Stock Trading – Entry 9

I woke up one morning and saw a notification that put me in panic mode. That said, I have to ask you one question, how would you have responded to the following notification about your stock trading account?

The second I saw the word ‘loan’, the alarms in my head started sounding – which wasn’t great considering I was under the weather. The first thing I did was log in and check to make sure that I hadn’t accidentally setup any ongoing trades (e.g. always buy when the price is a certain amount or below). Nope, wasn’t that.

Then I checked my account balance. Originally, I had left enough money in there to cover the sell fee ($6 per transaction) of the first three stocks I bought. That was still there, so I hadn’t lost that money. Also, the amounts of the buy fees, purchase price of those first three stocks, and the leftover funds I just mentioned all added up correctly, so I didn’t owe anybody anything.

So, I clicked and tapped around a little more and found the following:

I discovered there was an ‘earnings’ field. Since I didn’t owe anybody anything, my mind started to switch gears and wondered what other investment type I had somehow gotten into. Then I read this article and things made sense and my panic subsided. I had the answer to the question ‘what happened’?

Basically, those 37 shares are now earning me half of 15% interest (so 7.5%). Ok, I think I like that idea. In terms of how that happened, someone is borrowing by using my shares as collateral. Oh don’t worry, those shares are currently mine, still are mine, and will continue to be mine until I sell. How is someone apparently tapping into that without it apparently affecting me?

While I don’t need to know the calculation to determine how many shares of mine can be borrowed by another party, their reasons warrant a little investigation. Besides, my panic was only beginning to subside at this point; so paranoia, concern, and curiosity were going to be my teachers.

Possible Explanation 1: Temporary Funding for the Company

The company needs more money to do something and is temporarily tapping into shareholder equity to do that. Fine. To that I would generally say, “Spend it wisely because those shares are still mine and I can sell whenever I want.” I will dive into analyzing that later in this article using two companies I currently own stocks in as examples.

Possible Explanation 2: Shorting

This involves some other investor(s) thinking the stock price will go down in the near-to-medium future. Basically, they would sell the stocks first at the current price (by borrowing mine) and then hope to actually buy stocks in that same company at a lower price later, at which point they can pocket the difference. Selling before buying is called shorting and is a way to buy into a future, potentially profitable trade. They can borrow against my stocks because the stocks will be there in the future, a contract is signed (often with prices and dates included), and the investor doing the initial selling is taking on all the risk without impacting my position. Risky for the shorting investor(s) because the stock price can easily go up, too. In any case, when that(those) investor(s) eventually buy, they use all of their own money – whether the price went down and they earn or whether the price went up and they lose. To be honest, I have known about the option to short for quite a while, but was not taught the actual mechanics of it. Now I (we) know a little bit more about it.

Am I worried about this being some kind of sign that my stocks are about to perform poorly? Nope – and this goes back to article 4 where I talk about the floor. I know where the medium-to-long-term floor is for each of my stocks and for the one in question, I am not concerned. If there is an ever-so-slight dip that someone wants to make a grand total of a few pennies, then that is fine as it does not impact my investment strategy. If I see the floor moving down, however, I would have to make a decision of either (a) selling at a loss or (b) do a bit of research to confirm that my positive outlook on the company is warranted. In this case, for 37 very cheap stocks, I am not concerned.

Possible Explanation 3: Buying Votes

An investor who already owns a significant percentage of all the stocks in that company wants more votes in one or more decisions and will borrow your stocks to, literally, buy more votes so the decision(s) will go their way. To that, I defer to a reality check. Since I have influence of less than 7% of a company (a random number I picked out of a hat), I am going to say that voting is over my head. That said, one can always check to see what decisions are coming up at a shareholders’ meeting that would prompt a significant investor to have strong motivation to seek a majority influence. Newsflash #5: A whole bunch of shareholders who own a tiny % of the company (like me at the moment) can band together, fill out legal paperwork, and act as a voting block! Kinda cool; power to the people, eh? While I don’t ever expect to get involved in those voting blocks, I do not have a crystal ball....

Possible Explanation 4: Bridging the Spread

In article 5, I mentioned the difference between the highest sell price and the lowest buy price. The gap between those two prices is called the spread. To dive any deeper with my scenario, I’d need to get into the mind of a stockbroker as to why they would want to bring these two numbers closer together for a given stock at a given moment. Due to my sheer lack of knowledge and insight in the mind of brokers, I would only really be concerned if this was happening repeatedly with the same stock because one-offs, to be honest, currently strike me as fine since it gets an investor the stocks they seek for their portfolio. I also find it incredibly difficult to identify who might lose out and why via this trading mechanism at present.

So, this leaves a deeper dive into possible explanation 1 (where the company needs some more cash). While the actual loan was for stocks in FE Battery Minerals (FE), a mineral company, I will also pretend the same thing happened to Braille Energy Systems (BES) just to show how the same analysis will likely result in different key questions that I, as an investor, would need to answer. Here we go!

So, FE. Without needing to do additional research, I know that exploratory mineral companies need money to fund their operations plus all the explorations they do – and I want them to have both to increase their chances of striking it rich. That said, I do not want them to hemorrhage money by owing lots of money to subcontractors, employees, lending institutions, etc. With FE’s financials where they were at this point, it took me less than five seconds to find this article, where they reported that FE acquired 72 mining claims in a region rich in lithium deposits. As far as I am concerned, money well spent!

Then, let’s say, it had been BES stocks, an energy company, that had borrowed my shares. If the money was to pay for a supped-up engine for another race, I would have been disappointed since I did not choose to invest in the company for that reason. If it had been to cover the costs of IP rights or manufacturing or something positively impacting operations for the commercial/residential side of the business, I would have been peachy because that would have been for long-term growth in a hot market – the reason why I invested in them. Pause for a sec. Do you see how having a significant voting block would help steer a company to grow the way you want? Future food for thought.

How does the FE stock loan stack up against the four possible explanations of why that might have happened?

The company bought more mining rights under possible explanation 1 – me like. Regarding shorting, my long-term view of the company is not in question, so I was fine with possible explanation 2. Regarding vote buying, the company was still doing what I wanted them to do so I was fine with possible explanation 3. Regarding the spread, it was pretty close in general and I have no interest in selling any time soon, so I am not concerned about possible explanation 4. At this point, I convinced myself that the status quo was the way for me to go, so I could unglue from my monitor and continue my morning. Could I have researched for a few more hours? Sure, but I thought and felt that didn’t need to know any more due to my confidence in my trading strategy and analysis.

Now Wealthsimple’s trading platform (use referral code 6FEFNA for a sign-up bonus) allows me to easily toggle whether or not I want stock loaning to be enabled. Since I am (a) not penny trading and (b) want to hold for a while, I don’t mind earning an extra 7.5%!

To find out more about other trades, deals, and concepts I find and analyze in my stock trading journey, read on.