A split is the splitting of a security with a high value into several smaller, cheaper assets. In this case, the price of the new shares is equal to the value of the underlying asset.
Examples
Split can be carried out in different proportions: 2:1, 3:1 or even 100:1 depending on how much the issuer wants to reduce the price of one share.
For example, a company has 100,000 shares outstanding at $1,000 each.
The company’s capitalization is 100,000 * 1,000 = $100,000,000.
In a 5:1 split, the number of shares will increase to 500 thousand and their price will simultaneously decrease to $200 per share.
At the same time, the capitalization will also be 500,000 * 200 = $100,000,000.
Why a Stock Split Is Performed
Often the split is carried out by issuers whose shares have significantly increased in value for individuals. Such a procedure is often carried out by American companies, as retail investors play an important role in the U.S. stock market.
Advantages of Stock Splits
- Increased Liquidity:
Stock splits often result in a reduced share price, making the stock more affordable for retail investors and traders. This increases trading volume and enhances liquidity, making it easier for market participants to buy and sell shares. - Boosted Market Perception:
Stock splits are often interpreted as a sign of confidence from the company, improving market perception. Market participants may view the company as thriving, driving demand for the stock. - Enhanced Accessibility Through Fractional Investing:
By reducing share prices, stock splits complement fractional share investing strategies. Retail investors with limited budgets can now buy whole shares or larger fractions, broadening the investor base. And that’s what short-term traders take advantage of by opening long positions. - Psychological Impact (Anchoring Bias):
Lower prices create an anchoring bias, where investors and traders perceive the stock as cheaper and more attainable, potentially increasing demand and driving prices higher in the short term. - Temporary Announcement Premium:
A split announcement often creates an announcement premium — a short-term increase in share price due to positive market participants sentiment and speculation about future performance.
Disadvantages of Stock Splits
- Stock Volatility:
Lower-priced stocks post-split can experience higher stock volatility due to increased trading activity from retail investors and speculators. This can lead to unpredictable price movements. It is very important to strictly adhere to risk management, especially if trading with a multiplier. - Short-Term Selling Pressure (Availability Bias):
Traders driven by availability bias may sell shares immediately after a split, believing the stock is at a peak. This can lead to short-term price declines and impact market capitalization temporarily. However, on MOVO, everyone has the opportunity to take short positions to capitalise on a potential correction. - No Change in Business Fundamentals:
Stock splits do not alter a company’s business fundamentals or intrinsic value. Market participants relying solely on the split as a growth signal may overestimate its impact on the company’s performance. - Increased Costs for the Company:
Companies incur legal fees and higher shareholder communication expenses during the process of splitting shares, which can marginally impact their financial statements. - Potential Misinterpretation:
Splits may cause confusion among less experienced traders, especially if the link between split pricing and market capitalization is misunderstood. This could distort trading decisions and impact shareholder trust.
How Will the Split Affect the Share Price?
A stock split follows a clear sequence of events, starting with an announcement and leading to notable price changes before and after the split.
The Announcement Phase
Usually, a split does not happen immediately. First, there is an announcement with a final date for the split. In most cases, it takes about a month. During this time, the stock tends to rise significantly.
This trend was evident in Apple (August 2020), Amazon (June 2022), Tesla (August 2022), and Nvidia (June 2024). These stocks showed gains of 15% to 25% after their split announcements. This price increase is often referred to as an “announcement premium” and reflects the market’s positive sentiment at this stage.
Post-Split Price Correction
However, after the split itself, the stock often drops noticeably over the following month. The correction can range from 10% to 20%. This is typically explained by the well-known phrase, “Buy the rumor, sell the news.” Speculators drive up the price leading up to the split and then sell their accumulated shares, creating significant selling pressure. At the same time, retail investors (or “households”) may not yet have bought enough shares to support the price rebound.
Short-Term Trading Strategy
Short-term traders have a strategy that involves opening a short position on the day of the split. These positions are typically held for a few hours to several days, with stops placed at the daily high.
However, as with any trading approach, there is no guarantee of success, so it’s essential to use Stop Loss and Take Profit orders to manage risks and maximize potential gains.
Opportunities in the Market
For traders using platforms like Movo, stock splits can create exciting opportunities. For example, Nvidia’s upcoming split on June 10 is expected to attract significant attention. With Movo’s multiplier feature, traders can magnify their potential profits up to 20 times. This makes splits like these an excellent opportunity to trade on significant market events.
The Long-Term Perspective
In the long term, stock splits are often viewed as a bullish signal. By reducing the price per share, splits make stocks more affordable to retail investors, which can lead to increased demand. Over time, this influx of investors often results in steady price appreciation, cementing stock splits as an important factor in a company’s market perception.
By understanding these phases and strategies, traders and investors can position themselves to benefit from the opportunities a stock split presents while managing their risks effectively.
Conclusion
A stock split has no direct impact on the return on investment — at least at the time of the procedure. For a trader, the split is beneficial immediately after it is carried out. After all, a lot of new opportunities open up for him — to trade a larger part of assets and earn on shorts.
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