Trading Securities

What are Trading Securities?

Trading Securities are companies' financial instruments that seek short-term gain from investing and trading investments. Typically, companies trade liquid securities such as stocks and bonds for a gain from the market price variance in a short period. 

Sounds familiar? Of course, this is what an ordinary person would think of “investments.” It's a popular term in the financial market, especially on Wall Street. There are dedicated exchanges and over-the-counter markets worldwide just to trade these securities. 

The trading platform is not reserved for the rich and the high-end; anyone with enough funds undertakes risks for gain, whether a corporation or an individual. Trading is open to everyone. But that doesn't mean it is for everyone. Risk plays an important factor here. 

Due to the heavy risks involved, such economic activities are regulated with rules and regulations to prevent market manipulation and insider trading. Gains and losses from these investments are also subjected to taxation based on local tax laws and held duration. 

Traders use brokerage accounts and online trading platforms to analyze market situations using technical skills to assess the current and historical records of securities’ price patterns and performance, using which the traders forecast future trends and take the next step decisions.   

Proprietary trading firms and brokerage firms actively engage in stock markets on behalf of their clients to increase the client's wealth; only the former play on a large scale using sophisticated algorithms and quantitative models to learn the market and executive decisions. 

But nothing is butterfly and roses here; beware of the stock brokers who can either make you wealthy or file for bankruptcy. Thank you, "Wolf of Wall Street". It just goes without saying how important it is to choose wisely those who deserve your trust.

“But how can we be aware of who to depend on?” Simply, just trade on a small scale at first and climb up after gaining experience. Expand your network and be around those whom you can trust. But before we reach there, why not get to know what trading is before you indulge in it?

Understanding Trading Security 

As mentioned before, trading securities is a short-term investment strategy aimed at capitalizing and profiting from the market movements or fluctuations of the security’s price value at a point in time through trading.

Simply, trading means buying securities or assets to sell shortly for a price higher than the security's book value (acquired value), depending on the security's current market price. 

Thus capitalizing on the market price fluctuations for a short-term gain. Any securities investment is recorded in the company's Statement of Financial Position (Balance Sheet) under current assets (liquidated within a year). 

Trading is indeed a risky venture with heavy market volatility. Because of this, it has become essential to implement the best strategy to overcome any unwanted obstacles and achieve the goal of realizing a quick profit for the risk taken.

Below, we mention some of the common strategies traders use when trading their held securities for a quick gain in the volatile market: 

• Day Trading: Day trading is a short-term acquiring strategy in which new securities are bought and sold on the same day due to favorable intraday price fluctuations.  
• Swing Trading: Swing trading is also another short-term acquiring strategy in which new securities are bought and held for a few days to several weeks in order to capture larger favorable price “swings” than that of day trading.
• Scalp Trading: Scalp Trading, or Scalping, is a short-term strategy of engaging in numerous small trades, preying to take advantage of small-price fluctuations.  

Now, for anyone indulging in trading securities, be it an individual or an organization, market fluctuations don't discriminate who is investing in, but rather depend upon various factors that affect its pricing, leading to adverse fluctuating, thus explaining its volatile nature. 

Below, we will explore some factors that drastically affect the market pricing of held securities and influence investors’ decisions.

• Industry Trends: The pricing of an index or a commodity differs from industry to industry. Therefore, investors consider broader economic trends and industry-specific trends to analyze the security performance. 
• Market Conditions: Every event that can affect a region’s stability will affect its market condition. Factors like geopolitics and economic conditions have a direct effect, which can be seen in the region’s stock market.  
• Investor Sentiment:  Investors are human beings just like us; if we perceive something to be bad for us before it's too late, we normally wouldn't go there. 
  • Similarly, when investors hear rumors or recommendations from others, this can heavily influence the investor’s sentiment and perception. 
• Company Performance: Company Performance: Those securities that heavily rely on the company’s performance, such as stocks/shares, influence the decisions of current or potential investors. 
  • Increased performance, the more expensive it is to acquire a share; decreased performance, the cheaper to acquire. Therefore, the financial outlook of the issuing company plays a significant role.     
• Supply and Demand: It goes without saying that any economic activity relies on this fundamental economic concept of scarcity. Any commodity that is high in demand will diminish its supply due to people buying it, leading to inflated prices to reduce demand. 
  • So is the opposite, as any commodity that is low in demand will have more available supply due to people NOT buying it, leading to reduced prices to attract customers. 
• Macroeconomic KPIs: Macroeconomic Key Performance Indicators (KPIs) are another factor driving the market price as indicators like GDP, unemployment rates, inflation, interest rates, etc, drive the sentiment and preference of a potential investor affecting the region’s market conditions. 
• Interest Rates: Interest rates are a key component an investor checks for before investing in interest-based fixed-income securities such as bonds. When the interest rates increase, the bond prices may fall, attracting potential investors for an inexpensive, stable, low-risk return. 
  • However, if the interest rates are lowered, the bond prices may go up, thus attracting fewer investors for an expensive, low-risk-less return scheme.

At its core, securities are a guarantee or assurance that the pledged property is bound to return an income or ownership. It's a financial instrument that generates wealth by indulging in a risky endeavor of market behavior capitalization. 

Therefore, securities can be based on high risk and high reward (equity), low risk and low reward (debt), or hybrid leveraging, which possesses both the qualities of equity and debt.

Securities, especially the fast-moving ones (i.e., stocks and bonds), are recorded at a fair value in the balance sheet due to regular market fluctuations, so any differences in fluctuated values are recorded in the income statement. 

Types of Trading Securities 

When liquid assets get affected regularly in an open, volatile market, potential investors must understand what securities are and their prominence in the modern financial market before engaging with them.   

Securities are of many types and forms, and all of them are bought to sell for a gain shortly by capitalizing on market fluctuations. But our focus on securities in this article is fast-moving in nature. So why don't we see some common types of traded securities? 

Stocks

Stocks, commonly known as shares, are ownership units in a specific company. Stock is the portion of ownership a company sells to bring further funds into the company to meet its operational requirements. 

Individuals or corporations who invest in stocks are considered shareholders (part owners) of the business. Acquiring part of the business involves getting involved in the company’s decisions. Therefore, the more shares are owned, the more power is retained.  

Since shareholders, the ones who hold a share, are technically owners, a percentage of the risk and profit of the business are entitled to such shareholders as per their owned share; this is called dividends. 

Financial instruments, such as stocks, are recorded in the company's statement of financial position (balance sheet). Due to its sensitivity, shares are what large corporations target when they want to acquire a small-medium company in a hostile manner.   

Bonds 

Bonds are debt instruments utilized by companies who want to preserve their ownership, along with raising capital other than traditional means, i.e., loans. The company issues bonds in the bond market, where the public buys the bond. 

The main mechanism of a bond is similar to that of a loan. Bonds ensure a fixed rate of risk-free return to its investor within a period of time (maturity rate) along with interest on the issued amount (known as coupon payment). 

Generally, bonds are available in many forms, which an investor can indulge in depending upon his/her risk tolerance level, objectivity, investment horizons, and preference. Investors with a good credit score record typically invest in bonds.

Exchange-traded funds (ETFs) 

An exchange-traded fund is the available next option that tracks a particular commodity in a stock exchange. ETFs operate similarly to a mutual fund as a pool of securities is acquired by multiple investors to diversify risk and returns instead of individually acquiring them. 

But unlike mutual funds, which are traded based on the day's end price of the issuer, ETFs are traded on stock exchanges either directly or through brokerage firms, due to which ETF holdings are updated regularly online, which increases transparency and investor confidence.

ETFs are an excellent option for those who want to take advantage of buying securities in bulk, as they have low expense ratios and low brokerage commissions. ETFs generally acquire diversity in investment portfolios to mitigate risk levels and maintain a good ROI track record.

Derivatives 

Derivatives are financial instruments based on a contractual agreement between two parties, whose value of contracts is based upon any underlying monetary value instruments (assets). 

Preferred Shares

Preferred shares are those issued by an economic entity for a premium share price offering preference over the common shares. Shareholders who hold preference shares can receive preference during dividend distribution or company liquidation.

Accounting Treatment Of Trading Securities 

Now, we are going to the accounting treatment of trading securities. As mentioned before, traded securities are generally recorded in the Statement of Financial Position (Balance Sheet) at fair value since the investment is an asset to a company. 

"But why at fair value? Aren't we supposed to record the market value of the acquired asset?"

Since the market value of a security is unstable, it is rather difficult to record the asset's market value as the balance sheet presents the economic benefit or loss at a point in time.

Hence, these securities are recorded at fair value instead of market value in the balance sheet under the 'Current Assets' section, given their nature as short-term investments, typically holding periods lasting less than a year.

From the recorded fair value, the investor evaluates the financial health of the asset by differentiating the fair value from the acquisition value. Any gain or loss in valuation is termed as unrealized gain or unrealized loss. 

After all, every transaction requires an account to record. An unrealized loss or gain from trading securities is no different and requires an account to record. 

Therefore, the investor creates a temporary account meant for unrealized loss/gain till the time comes to realize the asset (trade). Such temporary accounts can be written off and transferred to the Income Statement.

Practical Application of Trading Securities 

Let's use a simple hypothetical scenario to understand the practical implications of the standpoint of trading securities and the accounting of such transactions to give a simple technical standpoint to get a basic overview of trading securities.

Division Co is a real estate establishment interested in investing surplus revenue on financial investments for a short-term gain in stocks, as they believe such endeavors can increase shareholders' wealth even by a small margin. 

Division Co incurred a USD 150,000 surplus profit from the previous year's end, from which the company decided to invest 65% of its surplus in liquid securities (stocks) for a quick gain. 

Xiro Corp, a local company, was issuing 100,000 common shares priced at USD 10.6 per share. Due to the company's previous years' performance, the Division Co invested USD 97,500 into Xiro Corp, owning 9,198 common shares of Xiro Corp. 

The shares held by Division Co at the year-end resulted in a total value of USD 110,200, which is an unrealized 0.13% gain. The very next month, Division Co decided to sell the shares, therefore realizing an amount of USD 125,000. 

Let us see how Division Co recorded the transactions till now. 

The above journal entry accounts for Division Co’s USD 97,500 investment to acquire Xiro Corp’s stocks. 

During the year-end, Xiro Corp's shares are valued. Since recording security is at the rate of fair value due to its nature of volatility. Division Co assesses its unrealized gains and records such gains even though the gain is not materially received. 

Expected Gain - Amount Invested 

USD 110,200 - USD 97,500

USD 12,700 

The very next month the Division Co successfully sold the shares and received USD 125,000 for the sale attaining USD 27,500 in profit. Having to account for the unrealized gain in its balance sheet, Division Co now offsets it since the gain has been realized. The realized gain incurred from the trade can be computed by 

(Realized Gain - Invested Amount) - Unrealized Gain 

(USD 125,000 - USD 97,500) - USD 12,700

USD 27,500 - USD 12,700

USD 14,800

Researched and authored by Muhammed Ishfaque Ishaque | LinkedIn

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