually drives the price of the stock up.

An Example of Wash Trading

BIOS is a stock with typically a low volume. An investor buys 10,000 shares of BIOS, he then sells them in a few minutes, and then buys them, and then sells them (every 5 minutes). We know that the trading day starts at 9:30 and ends at 4:00, so he can do this buy-sell strategy 66 times, which means that investor alone will inflate the volume by 660,000 shares, making the daily volume 3 times of what the average is (average volume on BIOS is around 330,000 shares/day). At one point, other investors will start noticing the extraordinary volume on the stock, and will start getting into the game (e.g. buying the stock), thinking that someone knows something they don’t. When the real activity start happening, the stock price will go up in a natural way, and this is how the investor that started the wash trading process makes money.

Why Is Wash Trading Illegal?

Wash trading is illegal because it’s misleading and artificially inflates the price of the stock when there is no concrete reason for the stock price to go up. Wash trading, when discovered, can easily corrupt the image of the involved company (from an investor’s point of view), even if the company is not involved in the wash trade activity. Additionally, whoever initiated the wash trade usually has the intention to sell all the stock back, at a higher inflated price, leaving other investors who were duped into buying the stock, with an inflated stock worth less than what they paid for.

When Was Wash Trading Declared To Be Illegal?

Wash trading was declared to be illegal in 1997, after the Farni wash trading activities with the Angeion stock was uncovered, which moved the stock price to a high of $10.375 in March of 1991. The stock then fell to a low of $2.75 in July of 1991.

This article (as well as all other articles on this website) is an intellectual property and copyright of Fadi El-Eter and can only appear on fadi.el-eter.com.

August 31, 2011 | In: Technology

Is HPQ a Buy or Sell?

I was just reading an article about HP producing more of its TouchPad tablets running its soon-to-be-obsolete WebOS. HP apparently is selling these tablets at $99 each, losing about $229 for each tablet (the cost for producing each TouchPad is around $328). Of course, most of us investors are half-brained when it comes to marketing, and maybe here’s what HP is doing:

- Sell these tablets at a loss.
- Grab some market share from Apple’s iPad (the main competitor to the TouchPad).
- When the new HP tablets are released, people will be used to the old HP tablets and the new tablets will be selling like hotcakes.
- HP will rule the tablet market.

The plan above is very nice, except, of course, it has many flaws:

- Most of the people who bought these TouchPads bought them because they are cheap, and not because they needed them or wanted them.
- What’s the point of buying a new HP tablet if the old HP tablet is using a completely different OS. And even if they provide a way to migrate from one OS to the other, who would want to go through this trouble?
- With its huge cash reserves, Apple will crush HP in an instant.
- If HP continues with its strange (if not crazy) marketing strategies draining its cash reserves, the company won’t even exist to release its next generation of tablets.

Now, judging from what HP is doing since the departure of Mark Hurd over a scandal that wasn’t really a scandal, I’d say that the stock is a sell, and not only a sell, it is a very very strong sell. HPQ dropped from $46 to $26 (or 43%) since Hurd left just over a year ago, take a look at the below chart (courtesy of Google finance):

HPQ since Hurd left HP (or was fired, depends on which story you have read) back in August of 2010

Now if you want to look also at the technical details of HPQ, then you can easily see that the stock is bearish on both the short and the medium term, and very bearish on the long term. HPQ is a dead stock, and only dumb investors will buy it long term.

It’s obvious that the problem lies in HP’s management: the company is not sure of its future, it’s not sure of which products to continue/discontinue (including its laptop market – by the way, HP is the number one laptop seller in the world, if I’m not mistaken), and it has no idea what to do with its ever dwindling cash reserves (now they’re subsidizing their own products, who knows what crazy idea they’ll have next to spend all that money).

Conclusion: HPQ is no longer a buy, in fact, it stopped being a buy for more than year now, it’s a sell, sell, sell!

August 31, 2011 | In: Opinion

The Devaluation of the Dollar

I remember that 6 years ago, I was able to buy a house in my country of origin, a very nice house in a very nice area, for a mere $50,000. Fast forward to today, that same house now costs $600,000 (I’m not kidding). The price of the house was up 12 times in the span of 6 years. Apparently, the dollar has been devalued excessively over these past 6 years. But what happened that lead us here?

Well, many things happened:

- The US adventure in Iraq started bearing fruits, but these were fruits of different nature. The fruits included mistrust in the US economy because of the exorbitant spending on the war (last time I heard of this issue the US spent over $1 trillion on the Iraq war alone), massive debts, and ultimately fear from the USD as a reserve currency.

- Oil was up considerably in the past 6 years, I remember I was able to fill in my tank for something like $20 or so. Nowadays, that same tank will cost me $100 to fill. What’s interesting is that the price of gas went much more than that of oil (so while oil went up only 2 folds from then, gas prices went up 4 folds). The increase in oil prices contributed to the massive inflation.

- People working outside of the US benefited from a favorable exchange rate. Back in 2001, 90 cents used to buy a Euro. Today, you will need something like $1.44 to buy a single Euro. Same story for the Canadian dollar, the CHF (Swiss France), and the Yen.

- The economies of the BRIC countries exploded. Brazil, Russia, India, and China have all started benefiting greatly from their long term financial plans to expand their economies. That expansion came at the expense of the USD.

- While (unfortunately) Americans are getting poorer, people elsewhere are getting richer, which is increasing worldwide spending. Most people in some developing countries, such as India and China, didn’t have enough money to buy food a decade ago. That has changed, not only now they can buy food, they can also buy decent food, and they can buy luxury items. China is the number one buyer of cars since 2009, and a few weeks ago, China surpassed the US in becoming the number one buyer of personal computers, which is saying something. While the American economy is contracting, other economies are expanding at an alarming speed. Having the USD is easier than before, and it’s all about supply and demand. Imagine we’re talking about bananas, if only a few million bananas were cultivated each year, then bananas would be very expensive, but when there are billions and billions of bananas, then bananas can be sold for as little as 50 cents a pound. This is the same for the USD, when there is just too much of it worldwide, then it starts losing its intrinsic value.

- Investors are fleeing the USD to the so called hedge currencies (CAD, YEN, CHF, AUD) and gold.

- The treasury is printing money like there’s no tomorrow. The US economy is running into trouble again? No problem, let’s throw another trillion or two in the market (that’s trillion, 1 with 12 zeros next to it).

- The interest rates in the US (and thus the whole world for USD accounts) are at an all time low. Would you like to buy a house for a fixed rate of 4.5% for the next 30 years? Of course, I want to, that’s a very tempting offer! In fact, I’ll buy two houses, you know what, make that three!

The era of cheap money is now, but it will end soon. The US cannot continue, for foreign and local considerations, to devalue its dollar. However, the devaluation of the US dollar is now greatly helping the US economy, I think if the trend continues, American workers will start producing “stuff” that will be sold for Chinese consumers! I think this is the last year (at least for the medium term) where the USD will continue its decline, because of the US money policy. Next year, the Euro will become the main concern for investors (I think the Euro will vanish by 2013 anyway) as well as the other so called hedge currencies.

The dollar will survive, but its devaluation will not be reversed. That house will not go back to $50,000, well, it won’t even go back to $200,000. What’s done is done, but the dollar will be steady for years to come and will remain the number one reserve currency in the world, unless the US policy makers do something really, really terrible for the US economy.

There are many stocks that don’t experience any volume activity on a trading day. A recent example of a stock with no trading activity is EAGL. That stock didn’t experience any activity neither on Friday nor on Monday.

Take a look at the Google chart for the above stock, and you can see that the days where the stock had no volume are skipped. In short, when a stock has no volume on a trading day, then its price won’t change whatsoever. Now since the volume is nothing, it means that the stock is completely illiquid, which in its turn means, that any sell or buy transaction, regardless of the size, will significantly deflate or inflate the price.

I would avoid stocks with low or no trading volume at all costs, they are hard to sell, and the significant difference between the ask and the bid doesn’t usually make the stock worth trading. C and BAC (the latter is a stock that I really hate) both have a difference between the bid price and the ask price of only 1 cent. So, if you buy a 100 shares of C, and your commission is only $20 (both ways), then you only need to wait for the stock to increase 22 cents in price in order to start making a profit. If C was one of those bugs bunny stocks, then it would probably have to increase for more than 40 cents before you being able to make a profit.

There’s something that I forgot to mention, when you buy/sell such a stock, you have to wait, sometimes for the whole day before you find a seller or a buyer, and usually, the buy price or the sell price are then completely different than those you thought they were when you first made the transaction, so beware! (I experienced this problem in two stocks: CVBF and BIOS, but the wait was for only a few minutes, because they do have a few hundred thousand shares of daily volume, but imagine if you’re trading a stock with only a few hundred shares of average daily volume).

Again, stay away from stocks that have little or no volume, it’s not fun when you can’t find a seller or a buyer!

This article (as well as all other articles on this website) is an intellectual property and copyright of Fadi El-Eter and can only appear on fadi.el-eter.com.

Now that AIB is shown as having a zero dollar value on Google Finance, I thought that an appropriate question for many investors would be, “what will happen when a stock hits a zero”?

Let me answer this question…

When a company issues shares to be traded in the public market, its ultimate aim is to raise cheap money (to expand the business, for example). In this case, cheap money means money at no interest whatsoever. For example, let’s say a company wants $10 million dollars to build a plant. The company decides to go public, so it creates a million shares, each trading at an initial value of $10. Assuming the company sells all million shares in the market, the company will raise $10 million dollars (of course there are listing fees and other fees to be taken into consideration, but for the sake of simplicity, we are going to ignore them). Now the company has borrowed $10 million dollars from investors at 0 percent interest. The investors fund the company because either they think it will pay them dividends, or they think that the stock price will go up. In any case, the company now has the money.

Now the performance of the company directs the price of the stock in the market, if the company is performing well then the stock goes up, if the company is performing poorly, then the stock price will go down. If the company goes bankrupt (files for Chapter 11), then the stock price will drop to zero or, at best, to a few cents. In this situation, the NYSE/NASDAQ will halt its trading and all the investors will lose their money (of course, investors can sue the company, but that usually doesn’t lead to anything). So, when a stock hits zero, it means that the company is bankrupt, and has lost all the money that its investors put it.

Now you may ask this question “Isn’t this a scam?” Well, think about it this way, let’s say you gave $1,000 to a friend of yours because he needed the money to do a business. 2 days later, your friend died, and unfortunately, your friend has no kins whatsoever – no kids, wife, etc… This is the same situation, you gave some of your money to a company (instead of a friend), the company died, and now you lost all your money. Now as for the “scam” part, there are quite a few companies that go public (I can think of some) for the sole reason to steal money from the investors by convincing them that the company has actually a feasible business plan that will generate a lot of money to its investors. If you can prove that a company did this to you, then you can sue its board (who probably made a lot of money out of this scam) and win.

In a nutshell (and to conclude), here’s what will happen when a stock hits zero:

- The stock is booted from all markets, including secondary and OTC markets.
- All the investors lose their money.
- The company files for Chapter 11.

After my post on AIB delisting itself from the NYSE yesterday, I was wondering what will happen to the investor’s shares when a stock gets delisted from either the NYSE or the NASDAQ, so I just did research on this topic and I will now share my results with you!

Essentially a company is delisted (or delists itself) from the stock market for the following reasons:

  1. The company can no longer maintain the listing requirements. This typically means that the stock has dropped below the $1 level for an extended period of time.
  2. The SEC (the US market regulator) has determined that the company is deceiving investors. For example, the financial reports that the company is submitting are fake and/or misleading.
  3. The company willingly elects to get out of the stock market. This is the case of AIB last week. Usually this means that the company feels that it can no longer maintain its listing requirements on the long term.
  4. The company is filing for Chapter 11 (e.g. the company is going bankrupt).
  5. The company is receiving a buyout from another company.

The last case is the best case scenario for the shareholders, because when a company receives a buyout, its stock spikes on the last few days of trading, and investors can sell their shares at a very high price. Those who do not sell will be offered one of the following (they will be notified by mail on what will happen to their shares):

  • Shares in the new company. The amount of the shares will be equivalent to the total amount of their shares based on the buyout plan (for example, if the company decides to buy another company for $10 a share, and an investor owns a thousand shares in the latter company, then he will be offered $10,000 worth of shares in the former company)
  • Cash equivalent to the number of shares multiplied by the price per share offered by the buying company
  • A mix of shares and cash equivalent to the number of shares multiplied by the price per share offered by the buying company
  • Investors are always ecstatic when their company gets bought by another company…

    Now as for the first 3 cases, here’s what will happen:

    • The shares will still exist, however, they will no longer exist on the NYSE or the NASDAQ. They will be trading automatically on the OTC Markets, which means that the stock will be officially labeled as a penny stock.
    • The stock symbol will change. You will be notified by the company of the new stock symbol.
    • The stock will be priced at the same closing price of the last trading day on the NYSE or the NASDAQ. However, the stock price will instantly collapse because all the investors will start jumping ship. OTC markets are bad news.
    • My broker doesn’t provide me with the functionality to trade stocks on the OTC markets, and I suspect this is the same for most brokers. This means that if you want to get out of this stock it’s not as easy as entering the number of shares, entering the stock symbol, selecting “sell” as type of transaction, and clicking on submit. It will most likely be a logistical nightmare to get out of these shares.

    As for the 4th case, when a company files for bankruptcy (chapter 11), then the stock will be worthless and you will lose all your investment. The only thing that you can do at that moment is suing the company.

    Some tips:

    • It is always wise to avoid stocks hovering around the $1 level, and you should immediately sell your shares when the stock drops below $1, even for a minute. The stock can lose 20% of its value the second it starts trading on the OTC markets.
    • Avoid stocks that are consistently plagued with bad news/rumors.
    • Avoid investing in a company that has no future.
    • Avoid stocks with very high short ratio.

    This article (as well as all other articles on this website) is an intellectual property and copyright of Fadi El-Eter and can only appear on fadi.el-eter.com.

August 28, 2011 | In: Financial

AIB Delisted from the NYSE

I though there was going to be another reverse split, but I was wrong. AIB (Allied Irish Banks) elected to delist itself from the NYSE after reaching an all time low of $0.68/share (or $0.136 before taking the reverse split of 1:5 back in February into consideration).

AIB has been trading in the NYSE since January of 1991 where it started trading at $29, and has reached an all time high of $313 (both numbers are when taking the reverse split into consideration) back in February of 2007. The stock then started collapsing because of the Irish debts problem. AIB was bailed out by the Irish government last year (the Irish government technically bought AIB). The stock fell below the necessary $1 level for the first time in December of 2010, which means that back then it was below the minimum price level to maintain listing at the NYSE. AIB elected to do a reverse split in February of 2011. In August of 2011, the stock started trading below the $1 level again for 3 weeks, until AIB decided to pull the plug and get out of the US stock market.

I hate to see these things happen, but in this industry, there is no such thing as mercy. Investors decided to kill AIB and they did, driving its market cap from about $400 billion to less than a billion in just 4 years and a half.

Finally, take a look at AIB’s chart on Google finance, as probably you won’t have the chance to see it again on Google:

AIB’s price is shown at zero dollars on Google finance. I would like to buy 1.23 billion shares of AIB, at zero dollars!

I can only say farewell, and for many investors, AIB was a joyful ride most of the times. You will be missed by many investors. I do wonder though what happens to one’s shares when a stock gets delisted. I guess it’s the topic of yet another article on fadi.el-eter.com!

This article (as well as all other articles on this website) is an intellectual property and copyright of Fadi El-Eter and can only appear on fadi.el-eter.com.