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Held For Trading : Everything You Need to Know
When it comes to investing, there are various types of securities that investors can choose from. One such type is a held-for-trading security. Held-for-trading securities are financial instruments that are bought and held with the intention of selling them in the near term to generate profits. In this article, we will explore what held-for-trading securities are, how they are accounted for, and the advantages and disadvantages of investing in them.
What are Held-For-Trading Securities?
Held-for-trading securities, also known as trading securities, are financial assets that are bought and held by an investor with the intention of selling them in the short term to take advantage of price fluctuations. These securities are typically actively traded in the market and can include stocks, bonds, options, and derivatives.
Unlike other types of securities, such as held-to-maturity or available-for-sale securities, held-for-trading securities are not held for long-term investment purposes. Instead, they are actively traded with the goal of generating short-term profits.
Accounting for Held-For-Trading Securities
Accounting for held-for-trading securities is done under the fair value accounting method. This means that these securities are recorded at their fair value on the balance sheet, with any changes in fair value being recognized in the income statement.
When a held-for-trading security is initially purchased, it is recorded at its cost, which includes the purchase price and any transaction costs. Subsequently, the fair value of the security is determined at each reporting period, and any changes in fair value are recognized as gains or losses in the income statement.
For example, let's say an investor purchases 100 shares of XYZ Company at $50 per share as a held-for-trading security. At the end of the reporting period, the fair value of XYZ Company's shares has increased to $60 per share. The investor would recognize a gain of $1,000 ($10 per share x 100 shares) in the income statement.
3 Advantages of Investing in Held-For-Trading Securities
Investing in held-for-trading securities offers several advantages for investors:
Held-for-trading securities are actively traded in the market, which means that investors can easily buy and sell them. This provides investors with the flexibility to quickly react to market conditions and take advantage of short-term price movements.
- Profit Potential:
The main objective of investing in held-for-trading securities is to generate short-term profits. By actively trading these securities, investors can capitalize on price fluctuations and potentially earn higher returns compared to long-term investments.
Investing in held-for-trading securities allows investors to diversify their portfolio. By holding a mix of different securities, investors can spread their risk and reduce the impact of any single investment on their overall portfolio.
3 Disadvantages of Investing in Held-For-Trading Securities
While there are advantages to investing in held-for-trading securities, there are also some disadvantages that investors should be aware of:
- Higher Risk:
Held-for-trading securities are subject to higher levels of market volatility and price fluctuations. This increased risk can result in significant losses if the market moves against the investor's position.
- Short-Term Focus:
Investing in held-for-trading securities requires constant monitoring of market conditions and price movements. This short-term focus can be time-consuming and may not be suitable for all investors who prefer a more passive investment approach.
- Transaction Costs:
Due to the frequent buying and selling of held-for-trading securities, investors may incur higher transaction costs, such as brokerage fees and commissions. These costs can eat into the overall returns generated from trading activities.
Case Study: Held-For-Trading Securities in Action
To better understand how held-for-trading securities work in practice, let's consider a case study:
John is an experienced investor who actively trades stocks. He identifies a company, ABC Inc., that he believes is undervalued and has the potential for significant price appreciation in the short term. John purchases 1,000 shares of ABC Inc. as a held-for-trading security at $10 per share.
Over the next month, the price of ABC Inc. shares increases to $15 per share. Recognizing the opportunity for profit, John decides to sell his shares. He sells all 1,000 shares at $15 per share, resulting in a gain of $5,000 ($15 – $10 x 1,000 shares).
In this case, John successfully generated a profit by actively trading a held-for-trading security. However, it's important to note that not all trading activities result in gains, and investors should carefully assess the risks involved before engaging in such activities.
Summary: Thinking Short Term
Held-for-trading securities are financial assets that are bought and held with the intention of selling them in the short term to generate profits. These securities are actively traded in the market and are accounted for under the fair value accounting method. Investing in held-for-trading securities offers advantages such as liquidity, profit potential, and diversification. However, there are also disadvantages, including higher risk, short-term focus, and transaction costs. It's important for investors to carefully consider these factors and assess their risk tolerance before engaging in trading activities.