How do Stock Splits Work?

Corporations have a lot of power over their stocks and can manipulate them to make them more desirable to investors and traders. One such move that a corporation can do is perform a stock split on their shares. This is a common move performed by big companies in the hope that it will make the shares seem more interesting to investors of all sizes, big or small. The concept behind a stock split is very simple and is not different to understand. As a day trader, they may never really affect but they can indicate when it is time to invest in a stock, as stock splits can act as strong predictors.stock-spilits

If you are not sure what a stock split is and why you should be bothered about them, continue to read on. It is important to familiarize yourself with these terms as you may come across them in later in your trading career

What is Stock Split?

A stock split is very similar to splitting a $20 note into two tens. The overall value of the money you’re holding has not changed by you now have two notes. So why does this matter? Well, in stocks, this can happen with individual shares.

A stock split is essentially when a company decides to split their shares to give them less value. The actual price of the stock doesn’t change but the price of individual shares does. There are a range of different splits that can occur and the most common is a 2-for-1 split, which cuts the shares by 50%. Current shareholders will get an additional share for each one they own and individuals looking to invest will now have to option to select cheaper shares. As I have stated, the overall market capitalization doesn’t budge because the overall price hasn’t changed.

You can even have a reverse-split. This is where the opposite happens where a corporation merges their shares together. For example, you could have a 1-for-10, where 10 shares are not added to produce one share. This, of course, raises price of shares 10x.

So what’s the Point of Stock Splits?

There are a range of reasons why a company might authorize a stock split. One of the most common reasons is for investor psychology. This is particularly true when the corporation is very large and their share price is very high. The high share price will deter investors from buying so my splitting the shares, it gives the impression that there is less money spent and less risk. In addition, current shareholders will feel happy that they now have more shares and will have more to trade if prices go up.what-is-stock-spilit

The benefit of a stock split is also that is increases the liquidity of the stock. This will increase with the number of shares and this can make the stock more stable. Some companies that have never split have large ask/bid price ranges because their shares are worth so much and because there is so little of them.

Conclusion

If you ask any professional or teacher in the stock market industry, they will tell you stock splits are a waste of time. They don’t really change a lot and benefit the corporations more than the investors and traders. However, a stock split can have some effect on your psychology of a stock. Just because there are cheaper shares, it doesn’t mean you should invest. However, saying this, if a company is splitting, it could indicate they’re doing well and they may be a company you want to invest in.