Misconceptions Of The Reverse Split Video Lecture | Stock Trading: A Complete Guide (English) - Business Basics

hey what's up guys Alan here with eat
sleep trade net I want to bring you guys
a lesson video on what a reverse stock
split is and how it can affect people
that are trading from a swing trade or a
longer-term trade perspective and the
misconceptions that typically follow a
reverse stock split here's a little
diagram kind of gives you an idea of
what happens when reverse slits occur
you get a reverse split the stock gaps
up tends to have a decent run for you
know a couple of days usually and then
the company will start to dilute shares
add them to the float and raise money
for themselves and the chart usually
will head back down so we're gonna go
into what a reverse split is and why you
kind of want to stay away from reverse
splits
alright guys so let's take a look at
what a reverse stock split is and the
definition is right here which is just
off of investopedia and the basic idea
is a corporate action in which a company
reduces the total number of its shares
outstanding
now just reading that out loud it sounds
like something that's really positive
something that would increase the value
of a company because you're reducing the
outstanding shares therefore bringing up
the value at a price per share therefore
should you know in terms makes it seem
like the company should be worth more a
reverse stock split involves a company
dividing its current shares by a numbers
such as five or ten which would be
called a 1 4 5 or 1 4 10 split
respectively now one thing that people
need to understand about a reverse split
is that a reversal it does not add any
real value to the company but since the
motivation for reversal it is very
different from that of a forward split
the stock's price moves after a reverse
and forward split may be quite divergent
so yes typically after you get a reverse
split stock is gonna move for a day or
two but I'm gonna show you guys why
anybody who's already in the stock prior
to this reverse split is 90% of the time
gonna be stuck and not make any money
and not have a choice but to close a
trade out for a loss alright so let's
look at this real quick so let's say
we've got a company doesn't matter what
the company is called but let's say that
it's trading at $1 per share and you
decide you're gonna buy a hundred shares
okay so you get him at $1 each giving
you $100 position size okay and you've
got fundamentally this company's broken
it's a penny stock most of them are but
you've got news okay people on social
media are saying hey this is the next
big stock you've got believers and you
just so happen to be one of those
believers and you think that the stock's
price is going to go higher okay so
let's say now that the stock goes and
tends to fade away and stops at 50 cents
a share
so you're still sitting over here and
you have a hundred shares at 50 cents
your share and now your account value is
worth $50 okay you still believe in the
stock you think it's gonna go higher so
you continue to hold and before you know
it a reverse split is announced okay
and let's say they decide they're gonna
go and do a one for three
reverse split so what is that gonna do
that's gonna multiply our price per
share by three so we're gonna have a
stock that's now trading at a dollar
fifty per share sounds great right we
got in at a dollar and we're now trading
at a dollar fifty so we're looking
pretty good hey we thinking hey we made
our money back we're gonna be going
higher making nice profit on this but
what also happens in that reverse split
is the number of shares outstanding
which includes the shares you own is
divided by three right so that leaves
you with thirty 3.3333 shares right and
there's not a whole lot you can do with
that so we're just gonna say you were
left with thirty-four shares at a dollar
fifty okay so now your position value is
50 so now you have shares and the price
per share has gone up but your overall
account value has still gone down and
you've still lost 50% of your position
even though the stock is trading higher
and after a reverse split what happens
two fundamentally broken companies the
next step is dilution adding more shares
to the float so they take the shares out
okay and then they're gonna add them
back in which is gonna drive the price
down so let's say that this dilution
drives the price back down
to $1 you're still holding your same
shares you started with which is now 34
shares at $1 and you've got a $34
position now
so now you've lost 66% of your position
through this reverse flip right you had
a hundred shares at $1 give you $100
position the stock started to drop and
he lost half of it but you got hope when
you heard the announcement of the
reverse split but what happened after
reverse split yes the stock was worth a
dollar 50 but you've only got 34 shares
now so let's say after the reverse split
then the stock decided to run all the
way to to $2 how many shares do you have
34
now the stock price has doubled on you
and your account value is still only $64
or $68 so not only is the stock trading
at a higher price than what you bought
but it's actually gone momentum gained
momentum gone up by 50 cents in you're
left with $68 still a 32% loss even with
the soccer and back up
you're losing then what happens what
happens after more dilution well Daft
reversal it again they're gonna down
list they're gonna do this they're gonna
you know go bankrupt they need to raise
money that's how they that's what they
do right here at dilution that's how
they raise money they sell you guys
shares at a dollar fifty these shares
are really only worth a dollar and that
price shows back up after dilution and
the price is back at a dollar and you're
left with less shares from the reverse
split so I hope that kind of clears it
up for you guys that you don't want to
be stuck in a stock that's reverse
leading especially a penny stock nine
out of ten times in the penny world
reverse splick a reverse split leads to
dilution because the company needs money
and it's a losing battle for investors
and traders like you're not gonna win
this battle so stay away from the stocks
that are reverse splitting and again not
all stocks are reverse splitting because
they're doing terrible things like this
but this is a very common practice in
the penny
old and everybody needs to be aware of
that reverse slits are not something
that's awesome you get a stock alright
and you buy it right here and after you
buy it the stock fades away ok and then
it reverse split comes and after the
reverse split stock gaps right
because the price was here we reversed
it another price for shares here and
goes up so now the price is up here
which is higher than what you bought it
at but you have less shares therefore
you're still losing money and then what
happens to the company dilution then it
fades and it comes back and then it
reverse splits again here we are and you
have less shares again even though the
stock price has gone higher so what
you're left with is a buying price a
higher price than you bought it a higher
price than you bought it yet you've lost
money so keep that in mind when you guys
are trading you know penny stocks and
socks that you know are gonna be reverse
slitting and you're trading it as a
bullish outcome know that there's a lot
of people that are pretty split and they
probably feel the same way that they're
gonna make money after this split but
the reality is 90% of the time they're
gonna lose money so keep that in mind
and that's my little lesson on reverse
splits and dilution alright guys thanks
for watching and we'll see you in the
next video