financial

Fact checked by Vikki Velasquez
Reviewed by Andy Smith

Exchange-Traded Products (ETPs) vs. Exchange-Traded Funds (ETFs): An Overview

Exchange-traded products (ETPs) offer investors diversity and liquidity through pooled investments that trade on stock exchanges, akin to individual stocks. ETPs are not stocks; they are sophisticated financial instruments that can pool a variety of investment types, including funds and commodities, traded like stocks.

Among ETPs, exchange-traded funds (ETFs) are the best known, and offer flexibility, cost efficiency, and comparatively lower fees. ETFs often mirror the performance of indexes, sectors, or commodities prices, providing a transparent and effective way to invest in entire markets or specific economic niches without having to buy the underlying assets.

Key Takeaways

• Exchange-traded products are accessible investments offering diversification and liquidity.
• Exchange-traded funds are a specific type of ETP that tracks an underlying index and can be bought and sold on an exchange throughout the trading day.
• ETPs also include other exchange-traded instruments, such as exchange-traded notes and exchange-traded commodities.
• Factors to consider when choosing between ETPs and ETFs include expense ratios, liquidity options, diversification, and regulatory oversight.
• Investors should thoroughly research any ETP or ETF and seek professional advice before investing in them.

With ETPs, the pooling of different investment types enables both seasoned and novice investors to access a broad range of assets, from traditional stocks and bonds to more niche markets like commodities or specific industry sectors, all with the ease of buying and selling shares throughout the trading day. ETPs not only provide a platform for portfolio diversification but also enhance the financial ecosystem’s adaptability, allowing investors to respond swiftly to market changes and opportunities.

ETPs include other securities beyond ETFs, such as exchange-traded notes (ETNs) and exchange-traded commodities (ETCs). ETNs are debt instruments that track an index while carrying credit risk, while ETCs offer exposure to commodities and currencies, but can face unique risks discussed below.

Exchange-Traded Products

ETPs bundle securities into a portfolio to provide exposure to a wide array of assets, all while trading like stocks on major stock exchanges. These products are designed to offer diversified exposure, high liquidity, transparency, and cost efficiency.

The first ETP is thought to be the Standard & Poor’s Depositary Receipts (SPDRs), commonly known as “Spiders.” The first SPDR was introduced in 1993 and is now known by its ticker symbol, SPY. This product was designed to track the S&P 500 Index, allowing investors to buy shares in a portfolio that mirrors the performance of the S&P 500.

The approval process for the first ETP was a significant milestone in financial markets, requiring collaboration among the American Stock Exchange, the Securities and Exchange Commission (SEC), and State Street Global Advisors, which developed and sponsored the ETP.

Before SPY’s debut, trading the S&P 500 Index was difficult, and investors had to dig into each component stock. SPY would expose investors to the broad index through a single product. Given the novelty of this product, there were regulatory and logistical hurdles to overcome. Until then, stock exchanges focused on individual company stocks rather than pooled investment products.

SPDRs adopted a unique share creation/redemption mechanism to assuage regulators to keep their prices closely aligned with the index it tracked. This mechanism allowed large broker-dealers to exchange underlying stocks for shares of the SPY ETP with the fund manager.

SPDRs paved the way for the ETP industry by proving the appeal and feasibility of packaged financial products that supply diversified exposure to indexes through a publicly traded security. SPY remains the world’s largest and most actively traded ETP, with an average of around 55 million shares exchanged daily and $602 billion in assets during the previous three months as of March 12, 2025.

Key Characteristics of ETPs

ETPs have these main elements:

• Basket of securities in one security: Each ETP contains a portfolio or basket of assets rather than a single security. The basket can include stocks, bonds, commodities, currencies, and more. This provides instant diversification.
• Traded on exchanges: ETPs trade on major stock exchanges like individual stocks, allowing investors to buy and sell them throughout the trading day via their broker.
• Intraday pricing: The price of an ETP fluctuates throughout the day based on supply and demand, allowing for real-time pricing and trading flexibility.
• Cost-effective: A pivotal feature of ETPs is that they often offer low management fees and expense ratios, making them less costly to trade than mutual funds or even the underlying securities they hold. In addition, many brokerages today offer commission-free trading for these products.

Benefits of ETPs

Several advantages make ETPs an appealing investment vehicle:

• Diversification: ETPs provide instant diversification across asset classes, market sectors, industries, geographic regions, and more. Investors gain broad exposure through a single ticker.
• Liquidity: The ability to trade ETPs seamlessly throughout the day on major exchanges provides constant liquidity. This distinguishes them from mutual funds that trade once a day.
• Low costs: ETPs have lower expense ratios than actively managed mutual funds since they passively track an index. This means saving substantially on fees.
• Tax efficiency: ETPs are structured in a tax-efficient manner compared with mutual funds in most cases, saving investors further costs.

ETP Regulations

While they may be structured differently, all ETPs in the United States are regulated by the SEC for investor protection and transparency. The SEC reviews ETP prospectuses, requires regular disclosures, oversees market trading, and enforces rules around practices like manipulation and fraud. This oversight applies across the ETP spectrum, no matter its structure.

However, the level of oversight depends on the type of ETP. For example, ETNs operate as unsecured debt securities issued by financial institutions. This differs from ETFs, which directly hold underlying assets.

As a debt instrument, ETNs carry credit risk should the issuing institution default. As a result, the SEC monitors ETNs more closely than it does the diversification and tracking error risks of ETFs. While both are ETPs, the SEC tailors its approach based on each structure’s characteristics to safeguard investors.

Exchange-Traded Funds (ETFs)

ETFs are popular financial instruments designed to offer investors an easy and efficient way to gain diversified exposure to an entire index or market segment through a single trade. They are easily the most traded and best-known of the ETPs.

Unlike mutual funds, ETFs trade on stock exchanges like equities. This gives ETFs the advantage of continuous pricing and trading throughout the day. ETFs hold a basket of assets that can include stocks across various sectors and industries, government and corporate bonds, commodities like natural gas or precious metals, and foreign currencies. The basket of assets held by an ETF is carefully selected and weighted to closely replicate the performance of a specific underlying index or benchmark.

For example, a total stock market ETF would hold hundreds or even thousands of different stocks in proportion to their weight in a broad stock market index. By buying a share of the ETF, an investor instantly gains diversified exposure to the returns of the entire equity market rather than buying each stock separately.

ETFs offer efficient, liquid, low-cost market access in a transparent, tax-efficient vehicle. Investors can also choose from various ETFs targeting more specialized market sectors based on their financial goals and risk tolerance.

Types of ETFs

ETFs track many different market segments. Here are the most common:

• Stock index ETFs: These track indexes like the S&P 500, Nasdaq 100, Dow Jones Industrial Average, etc.
• Industry/sector-specific ETFs: These focus on and track specific industries or sectors like technology or financials.
• Bond ETFs: These track government, corporate, or municipal bond indexes.
• Commodity ETFs: These track the prices of gold, silver, oil, grains, and other commodities. They either directly hold these commodities or use derivative products like futures.
• Currency ETFs: These track foreign currency exchange rates.
• Inverse ETFs: These furnish returns that move the opposite of benchmarks. This allows for short-market exposure.
• Leveraged ETFs: These want multiple returns, such as plus or minus two or three (or more) times the return of an underlying index or asset.
• Crypto ETFs: These track one or more major cryptocurrencies such as Bitcoin or Ethereum. They may directly hold cryptocurrencies or use derivatives contracts to gain exposure.

Difference Among ETFs, Mutual Funds, and Single Stocks
Feature	ETFs	Mutual Funds	Stocks
Pricing/Trading	Intraday pricing and trading	End-of-day pricing; trades once per day	Intraday pricing and trading
Costs	Lower expense ratios than active mutual funds	Typically higher expense ratios	May have commission fees on trades
Tax Efficiency	More tax-efficient in most cases	Can have capital gains distributions	Taxes on dividends and capital gains
Diversification	Holds basket of securities	Holds basket of securities	A single security
Risk Profile	Potentially lower volatility than individual stocks because of multiple holdings	Often lower volatility than individual stocks	Higher volatility as a single security
Transparency	Full portfolio holdings disclosed daily	Periodic portfolio disclosures	Public filings from a single company
Index Tracking	Follows underlying index	Actively managed or passive index tracking	Follows the performance of a single company

Other Types of ETPs

In addition to ETFs, other types of ETPs include ETNs and exchange-traded commodities (ETCs).

Exchange-Traded Notes (ETNs)

ETNs combine bond investing with the tradability of stocks. Unlike ETFs, which hold underlying assets, ETNs are structured as unsecured debt securities issued by financial institutions. These notes promise to pay the holder a return based on the performance of a market index or other reference measure, minus applicable fees, at maturity.

ETNs, however, have some unique risks and benefits:

• Credit risk: Since ETNs are debt instruments, their value is dependent, in part, on the creditworthiness of the issuing bank. If the issuer faces financial difficulties, the ETN could lose value, no matter the performance of the underlying index.
• Price tracking: ETNs aim to closely track the performance of their underlying index or benchmark. They do not experience tracking errors the same way that ETFs might.
• Liquidity risk: Some ETNs may have lower trading volumes than ETFs, potentially leading to wider bid-ask spreads and impacting the ease with which they can be bought or sold at desired prices.
• Tax efficiency: ETNs can offer unique tax benefits in certain situations. For instance, since they do not distribute dividends, investors might not incur taxes until the sale of the ETN or its maturity, potentially deferring tax liabilities.
• Market exposure: ETNs can provide exposure to many assets, including hard-to-reach markets and strategies. This includes commodities, emerging markets, private equity, or specific investment strategies that might be difficult or costly to access directly.

Exchange-Traded Commodities (ETCs)

ETCs offer exposure to commodities, including metals, energy, and agricultural products, without directly investing in physical commodities or futures contracts. ETCs track the commodity’s price or a basket of commodities, allowing investors to gain exposure to commodity markets through a security that trades on a stock exchange.

There are differences between ETCs and ETFs that track commodities. Commodity ETFs are structured as funds and regulated under the Investment Company Act of 1940 in the U.S. They hold either physical commodities (like gold or silver) or futures contracts on commodities. Commodity ETFs are considered equity products and are regulated like mutual funds and other ETFs.

Exchange-traded commodities, like ETNs, are structured as debt securities, even though they track commodity prices. They are not considered funds in the traditional sense, but are debt instruments issued by a single entity. This means there are credit risks involving the issuer.

ETCs can be broadly classified into two categories:

• Physical ETCs: These ETCs hold physical commodities, such as gold or silver bars, in secure vaults. Investors in physical ETCs have a claim on the underlying metal, and the value of the ETC is directly tied to the price of the physical commodity.
• Synthetic ETCs: Instead of holding physical commodities, synthetic ETCs use derivatives like futures contracts to replicate the performance of the underlying commodity. This approach can provide exposure to a broader range of commodities, including those difficult or impractical to store physically.

As with ETNs, ETCs also present unique risks and benefits:

• Direct commodity exposure: ETCs offer a straightforward way to invest in commodities, which can serve as a hedge against inflation or a diversification tool outside traditional stocks and bonds.
• Variety: Investors can choose from various commodities, from gold and silver to oil and agricultural products, depending on their investment goals and market outlook.
• Transparency: ETCs offer transparency in holdings and pricing, with the value of the ETC closely tracking the underlying commodity or commodities.
• Volatility: Commodity markets can be highly volatile, with prices influenced by various factors, including geopolitical events, weather conditions, and changes in supply and demand.
• Counterparty risk: Synthetic ETCs can involve counterparty risk since their performance depends on the ability of the issuer or counterparty to fulfill their obligations under the derivative contracts.
• Credit risk: Because they are structured as unsecured debt instruments from a single issuer if the issuer faces financial difficulties, the ETN could lose value, whatever the performance of the underlying commodities.

What to Consider When Choosing Between ETPs and ETFs

When deciding whether an ETP or ETF makes the most sense for an investment strategy, investors should weigh several key factors:

• Expenses and fees: ETPs and ETFs often have lower expense ratios than actively managed mutual funds, but fees vary between products. All else being equal, an ETP with a lower expense ratio is preferred. ETFs typically have lower fees than other ETPs since they have less complex structures. Consider the expense ratio, commission fees, bid-ask spreads, and premiums/discounts.
• Liquidity: ETFs tend to have higher daily trading volumes and tighter bid-ask spreads. Some ETPs have limited secondary market liquidity, which can impact prices. Assess the average trading volume and bid-ask spread for a particular ETP or ETF—the higher the volume and the tighter the spread, the better.
• Performance and tracking: ETPs are often highly efficient at replicating their benchmark index performance, but some have more tracking errors. Research historical returns and compare them with the ETP’s benchmark.
• Diversification: ETFs offer exposure to various indexes across all major asset classes. Some ETPs zero in on narrow commodities or niche assets. Other times, two or more ETFs may hold the same assets; for example, if a stock is represented as a significant part of the S&P 500 and a sector index. This could mean doubling the exposure to specific stocks. Assess how well an ETP or ETF aligns with your asset allocation and diversification goals.
• Reputation of issuer and regulatory compliance: The trustworthiness and track record of the ETP issuer matter. A well-regarded issuer with a history of regulatory compliance and transparency is likely to offer low-cost products managed in the best interest of investors. Investigate the issuer’s reputation, experience in managing investment products, and history of adherence to regulations.
• Tax efficiency: ETFs are generally known for their tax efficiency, especially those that track broad-market indexes because of their unique creation and redemption process, which can minimize capital gains distributions. Depending on their structure, ETPs might not offer the same level of tax efficiency. Understand the tax implications of each investment, including how distributions are taxed and the potential for triggering taxable events.

Costs and Fees Associated with ETPs and ETFs

All ETPs have costs that affect the total return on investment.

• Expense ratios: This annual fee, expressed as a percentage of assets under management, covers the operational costs of the fund, including management fees, administrative fees, and other operating expenses. ETFs often have lower expense ratios than actively managed mutual funds, and ETCs can vary widely based on the complexity of the commodity exposure and management.
• Trading costs: Investors also have trading costs, such as commissions when buying or selling shares, including brokerage commissions (if applicable) and bid-ask spreads. Some ETFs today may be part of commission-free trading programs offered by brokers.
• Premiums/discounts: ETPs can trade at a premium or discount to their net asset value (NAV), depending on market demand and the underlying securities. These differences can mean more costs or benefits when entering or exiting positions.

How Does Liquidity Differ for Different ETPs and ETFs?

ETFs generally offer higher liquidity than other ETPs due to their broader market appeal and higher trading volumes. ETF liquidity also depends on a unique creation and redemption mechanism that allows for the adjustment of supply in the market, helping to maintain the ETF’s price close to its net asset value (NAV).

Depending on their specific type and market demand, other ETPs may not have this mechanism and can experience wider bid-ask spreads and lower trading volumes, potentially lowering liquidity.

Are ETFs and ETPs Regulated by the Same Authorities?

Both ETPs and ETFs in the U.S. are regulated by the SEC. However, the specific regulations depend on the type of ETP.

Like mutual funds, ETFs are regulated under the Investment Company Act of 1940, with additional rules tailored explicitly to ETFs. Other ETPs, such as ETNs and ETCs, fall under different regulations based on their structure (e.g., debt securities). Despite these differences, all ETPs must follow SEC regulations to protect investors.

Can You Short ETPs and ETFs?

As long as your broker approves you for short selling, ETPs and ETFs can be shorted like shares of stock. In fact, short selling may be easier with ETPs and ETFs than individual stocks because of the improved liquidity. There are also inverse ETFs that deliver inverse returns for short strategies without having to sell short any security.

The Bottom Line

ETPs offer investors an efficient way to gain exposure to diverse assets pooled and traded on stock exchanges. ETPs have advantages like low costs, tax efficiency, liquidity, and transparency.

ETFs are a subset of ETPs regulated by the SEC under the 1940 Investment Company Act, while ETPs can fall under further regulations depending on their assets. Investors should weigh factors like expenses, tracking ability, liquidity, diversification, and risks when choosing between ETPs and ETFs.

Thorough research is vital to successfully incorporating these worthwhile investments in a portfolio. Both ETPs and ETFs can serve a valuable role in asset allocation when they match an investor’s strategy, goals, and risk tolerance.

How To Use These Metrics To Improve Returns

Reviewed by Thomas Brock

What is Options Trading Volume?

Trading volume and open interest are like the pulse and blood pressure of the options market. They give option traders vital signs about the health and direction of market activity. Trading volume refers to the number of option contracts exchanged during a given period, typically one trading day. Open interest, meanwhile, is the number of outstanding contracts that haven’t been settled.

Together, these measures offer clues about the strength of trends, the likelihood of price reversals, and the ease with which positions can be entered or exited. As we explore below the significance of these metrics, we’ll see how they can be leveraged to make better trading decisions and potentially improve your returns.

Key Takeaways

• Daily options trading volume is the number of options contracts bought and sold on a particular day.
• Open interest is the number of open positions in options contracts.
• Together, they provide a better understanding of a particular option’s liquidity, demand, and price moves.
• The greater the open interest and volume, the better the liquidity and efficiency of pricing.
• Trading volume is reset daily; open interest is calculated continuously over the life of the option.

Understanding Options Trading Volume

Each options transaction, whether a buy or a sell, contributes to the daily trading volume count. This metric is a significant indicator of the activity and liquidity of the options market for a particular security. Here is how options trading volume is used:

• Liquidity indicator: The daily trading volume is a primary indicator of options’ liquidity. Higher volumes often mean the option contract is more liquid, making it easier for investors to enter or exit positions at their desired price levels. A higher trading volume can also lead to narrower bid-ask spreads, reducing the cost of trading.
• Market sentiment: Analyzing daily trading volume can also provide insights into market sentiment. For instance, a sudden increase in trading volume might indicate that a new trend is starting, while decreasing volume could signal a potential reversal or the end of a trend.
• Volatility measurement: Increased daily trading volume can also be associated with higher volatility, especially if significant news or events are driving a large number of traders to buy or sell options contracts.
• Confirmation of price movements: Volume analysis is often used with price analysis and other indicators to confirm trends and chart patterns. For instance, an upward price shift with an increase in volume is often viewed as a stronger bullish (positive) signal compared with an upward movement with decreased volume.
• Historical comparison: Investors and analysts often compare the present daily trading volume with past volume levels to gauge the relative activity in the options market. This provides a context for interpreting the present volume levels.
• Institutional activity: Large trading volumes can sometimes indicate institutional activity, which may reflect professional opinions about the direction of the underlying asset’s price.

Why Is Trading Volume Important to Traders?

Trading volume helps traders understand market dynamics, liquidity, and potential prospects in securities. High trading volume for an option indicates strong market sentiment, but it can be either bullish or bearish, so you’ll need more information to see which.

In addition, a higher volume typically means better liquidity, allowing for easier entry and exit from positions, cutting trading costs with narrower bid-ask spreads. Also, a spike in trading volume generally precedes significant price shifts, making it helpful in determining volatility. Traders closely monitor volume to capitalize on these movements.

Volume can also be used to confirm the validity of market trends, such as breakouts or reversals, and can help prevent traders from falling for false signals when volume is low during price movements. Finally, traders look to options trading volume to develop and refine their tactics, employing volume-based indicators to help identify the best entry and exit points while managing risk.

High trading volume doesn’t always mean a strong trend. Sometimes, it can signal indecision as buyers and sellers clash, leading to a potential reversal.

What Is Options Open Interest?

Open interest is the number of outstanding options contracts traded but not yet liquidated or closed by either an offsetting trade, exercise, or assignment. As a measure of liquidity in options markets, it is the number of contracts that are still active.

Open interest increases when a new option order is executed and a new contract is added to the option chain. It’s lowered when an existing option contract expires, is exercised, or is closed through an offsetting trade. High and rising open interest suggests the option has active trading and interest, while a decline in open interest means traders are closing out positions (meaning a reduction in interest). More specifically, high open interest in call options signifies a bullish sentiment, while high open interest in put options suggests a bearish sentiment.

Open interest is tracked separately for call and put options.

Here’s how you can use open interest in your trading:

• Liquidity indicator: A higher open interest reveals there’s more liquidity for the options contract. This liquidity makes it easier for traders to enter or exit positions at fair market prices.
• Market sentiment: An increase in open interest might indicate new money coming into the market, suggesting that the trend is likely to continue. Conversely, a decrease in open interest can signal that the market is liquidating or a coming change in market direction.
• Support and resistance levels: Some traders analyze open interest at different strike prices to identify where the market may find support or resistance levels. High open interest at a particular strike price can serve as an area of resistance or support.
• Hedging and managing risk: Institutional investors and fund managers often use options open interest data to plan hedging strategies that protect portfolios against adverse price moves.
• Trading strategies: Options traders might use open interest to find potentially profitable trading opportunities. For example, they might look for options contracts with high open interest and volume since they can be easier to trade.

Why Is Open Interest Recorded?

Recording open interest ensures transparency in the options markets and shows they are still running smoothly. Open interest provides an appreciation for present and historical market activity, liquidity, and market sentiment. Participants can see the depth of the market, confirm trends, manage risk, and anticipate potential areas of volatility.

In addition, open interest helps regulators and participants monitor for market manipulation, boosting market integrity. Open interest also serves as inputs for many derivative pricing models market participants use.

How Does Open Interest Work?

Open interest increases when new contracts are created and decreases when existing positions are closed. Closing positions are typically when traders and market participants sell their contracts, exercise options, or let them expire.

In addition, open interest remains unchanged if a contract is transferred from one entity to another without closing any position. Exchanges report this data daily, reflecting the number of outstanding contracts at the close of each trading day.

How To Use Open Interest in Trading

Experienced traders use open interest to assess market sentiment, liquidity, and trend strength, which helps them refine their trading strategies. By analyzing open interest alongside price movements, traders can gauge whether the market is leaning bullish or bearish, with rising prices and increasing open interest often indicating strong bullish sentiment. In addition, experienced traders prefer options with high open interest for better liquidity, allowing for smoother entry and exit positions with minimal impact on prices.

Another use for open interest is to confirm trends and identify potential reversals. For example, increasing open interest with strong price movements suggests that the trend is likely to continue, while decreasing open interest may signal a weakening trend. Moreover, traders monitor open interest at specific strike prices to identify support and resistance levels, particularly when the expiration date approaches, where sizeable open interest can lead to significant price movements.

Combining open interest with trading volume can offer a clearer picture of market dynamics, helping traders confirm breakouts and anticipate volatility. Strategically, open interest can be used during expiration and around significant market events when traders anticipate price movements and adjust their positions accordingly.

Illustration of Options Volume and Open Interest

Above is the options chain for Tesla, Inc. (TSLA) with an expiration date of Sept. 6, 2024. The chain comprises call and put options with various strike prices ranging from $75 to $212.50. Also included are the last traded price, price change, bid and ask prices, trading volume, and open interest for each option.

At the time of this chain, call options showed large declines in last traded prices, while put options display mostly positive changes, indicating potentially bearish sentiment. The open interest and volume data suggest varying levels of activity across different strike prices, with some strikes showing high engagement, particularly in strike prices for $190.00 to $202.50 and above.

Example of Options Volume and Open Interest

Let’s drive these ideas home with a hypothetical scenario involving an imaginary company called TechFlow Inc. (fake ticker: TFL). Suppose it’s trading at $100 per share, and you’re interested in buying the $105 call option (options that become profitable when the price of TFL rises above $105) expiring in one month.

Now, you look at the options volume and open interest to get a sense of market sentiment and activity around these options:

• Today, you notice that the trading volume for the TFL $105 call options is 500 contracts when the normal average volume is less than 50 contracts. The high volume reveals a significant amount of new trading.
• You also see that the open interest for the TFL $105 call options is 2,000 contracts, which has grown steadily over time from under 100 contracts. This suggests that there are now 2,000 open contracts that have not been exercised, closed, or expired.

Analyzing these figures reveals the following:

• Increased activity: The high volume of 500 contracts traded in a day compared with previous days indicates a growing interest in TFL stock, possibly because of a recent positive earnings announcement or favorable market news about the tech sector.
• Sustained interest: The open interest of 2,000 contracts indicates a sustained interest in these specific options, which could indicate ongoing bullish sentiment among investors expecting the price of TFL to rise above $105.
• Good Liquidity: The increase in open interest also suggests rising liquidity for the TFL $105 call options, making it easier to enter or exit positions at desirable prices.

Based on this data and other research, you buy some TFL $105 call options, anticipating the price to go up. The high volume and open interest could be a positive sign, suggesting that other market participants might also expect TFL’s stock price to rise. Over the next few days, you continue to monitor the volume and open interest. If the volume and open interest continue to rise along with TFL’s stock price, that will reinforce your bullish outlook. Conversely, you’ll reevaluate your position if the volume and open interest decline.

In this scenario, the volume and open interest work together to provide a clearer picture of market sentiment regarding TFL’s potential price movement. A high trading volume coupled with substantial open interest suggests a heightened activity and a sustained interest in the TFL $105 call options. By analyzing both metrics together, you help confirm the prevailing market sentiment, which bolsters your confidence in deciding on the TFL $105 call options.

How Can an Option Have Volume But no Open Interest?

Volume resets daily, but open interest carries over. If an option has volume but no open interest, it means that all open positions were closed in one trading day.

Is Open Interest a Good Indicator?

Rising open interest shows an increase in activity, while falling open interest reveals that traders are closing their positions.

Should Volume or Open Interest Be Higher?

It depends. Volume can be higher than open interest on a given day. Volume resets each trading day, while open interest carries over. When trading volume is higher than open interest, this usually indicates that traders are closing positions (which reduces open interest).

The Bottom Line

Trading does not occur in a vacuum. Indicators that show traders what other market participants are doing can help you discern where a stock price might be headed. Daily trading volume and open interest can be used to identify trading prospects that you might otherwise overlook.

These indicators are also useful for making sure that the options that are traded are liquid, allowing you to easily enter and exit a trade at the best possible price.

Fact checked by Amanda Bellucco-Chatham
Reviewed by Somer Anderson

What Is Deflation?

Deflation is when prices decrease over time. It stands in contrast to inflation, which is when prices rise. Deflation can be driven by many different factors, including an increase in productivity and the abundance of goods and services, a decrease in total or aggregate demand, or a decrease in the supply of money and credit. Most of the time deflation is a good thing, but sometimes it can indicate a contraction of the economy.

When deflation occurs throughout an economy, this typically means there is a fall in the overall level of prices and an increase in the purchasing power of the currency.

Key Takeaways

• Deflation is when prices in a country are falling.
• Deflation can be caused by an increase in productivity, a decrease in overall demand, or a decrease in the volume of credit in the economy.
• Most of the time, deflation is unambiguously a positive trend for the economy, but it can also, under certain conditions, occur along with a contraction in the economy. 
• In an economy dominated by debt-fueled asset price bubbles, deflation can lead to a temporary financial crisis and a period of liquidation of speculative investment known as debt deflation.

Understanding Deflation

Changes in consumer prices can be observed in economic statistics compiled in most nations by comparing changes in a basket of diverse goods and products to an index. In the U.S. the Consumer Price Index (CPI) is the most commonly referenced index for evaluating inflation rates. When the index in one period is lower than in the previous period, the general level of prices has declined, indicating that the economy is experiencing deflation.

This general decrease in prices is a good thing because it gives consumers greater purchasing power. To some degree, moderate drops in certain items, such as food or energy, even have some positive effect on increasing nominal consumer spending. Beyond these basic staples, a general, persistent fall in all prices not only allows people to consume more but can promote economic growth and stability by enhancing the function of money as a store of value and encouraging real saving. 

However, under certain circumstances, rapid deflation can be associated with a short-term contraction of economic activity. In general, this can occur when an economy is heavily laden with debt and dependent on the continuous expansion of the supply of credit to inflate asset prices by financing speculative investment, and subsequently, when the volume of credit contracts, asset prices fall, and speculative over-investments are liquidated. This process is known as debt deflation.

Otherwise, deflation is normally a positive feature of a healthy, growing economy that reflects technological progress, increasing abundance, and rising living standards.

Deflation: Causes and Effects

If, as the common saying goes, inflation is the result of too much money chasing not enough goods in the economy, then conversely deflation can be understood as a growing supply of goods and services being chased by a constant or slower-growing supply of money.

This means that deflation can be brought about either by an increase in the supply of goods and services or by a lack of increase (or decrease) in the supply of money and credit. In either case, if prices can adjust downward, then this results in a generally falling price level.  

An increase in the supply of goods and services in an economy typically results from technological progress, the discovery of new resources, or an increase in productivity.

Consumers’ purchasing power increases over time. Living standards rise as the increasing value of wages and business incomes allow consumers to purchase, use, and consume more and better quality goods and services.

Note

The U.S. government targets an annual inflation rate of 2%.

At times, some economists have expressed fears that falling prices would paradoxically reduce consumption by inducing consumers to hold out or delay purchases in order to pay lower prices in the future. However, there is little evidence that this actually occurs during normal periods of economic growth accompanied by falling prices due to improvements in productivity, technology, or resource availability. 

Moreover, the vast majority of consumption is made up of goods and services that are not easily deferred to the future, such as food, clothing, housing services, transportation, and healthcare.

Beyond these basic needs, even for luxury and discretionary spending, consumers would only choose to reduce current spending if they expect the rate of decrease in prices to outweigh their natural time preference for present consumption over future consumption.

The one type of consumer spending that would suffer from falling prices would be items that are routinely financed by taking on large debts, since the real value of fixed debt will increase over time as prices fall.  

Debt, Speculation, and Debt Deflation

Under specific conditions, deflation can also occur in and after periods of economic crisis. 

In a highly financialized economy, where a central bank, another monetary authority, or the banking system, in general, engages in the continuous expansion of the supply of money and credit in the economy, the reliance on newly created credit to finance business operations, consumer spending, and financial speculation, results in ongoing inflation in commodity prices, rents, wages, consumer prices, and asset prices. 

Increased investment activity starts to take the form of speculation on the price appreciation of financial and other assets, rather than profit and dividend payments on fundamentally sound economic activity.

Business activities tend likewise to depend more and more on the circulation and turnover of newly-created credit rather than real savings to finance ongoing operations. Consumers also come to finance more of their spending by borrowing heavily rather than using their savings. 

Gold is usually considered to be a good hedge against inflation. It can also be a good hedge against deflation.

To compound the problem, this inflationary process usually involves the suppression of market interest rates, which distorts decisions about the type and time horizon of business investment projects themselves, beyond simply how they are financed. Conditions become ripe for debt deflation to set in at the first sign of trouble. 

At that point, either a real economic shock or a correction in market interest rates can put pressure on heavily indebted businesses, consumers, and investment speculators. Some of them have trouble revolving, refinancing, or making their payments on various debt obligations such as business loans, mortgages, car loans, student loans, and credit cards.

The resulting delinquencies and defaults lead to debt liquidation and write-downs of bad debts by lenders, which start to eat away some of the accumulated supply of circulating credit in the economy. 

Banks’ balance sheets become shakier, and depositors may seek to withdraw their funds as cash in case the bank fails. A bank run may ensue, whereby banks have over extended loans and liabilities against inadequate cash reserves and the bank can no longer meet its own obligations. Financial institutions begin to collapse, removing liquidity that indebted borrowers have become even more desperate for.

This reduction in the supply of money and credit then reduces the ability of consumers, businesses, and speculative investors to continue to borrow and bid up asset and consumer goods prices so that prices may stop rising or even begin to fall.

Falling prices put even more pressure on indebted businesses, consumers, and investors because the nominal value of their debts remains fixed as the corresponding nominal value of their revenues, incomes, and collateral falls through price deflation. And at that point, the cycle of debt and price deflation feeds back on itself. 

In the near term, this process of debt deflation involves a wave of business failures, personal bankruptcies, and increasing unemployment. The economy experiences a recession, and economic output slows as debt-financed consumption and investment drop.

What Is Deflation in an Economy?

Deflation is when the prices of goods and services decrease across the entire economy, increasing the purchasing power of consumers. It is the opposite of inflation and can be considered bad for a nation as it can signal a downturn in an economy—like during the Great Depression and the Great Recession in the U.S.—leading to a recession or a depression. Deflation can also be brought about by positive factors, such as improvements in technology.

Is Deflation Worse than Inflation?

It depends. Deflation can be worse than inflation if it is brought about through negative factors, such as a lack of demand or a decrease in efficiency throughout the markets. Deflation can be better than inflation if it is brought about by positive factors, such as improvements in technology that make the costs of goods and services cheaper.

How Do You Make Money During Deflation?

To hedge against deflation, investors can purchase investment-grade bonds, consumer-staple stocks, dividend stocks, and keep their money in cash. A diversified portfolio can protect against a variety of economic scenarios.

The Bottom Line

A little bit of deflation is a product of, and good for, economic growth. But, in the case of an economy-wide, central bank-fueled debt bubble followed by debt deflation when the bubble bursts, rapidly falling prices can go hand-in-hand with a financial crisis and recession.

Thankfully, the period of debt deflation and recession that follows is temporary and can be avoided entirely if the perennial temptation to inflate the supply of money and credit in the first place can be resisted. 

All in all, it is not deflation, but the inflationary period that then leads to debt deflation that is dangerous for a country’s economy. Perhaps, unfortunately, consistent and repeated inflation of this kind of debt bubble by central banks has become the norm over the past century or so.

At the end of the day this means that while these policies persist, deflation will continue to be associated with the damage it causes to the economy.

Fact checked by Suzanne Kvilhaug
Reviewed by Andrew Schmidt

The relative rotation graph (RRG) is a sophisticated tool in technical analysis that helps investors decide which sectors, stocks, and other assets to pursue. Investors can use the graph to visually compare the performance and momentum of securities and asset classes against a benchmark.

RRGs plot assets on a two-dimensional graph, with the x-axis representing the relative strength ratio and the y-axis for relative strength momentum. This allows traders and investors to visually assess the relative strength and trend line of different securities, making it valuable for trading, rotation, and asset allocation strategies.

Key Takeaways

• The relative rotation graph is a chart used in technical analysis to test the performance and momentum of securities or asset classes against a benchmark.
• RRGs provide a comprehensive view of the market, helping investors spot trends, compare multiple securities simultaneously, and make more informed decisions when rebalancing portfolios.
• RRGs should be used with other forms of analysis since they are a partial view of the market.
• Several tools and resources are available to create and analyze RRGs, including professional software from Bloomberg and Optuma and accessible platforms like StockCharts.com.

What Is a Relative Rotation Graph?

RRGs are used to identify which stocks or sectors are underperforming and outperforming a market index or benchmark. The RRG has four quadrants: leading, weakening, lagging, and improving.

Each quadrant is for different stages of an asset’s performance cycle, providing insights into the rotation of market leadership. This movement of securities through the quadrants helps to spot trends and potential reversals and could provide investors with a strategic advantage in both short- and long-term trading.

RRGs were created by Julius de Kempenaer in the early 1990s to visualize the relative performance of stocks and other securities against a benchmark and each other. His work has been valuable because it helps investors make more informed decisions about trading, rotation, and asset allocation.

RRGs are an excellent visual way of analyzing market trends and relative performance. However, like all technical tools, they should be used with other techniques for a more comprehensive approach to trading and investing.

Understanding the Parts of the Relative Rotation Graph

The key elements of the RRG and how they indicate relative strength and momentum are as follows:

• Axes: The x-axis is the relative strength ratio. This axis measures the performance of a security relative to a benchmark (hence, the strength is “relative”). A value more than 100 indicates outperformance, while a value less than 100 indicates underperformance. The y-axis represents the momentum of the relative strength. This axis shows the rate of change in the relative performance. It is essentially the momentum of the relative strength ratio.
• Top right quadrant: The top right quadrant in the RRG is the leading quadrant. Securities in this quadrant are outperforming the benchmark, and their momentum is positive. This indicates strong and improving performance.
• Bottom right quadrant: The bottom right quadrant is the weakening quadrant. Here, securities still outperform the benchmark, but their momentum decreases. Being here suggests that while they are strong, they might lose their edge.
• Bottom left quadrant: This is the lagging quadrant. Securities in this area are underperforming the benchmark with negative momentum. It is a sign of weakness.
• Top left quadrant: This is the improving quadrant. This quadrant contains securities that are underperforming the benchmark but show increasing momentum. Being here suggests the potential for a turnaround.
• Data points and movement: Each security or asset is represented as a data point on the graph. The position of a data point within the graph indicates its relative strength and momentum. The movement of these data points is tracked over time, usually in a clockwise direction through the quadrants, which illustrates the evolution of their relative performance.

RRGs help investors spot trends and compare several securities at once. However, RRGs should be used with other forms of analysis since they provide a relative, not absolute, view.

How to Interpret Relative Rotation Graphs

Interpreting RRGs involves analyzing the patterns and movements of securities on this chart to identify market leaders, laggards, and potential rotation opportunities.

Movements and Patterns in RRGs

Securities in the RRG generally move clockwise through the four quadrants. This rotation reflects the natural ebb and flow of securities’ relative strength and momentum relative to a benchmark. The further a security is from the center, the stronger its relative strength or weakness is compared with the benchmark. A security far out in the leading or lagging quadrant has a strong trend, whether positive or negative.

The speed at which a security moves through the quadrants can indicate the stability of its trend. Rapid movements might suggest more volatile or less stable trends. Indeed, many RRGs show tails behind the data points, representing their historical path. Longer tails provide more context on historical performance and trend stability.

Identifying Market Leaders and Laggards

Securities in the leading quadrant are outperforming the benchmark with positive momentum and are considered market leaders. A security with a presence or movement deeper into this quadrant suggests a strong and stable outperformance.

Meanwhile, securities in the lagging quadrant are underperforming and have negative momentum. These are the laggards of the market. A security that is continuously in or moving deeper into this quadrant has a strong downtrend relative to the benchmark.

Identifying Rotational Opportunities

A security moving from the improving quadrant into the leading quadrant can be an opportunity. This shift indicates a security is starting to outperform the benchmark with increasing momentum. Similarly, a security moving from the weakening to the lagging quadrant suggests that its previous outperformance is deteriorating, and it is now starting to underperform. This could signal a selling opportunity or a warning to avoid new investments.

Meanwhile, a move from lagging to improving suggests that a security begins to reverse its underperformance. This indicates an early stage of recovery, a potential buying opportunity for contrarian investors. Also, securities shifting from leading to weakening are still outperforming but are losing momentum. This could be a signal to take the profits or closely watch the situation to see if it continues to lose steam.

Using Relative Rotation Graphs with Other Technical Tools

RRGs can be more effective when used with other charts in the technical analyst’s toolkit. For example, once an RRG helps determine which sectors or stocks show relative strength, you can review stocks in those sectors in greater depth.

Candlestick patterns and volume analysis can give more details on the trading behavior for specific stocks, cluing you in about potential reversals in price trends. Indicators like moving averages, the relative strength index (RSI), and Bollinger Bands can also be used to assess the momentum and volatility of these stocks, helping you decide on entries and exits.

The RRG’s ability to depict sector rotation can also provide great help for those using a top-down investment approach. When showing the sectors moving into the leading quadrant, you might allocate more to sectors poised for growth and reduce your exposure to those going into the lagging quadrant.

This sector rotation strategy can be particularly useful during different phases of the economic cycle, as certain sectors tend to do better than others based on economic conditions. This then points to how fundamental analysis can be used with the RRG for a fuller picture of particular sectors and their prospects.

Benefits and Limitations of Relative Rotation Graphs

RRGs offer several advantages and limitations when used in trading, analysis, and portfolio management. Understanding these can help make better use of them for investing.

Benefits

• Easy visualization of market dynamics

• Comparison tool

• Helps identify trends

• Helps with timely decision making

• Complements other analysis

• Helps with deciding asset allocation

Limitations

• Shows relative, not absolute rotation

• Lagging indicator

• Requires a benchmark

• Not a stand-alone tool

• Provides no indication of value

Benefits of Relative Rotation Graphs

Here are some benefits of RRGs:

• Easy visualization of market dynamics: RRGs provide a clear, visual representation of the relative strength and momentum of various securities or sectors, making it easier to understand complex market moves.
• Comparison tool: With RRGs, you can compare several securities simultaneously against a benchmark, which can be valuable for portfolio diversification and sector rotation strategies.
• Helps identify trends: RRGs help pick out leaders, laggards, and emerging trends by observing the movement of securities through different quadrants.
• Helps with timely decision making: The dynamic nature of RRGs aids investors in making timely decisions by highlighting changes in momentum and strength before they become evident through price movements alone.
• Complements other analyses: RRGs can be used alongside other technical, fundamental, and quantitative analysis tools, providing a more holistic view of the market.
• Helps with deciding asset allocation: RRGs are particularly useful for sector analysis and distributing assets since they help identify industries or asset classes likely to outperform or underperform.

Limitations of Relative Rotation Graphs

Here are some limitations of RRGs:

• Shows relative, not absolute, rotation: RRGs illustrate the performance relative to a benchmark, not the absolute performance. A security in the leading quadrant could still be losing value in a bear market.
• Lagging indicator: RRGs inherently lag. They reflect past performance and trends, which may not always predict future movements.
• Requires a benchmark: The effectiveness of RRGs depends on the choice of an appropriate benchmark, which can vary based on the assets.
• Not a stand-alone tool: RRGs should not be used by themselves. They do not deliver insights into company fundamentals, macroeconomic conditions, or market sentiment.
• Provides no indication of value: RRGs do not provide information about the value of securities. A stock might be moving into the leading quadrant but still be overpriced.

Note

While RRGs are powerful for visualizing and analyzing market trends and relative performance, they are most effective when used as part of a broader, diversified approach to investment analysis and decision making. Understanding their limitations is crucial to avoid overestimating their relevance.

Differences Between the Relative Rotation Graph and the Relative Strength Index

	Relative Rotation Graph (RRG)	Relative Strength Index (RSI)
Scope	Compares several securities against a benchmark	Analyzes the price momentum of a single security
Dimensions	Provides a two-dimensional view	One-dimensional oscillator
Interpretation	Better for relative performance and identifying trends	Illustrates momentum and potential price reversals
Usage	Typically used for asset allocation and sector rotation	Commonly used to identify potential entries and exits

The RRG and the relative strength index are both used in technical analysis but serve different purposes and provide different kinds of information. RRGs are used to compare several securities against a benchmark, while the RSI is used to analyze the price momentum of a single security. In addition, RRGs offer a two-dimensional view (strength and momentum), while the RSI is a one-dimensional oscillator (it constructs high and low bands and provides a trend indicator).

The RRG is best used for relative performance and identifying trends. Meanwhile, the RSI is best for ascertaining momentum and potential price reversals. Another set of differences is that the RRG is often used for asset allocation and sector rotation, while the RSI commonly helps identify potential entries and exits.

As such, the RRG is a tool used to visualize and compare the relative strength and trends of multiple securities while the RSI sets out the momentum of individual securities and can help identify when there are overbought or oversold conditions.

Resources for Creating Relative Rotation Graphs

Making your RRGs requires specialized tools and resources, as these graphs involve complex calculations and dynamic visuals. Here are some great tools to use:

• RRG Research: Founded by Julius de Kempenaer, the creator of RRGs, the firm’s site provides tools and insights related to RRGs. The website offers educational resources, analysis, and access to RRGs.
• Bloomberg Professional Services Software: This software is a leading financial data and analytics platform and offers RRG charts as part of its services. It provides functions for creating and customizing RRGs, making it a popular choice among professional investors and analysts.
• Refinitiv Eikon: This platform is another leading financial data and analytics provider that offers RRG charts as part of its services.
• StockCharts.com: This online platform offers various chart tools, including RRGs. It has a user-friendly interface for creating RRGs, suitable for professionals and individual investors.
• Optuma: Optuma is a professional-level technical analysis software that includes RRGs among its features. Known for its advanced analysis tools, Optuma caters to professional traders and analysts.

The tool you choose depends on your needs, skill level, and access to resources.

Which Technical Analysis Indicators Work Well with Relative Rotation Graphs?

Combining RRGs with other indicators can provide a more comprehensive view of the market and help refine investment strategies. Some indicators include moving averages, the RSI, the moving average convergence/divergence, Bollinger Bands, support and resistance levels, and other chart patterns.

What Asset Groups Work Well with Relative Rotation Graphs?

RRGs are best used to analyze asset groups when relative performance is key. These can include equity sectors and industries, exchange-traded funds (ETFs), indexes, benchmarks, fixed-income securities, commodities, and currencies.

RRGs’ ability to compare several assets simultaneously makes them invaluable for a wide range of investment strategies, from picking individual stocks to deciding on broad asset allocations. However, like all financial and investment tools, they should be used as part of a broader, diversified approach to market analysis and not relied upon in isolation.

Which Benchmarks Work Well with Relative Rotation Graphs?

The benchmark chosen is critical in interpreting RRGs, setting the standard against which the other securities or asset classes are measured. The benchmark to use depends on the type of assets being analyzed and the specific goals of the analysis. Some commonly used benchmarks include broad market, sector, fixed-income, commodity, regional, country-specific, currency, real estate, and thematic indexes.

How Can the Reliability of Relative Rotation Graphs Be Improved?

Increasing the reliability of RRGs involves choosing the right benchmarks, using quality data, understanding the tool’s limitations, and integrating it with other forms of analysis. Regular reviews, adaptation to changing market conditions, and ongoing education are essential for effectively using RRGs in trading and investments.

The Bottom Line

RRGs help technical analysts visualize the relative performance and momentum of different securities against a chosen benchmark. Its design allows traders and investors to grasp market shifts and identify assets gaining or losing strength against others. This makes RRGs useful for strategies involving sector rotation, asset allocation, and portfolio diversification.

For traders, RRGs provide a strategic edge by enabling a clear understanding of various market segments’ relative trends and strengths. By integrating RRG analysis with other technical indicators and fundamental insights, traders can identify potential entry and exit points more effectively.

Warren Buffett is widely regarded as one of the greatest investing minds of all time. The “Oracle of Omaha” earned a bachelor’s degree from the University of Nebraska and a master’s degree in economics from Columbia University, where he studied under legendary investor Benjamin Graham.

But despite his own education, the Berkshire Hathaway Inc. (BRK.A) CEO has said he doesn’t care where someone went to school—or whether they attended college at all. “I never look at where a candidate has gone to school. Never!” he wrote in a February 2025 letter to shareholders.

Instead, Buffett believes successful business leadership stems from innate talent and real-world experience rather than prestigious diplomas.

Key Takeaways

• Warren Buffett values innate business talent and practical experience over prestigious degrees.
• He has cited successful entrepreneurs, like Pete Liegl and Bill Gates, as examples of business leaders who thrived without graduating from elite schools.
• Buffett has said he considers a $100 public-speaking course to be the most valuable education for his business career, despite also earning a bachelor’s degree from the University of Nebraska and a master’s degree from Columbia University.

What Buffett Says About Finding Good Business Talent

In his 2025 letter, Buffett said that while great managers can come from prestigious schools, there are many successful business leaders who didn’t attend elite institutions or even complete their formal education.

“I was lucky enough to get an education at three fine universities,” Buffett wrote. “And I avidly believe in lifelong learning. I’ve observed, however, that a very large portion of business talent is innate with nature swamping nurture.”

Buffett mentioned three examples of successful business minds who didn’t graduate from elite schools:

• Pete Liegl founded Forest River, a manufacturer of recreational vehicles that had $1.6 billion in annual sales when it was acquired by Berkshire Hathaway in 2005. Liegl received a bachelor’s degree from Northern Michigan University and an MBA from Western Michigan University. In his 2025 letter, Buffett praised Liegl as “a man unknown to most Berkshire shareholders but one who contributed many billions to their aggregate wealth.”
• Bill Gates dropped out of Harvard College to start Microsoft (MSFT) and became one of the world’s wealthiest people, though he hasn’t encouraged other students to do the same. “Although I dropped out of college and got lucky pursuing a career in software, getting a degree is a much surer path to success,” he wrote in 2015.
• Ben Rosner founded Associated Retail Stores, a retail chain that had 75 women’s apparel stores when it was acquired by Berkshire Hathaway in 1978. Buffett described Rosner as “a retailing genius,” despite having only a sixth-grade education.

Does a Diploma Still Matter?

While Buffett attended three universities, he has said that he considers a $100 public-speaking course to be “the most important degree I have.”

“It’s certainly had the biggest impact in terms of my subsequent success,” he said in an interview for Getting There: A Book of Mentors. He said he does not display his diplomas from the University of Nebraska or Columbia University in his office, but he keeps the public-speaking certificate on display.

“Some people are going to get a lot out of advanced education, and some people are going to get very little,” Buffett said in a 2019 interview with Yahoo Finance. “It depends on the person, much more than it depends on the school.”

Research shows that a college education does carry significant value for students, as people with higher educational attainment tend to earn more money. In 2022, the median earnings of those with a bachelor’s degree were 59% higher than the median earnings of those who had only completed high school. People with only a high school education also face higher rates of unemployment compared to people with either an associate’s or a bachelor’s degree.

It’s worth noting that the outcome of higher education can vary significantly depending on the type of school a student attends. Most colleges produce graduates who earn more than the typical high school graduate a decade after enrollment, according to a 2024 analysis by the HEA Group examining data from about 5 million former students. But at the majority of for-profit schools, most former students earned less than high school graduates 10 years after enrolling, the report found.

Meanwhile, public perception could be shifting to align more with Buffett’s view on the value of higher education. A 2023 Pew Research Center survey found that about half (49%) of those surveyed say a four-year college degree is less important for attaining a well-paying job than 20 years ago.

The Bottom Line

Buffett’s comments cut through the credentialism that dominates many hiring practices today. While education can provide valuable knowledge, Buffett emphasizes that natural talent, practical experience, and proven results ultimately matter more to him than where—or if—someone went to college.

Reviewed by Lea D. Uradu
Fact checked by Suzanne Kvilhaug

Comparing progressive taxes to flat taxes is an ongoing debate, with both systems having supporters and critics. In the United States, the historical favorite is the progressive tax. Progressive tax systems have tiered tax rates that charge higher income individuals higher percentages of their income and offer the lowest rates to those with the lowest incomes. Flat tax plans generally assign one tax rate to all taxpayers.

Both of these systems may be considered “fair” in the sense that they are consistent and apply a rational approach to taxation. They differ, however, in their treatment of wealth, and each system may be called “unfair” according to who benefits or is treated differently.

Key Takeaways

• Advocates for a progressive tax argue it promotes economic equality by taxing higher incomes at higher rates.
• Flat tax supporters claim taxing all income at the same rate is fairer, simplifies the system, and encourages economic growth.
• Critics of progressive taxes contend they may hinder economic growth by discouraging investment and job creation.
• Detractors of flat taxes argue they can exacerbate income inequality by disproportionately benefiting the wealthy.
• A case could be made that either system is fair—or unfair.

Understanding Progressive Taxes

Progressive tax systems levy higher tax rates on individuals with higher incomes. In countries like the United States, a tiered structure consists of multiple tax brackets, each associated with its own marginal tax rate. As income rises, individuals move into higher brackets, incurring progressively higher rates on specific income thresholds. For example, someone earning $600,000 faces a higher overall tax rate than someone earning $60,000.

This progressive approach aims to distribute the tax burden equitably, with wealthier individuals contributing a larger share of their income. The rationale is those who have less should contribute less, and those with more income who have benefitted from economic prosperity should be responsible for perpetuating the growth cycle.

Argument for Progressive Taxes

Supporters of the progressive system claim that higher salaries enable affluent people to pay higher taxes and that this is the fairest system because it lessens the tax burden on low-income people. Since low-income people have the smallest disposable incomes and spend a higher proportion of their money on basic survival needs, such as housing, this system allows them to keep more of their money. Affluent taxpayers are better able to provide for their physical needs and therefore are charged more. A flat tax would ignore the differences between taxpayers of different means. Some argue that flat taxes are unfair for this reason.

Note

The United States has a progressive tax structure. Individuals are taxed at rates ranging from 10% to 37% based on their adjusted gross income, with the higher rate applicable for individuals with more taxable income.

Understanding Flat Taxes

With a flat tax, there’s one tax rate. Theoretically, taxes do not discourage higher earners from earning more. This system does, however, risk taking too much money away from people with lower incomes.

Argument for Flat Taxes

Supporters of flat taxes argue that they’re a straightforward and efficient way to handle taxes. Unlike more complicated systems with varying rates based on income, a flat tax applies the same percentage to everyone, making it easier to understand and comply with. The simplicity of flat taxes is also thought to encourage economic growth by providing a stable and predictable tax environment. Many flat tax supporters believe the flat tax is a more fair approach, as every taxpayer is treated the same.

Progressive Tax Benefits

• It reduces the tax burden on those with the least income

• Gives lower earners more income to pay for housing and other essentials

• Helps reduce income inequality

Flat Tax Benefits

• It doesn’t put a higher tax burden on those with a higher income

• Gives everyone the same percentage of their income to spend

• Encourages individuals to earn more without fear of tax repercussions

Limitations of Progressive Taxes

Sometimes, to best understand whether something is fair, you must look at its downsides. We’ll start by discussing the limitations of progressive taxes.

Critics of progressive taxes point out a couple of drawbacks. One concern is that when the wealthy face higher tax rates, it might slow down the economy. The idea is that if wealthy individuals and businesses have to pay more in taxes, they might be less likely to invest or expand, which could then limit overall economic activity, job creation, and consumer spending.

Last, critics of progressive taxes also highlight concerns about tax evasion and the use of legal loopholes as people try to minimize their tax payments. Individuals are incentivized to seek legislation and strategies that can further reduce their income. Therefore, those who should be taxed at a higher marginal rate may ultimately pay a much lower effective rate.

Limitations of Flat Taxes

Critics of flat taxes raise several concerns as well. The primary argument is that flat taxes can be regressive, placing a proportionately higher burden on lower-income individuals. Since everyone pays the same percentage regardless of income, those with lower earnings feel the impact more based on the proportion of their income they have to pay.

Another criticism is related to the potential reduction in government revenue. Since flat taxes often result in lower rates for the wealthy, there’s concern that the government might struggle to fund essential services and social programs adequately. When wealthier people have to pay more money in taxes, programs are better funded.

Last, critics also point out that the simplicity of flat taxes, while appealing, might oversimplify the intricacies of people’s financial situations. For instance, should the IRS still offer tax credits under a flat tax regime, individuals will naturally fall into a progressive system as some will get credits while others won’t.

Which Is More Fair: Flat or Progressive Tax?

The debate between flat taxes and progressive taxes centers on the fairness of distributing the tax burden. In truth, the answer of which is more fair resides in personal preference and individual ideologies.

In the end, this analysis won’t conclude what is most “fair.” A valid argument could be made that either tax is the more fair option.

How Are Tax Brackets Determined in Progressive Systems?

Tax brackets in progressive systems are determined by income levels. Policymakers set income thresholds for each bracket, and the income within each bracket is taxed at the corresponding rate. In the United States, the IRS often adjusts the tax bracket dollar amounts in response to inflation.

Can Progressive Taxes Reduce Income Inequality?

Progressive taxes are designed to reduce income inequality by imposing higher tax rates on those with higher incomes. The additional revenue generated is often used to fund social programs that aim to support lower-income individuals and address economic disparities. In theory, income inequality is reduced with progressive taxes as wealthier people support programs that are perhaps more useful to lower-income individuals.

Are Flat Taxes Regressive in Nature?

Yes, flat taxes can be considered regressive. They may result in a proportionately higher tax burden on lower-income individuals. Even though everyone has the same tax rate, those with less income will likely pay a higher percentage of their disposable income.

Can Flat Taxes Encourage Economic Growth?

Advocates of flat taxes argue that the simplicity and transparency of this system can reduce compliance costs, stimulate economic activity, and attract economic investment. By taxing the wealthiest a lower amount (compared to progressive taxes), more money from these people can theoretically be put into the economy to drive job growth and business development.

The Bottom Line

With a progressive tax, people with higher incomes pay a higher percentage of their income in taxes than people with lower incomes. A flat tax, on the other hand, levies a uniform tax rate on all income levels, with everyone paying the same percentage of their income in taxes. The choice between these systems often reflects societal values and personal beliefs, as each can be seen as “fair” in certain contexts.

Candlestick charts are a cornerstone in technical analysis and perhaps one of the earliest forms of technical analysis, having been developed in the 18th century in Japan by rice trader Munehisa Homma. They help traders and investors quickly assess price movements and short-term market sentiment.

Key Takeaways

• Candlesticks originated in Japan and are useful for recognizing market sentiment and the balance of power between bulls and bears.
• Key components include the real body, shadows, and color.
• Understanding bullish and bearish patterns helps predict short-term price movements.
• Candlesticks offer visual and analytical advantages over other chart types.
• Due to their limitations, they are best used alongside other technical tools.

History of Candlesticks

With its origins in 18th century Japan, candlestick charting was built on the idea that market prices are influenced by both trader psychology and the balance of power between the bulls and bears. By studying historical price changes, Homma identified patterns that signaled shifts in sentiment and market control, helping him anticipate price reversals and trends. His system became widely adopted among Japanese merchants and evolved into a structured approach to market analysis.

The use of candlestick charts remained confined to Japan until Nison introduced them to Western financial markets in the late 20th century. Nison’s research and teachings highlighted the power of candlestick formations in predicting price movements, leading to widespread adoption among traders across stocks, forex, and commodities markets.

Today, candlestick charts have been integrated into the architecture of technical analysis, offering traders a visually intuitive way to assess market sentiment.

Components of a Candlestick

Each candlestick represents a specific period and is made of three (3) components:

• Real Body or Body: This is the rectangular section of the candlestick and shows the range between the opening and closing prices. Long bodies indicate strong buying or selling pressure, while short bodies suggest indecision.
• Shadows or Wicks: These extend above and below the body, marking the highest and lowest prices reached during the period, offering insights into market volatility.
• Color: The color of the candle provides a quick snapshot of price direction. A bullish candlestick is typically green or white and means the closing price is higher than the opening price, indicating upward momentum. Inversely, a bearish candlestick, generally red or black, signals that the closing price was lower than the opening price, reflecting downward pressure.

How to Read a Candlestick

Similar to bar charts, candlestick charts comprise four price points: open, high, low, and close. The high is marked by the top of the upper shadow or the real body if there is no shadow, while the low price is represented by the bottom of the lower shadow or the real body if there is no lower shadow.

Finally, the closing price’s relationship to the open determines whether the candlestick is bullish or bearish. If the price closes above the open price, the candlestick is bullish. On the other hand, if the price closes below the open price, the candlestick is bearish. With colored candlesticks, you can recognize bullish or bearish candlesticks instantly.

By analyzing these four price points over multiple candlesticks, traders can identify market sentiment and how the bulls and bears are faring against each other, helping to predict potential price changes.

Common Candlestick Patterns

Bullish Patterns

Bullish Engulfing Pattern

This pattern consists of two candlesticks. The first is a small, bearish candle followed by a larger, bullish candle. As the name implies, the larger candle completely engulfs the previous candle’s body. That is, it opens below the lowest point of the smaller candle’s body, but the bulls take over and push the price to a close above the highest point of the previous candle’s body. This indicates a shift from bearish to bullish, reflecting strong buying pressure that may mark a potential reversal.

Bullish Harami Pattern

Another bullish candlestick pattern is the bullish harami. This is a two-candlestick reversal pattern. It consists of a large bearish candlestick followed by a smaller bullish candlestick that is completely contained within the body of the previous larger candle. This formation suggests that selling pressure is weakening, and on the second day, buyers are reasserting control. Confirmation is seen when the harami is followed by a strong bullish candle.

Bullish Harami Cross

This is a variation of the bullish harami pattern where the second candlestick is a doji, signifying very little difference, if any, between the open and close. Unlike the bullish engulfing pattern, which shows the bulls gaining the upper hand, the doji reflects a stalemate. This often means selling pressure has faded the bulls are about to take over for a while.

Rising Three Methods

This bullish continuation pattern signals a temporary consolidation before the prevailing uptrend resumes. The components include a strong bullish candlestick, followed by three or more smaller, bearish candlesticks that remain within the range of the first candle. Finally, another strong bullish candlestick closes above the most recent bullish candle’s close.

The smaller bearish candles reflect a brief period of profit-taking or a pause in buying without much selling pressure. The final bullish candle confirms that buyers have regained control and the price is likely to continue moving higher.

Morning Star

The morning star is a three-candlestick pattern that appears at the bottom of a downtrend. This first candle is a long bearish candle, while the second is a small-bodied candle that indicates a stalemate, much like the bullish harami cross. Lastly, there is a strong bullish candle that confirms the reversal. This pattern suggests that on the third day of the pattern, buyers have gained control. It often leads to an uptrend.

Bearish Patterns

Bearish Engulfing Pattern

This pattern consists of two candlesticks. The first is a small, somewhat bullish candle at the top of an uptrend, followed by a larger bearish candle that completely engulfs the previous candle’s body. The bearish engulfing pattern indicates a shift in market sentiment from bullish to bearish, suggesting an impending price decline. It typically marks the end of an uptrend.

Evening Star

This is a three-candlestick pattern that appears at the top of an uptrend. The first candle is a long bullish candle. It is followed by a small-bodied candle that signals market indecision. Finally, a strong bearish candle confirms the reversal. This pattern suggests buying momentum is weakening and sellers are taking control. It often leads to a downtrend.

Bearish Harami​

This is a two-candlestick pattern that signals an uptrend’s potential reversal. It comprises a large bullish candlestick that is followed by a smaller, bearish candlestick that is completely contained within the body of the previous candle. The bearish harami signals that buying momentum is weakening, and sellers may be starting to take control. A strong bearish candle would confirm the reversal.

Bearish Harami Cross

This is a variation of the bearish harami, where the second candle is a doji, showing near identical opening and closing prices. This signals strong indecision and weakening bullish momentum. A strong bearish candle would confirm the reversal.

Falling Three Methods

The falling three (3) methods is a bearish continuation pattern that indicates a temporary consolidation before the downtrend resumes. It consists of a strong bearish candlestick, followed by three or more smaller bullish candlesticks that stay within the range of the first candle, and finally, another strong bearish candlestick that closes below the first candle’s close. The smaller bullish candles represent a brief pause in selling pressure, but their inability to break higher suggests that bears remain in control. The final bearish candle confirms the continuation of the downtrend.

Comparing Candlestick Charts to Other Chart Types

Candlestick charts offer superior visual representation and pattern recognition, making them ideal for active traders. While bar charts provide similar data, they lack the intuitive visual signals offered by candlesticks. Line charts, though useful for spotting trends, do not provide detailed price action.

Feature	Candlestick Charts	Bar Charts	Line Charts
Price Points	Open, High, Low, Close	Open, High, Low, Close	Close Only
Visual Clarity	High	Moderate	Low
Pattern Recognition	Strong	Strong	Weak

Practical Applications of Candlestick Charts

Candlestick charts help traders analyze potential market turning points by more clearly illustrating what’s happening in the battle between the bulls and bears than bar charts or line charts. Practical applications include:

• Trend Identification: Traders and investors analyze candlestick patterns to determine whether a market is trending, though for this purpose they’re best used in conjunction with an indicator such as the Average Directional Index.
• Confirmation: Used with other technical analysis indicators as well as support and resistance levels, candlestick formations can flag and confirm short-term market turning points.

Limitations and Considerations

Candlesticks do have limitations. Their predictive power is limited mostly to the short term, and they are most useful to swing traders. Relying solely on candlestick patterns can lead to misinterpretations and suboptimal decision making. Incorporating additional indicators, volume analysis, support and resistance levels, and even fundamental analysis can help traders and investors make more informed and accurate decisions.

The Bottom Line

Candlestick charts help traders and investors analyze price movements, market sentiment, and trend reversals. Developed in Japan, they use opening, high, low and closing prices to form predictive patterns. Since patterns can produce false signals, confirming them with support, resistance and other technical tools is essential.

Fact checked by Suzanne Kvilhaug
Reviewed by Andrew Schmidt

Environmental, social, and governance (ESG) scores are an essential tool for investors to assess a company’s sustainability and ethical performance. These scores typically range from 0 to 100, with a score of less than 50 considered relatively poor and more than 70 considered good.

Below, we will guide you through the basics of ESG scores, their key components, who the main rating agencies are, and how to access them—as well as provide some insight into their implications for investors.

Key Takeaways

• ESG scores provide a measure of a company’s environmental, social, and governance performance.
• Various criteria are used to evaluate companies on these three dimensions.
• Third-party ESG rating agencies offer different methodologies and scoring systems.
• ESG scores can be found online via brokerage platforms, financial portals, and rating agency websites.
• Investors use ESG scores to make informed investment decisions and assess the sustainability of a company’s operations.

ESG Scores: The Basics

ESG scores are a measure of how well a company addresses risks and concerns related to environmental, social, and corporate governance issues in its day-to-day operations. These scores are important for socially responsible investors who want to invest in companies with strong ethical and sustainability practices, as they provide insight into a company’s long-term performance and resilience.

ESG scores can serve as a basis for comparing companies and funds across different factors, such as a company’s carbon footprint and labor practices. These individual factors are combined and weighted to come up with a single ESG score that can be found for a significant portion of publicly traded funds and securities.

However, it is essential to note that ESG scores come from different providers that have their own ratings scheme and evaluation metrics, which means they are not standardized. Moreover, some ratings firms place greater emphasis on the E, S, or G parts. This lack of standardization can lead to variations in scores for the same company across different rating agencies.

As a result, investors should use ESG scores as a starting point for their research and compare them across multiple providers to get a comprehensive understanding of a company’s sustainability performance. Furthermore, investors should also consider other factors, such as financial performance and industry trends, when making their investment decisions to ensure a well-rounded approach to evaluating potential investment opportunities.

What Do ESG Scores Measure?

ESG scores evaluate companies based on various criteria, which are classified into three main categories:

Environmental Issues

• Carbon footprint
• Energy efficiency
• Renewable energy usage
• Water usage
• Pollution
• Waste management
• Biodiversity impact

Social Issues

• Labor practices
• Pro-diversity efforts
• Human rights
• Community relations
• Health and safety

Governance Issues

• Board diversity and structure
• Executive compensation
• Shareholder rights
• Business ethics
• Risk management
• Supply chain management

ESG Rating Agencies and Methodologies

ESG rating agencies are third-party companies that create ESG scoring systems. Each agency has a unique methodology and set of criteria for evaluating companies. Some rating agencies use a 0 to 100 scale, while others, like MSCI, classify companies as leaders, average, or laggards.

There are more than 140 ESG rating agencies in the United States alone, and each agency has its own methodology, which can be found on their respective websites or on resources such as the IRIS Carbon beginner’s guide to ESG rating agencies and methodologies. Below, we list some of the most influential ESG rating agencies and a brief overview of their scoring methodology.

Some of the Most Relevant ESG Rating Agencies & Data Providers

• Bloomberg ESG Data: Bloomberg provides a variety of data and proprietary scores that investors can use to assess company or government disclosure and performance on a wide range of ESG and thematic issues. Bloomberg’s ESG and thematic scores can integrate into company research and portfolio construction. Bloomberg’s proprietary quant model is informed by sustainability and industry frameworks, research, and analysis to reduce noise, normalize data, address size bias, and reduce disclosure gaps.
• Dow Jones Sustainability Indexes: The Dow Jones Best-in-Class World Index represents the top 10% of the biggest 2,500 companies in the S&P Global Broad Market Index based on long-term environmental, social, and governance criteria. The Dow Jones Sustainability North America Composite Index comprises the top 20% of the largest 600 North American companies based on the same criteria.
• MSCI ESG Research: According to MSCI, a “leader” (rated AAA and AA) indicates that a company leads its industry in managing the most significant ESG risks and opportunities. “Average” (rated A, BBB, or BB) companies are described by a mixed or unexceptional track record of managing ESG risks and opportunities relative to industry peers. A “laggard” (rated B or CCC) trails its industry based on its high exposure and failure to manage significant ESG risks.
• Sustainalytics: Sustainalytics is a leading ESG research and analytics firm. It produces ESG scores on a scale of 0 to 100, with a higher score indicating better environmental, social, and governance performance. The scores are normalized by industry to allow for comparability between companies operating in the same sector. In addition to the overall ESG score, Sustainalytics provides scores for each of the three dimensions (environmental, social, and governance) on the same 0 to 100 scale. This granularity enables investors to gain a more in-depth understanding of a company’s performance in each of the three ESG categories.
• LSEG Data & Analytics: LSEG is another prominent provider of ESG scores. Its scores are presented on a scale of 0 to 100, with higher scores indicating better environmental, social, and governance performance. The scores are percentile-ranked—for example, a score of 80 would indicate that a company performs better than 80% of its peers in the same industry.
• S&P Global: S&P Global uses its “Shades of Green” methodology to assess how a company contributes to “a low carbon and climate resilient future.” The ratings are red, yellow, light green, medium green, and dark green, with red being the lowest rating and dark green being the highest.
• ISS ESG: ISS rates companies from a scale of A+ to D- with the letter rating corresponding to excellent, good, medium, or poor. It provides a holistic approach to rating sustainability, assessing the risk and impact on all stakeholders, including employees, suppliers, customers, ecosystems, and communities.
• CDP Scores: CDP (formerly known as the Carbon Disclosure Project) focuses on environmental impact, or the “E” in ESG. CDP scores focus on individual companies and their efforts to disclose, manage, and reduce their environmental impact. Companies participating in the CDP disclosure process receive a score (A to D-) based on their transparency, risk management, and climate change mitigation efforts. A higher score (e.g., A or A-) indicates better environmental performance and commitment to addressing climate change. CDP scores are designed to incentivize companies to improve their environmental performance and provide investors with valuable information on corporate sustainability practices.
• Climetrics: CDP also introduced Climetrics scores, the world’s first climate impact rating system for investment funds. This innovative rating system enables investors to make climate-conscious investment decisions by assessing the climate impact of various funds. Climetrics ratings use a scale of one to five green leaves, with one leaf representing a low climate impact score and five leaves indicating the highest climate impact score. The ratings take into account several factors, such as a fund’s portfolio holdings, its asset manager’s climate performance, and the company’s climate-related disclosures.
• Corporate Knights Global 100: Corporate Knights has been ranking the world’s 100 most sustainable corporations since 2005, based on a rigorous assessment of public companies around the world with revenue of at least $1 billion. Companies are scored on each of the key performance indicators relative to their industry peers, and the top 100 performers are included in the Global 100 ranking. The list aims to showcase best practices and serve as a benchmark for investors and companies seeking to adopt more sustainable business models.
• FTSE Russell ESG Scores: FTSE Russell’s ESG Scores and data model allow investors to understand a company’s exposure to, and management of, ESG issues in multiple dimensions measuring ESG risk and performance on 8,000 securities across 47 developed and emerging markets. The ESG Scores are composed of an overall rating that breaks down into underlying Pillar and Theme Exposures and Scores. The Pillars and Themes are built on over 300 individual indicator assessments that are applied to each company’s unique circumstances.
• RepRisk: RepRisk produces The RepRisk Index (RRI). The RRI dynamically captures and quantifies reputational risk exposure related to ESG issues. The scale ranges from 0 to 100 with 0 to 24 denoting low-risk exposure and 75 to 100 denoting extremely high-risk exposure.

Note

ESG ratings can be based on qualitative or quantitative data or a combination of the two.

How to Obtain a Company’s ESG Scores for Free

Obtaining ESG scores for free can be challenging, as many ESG rating agencies charge for access to their data and research. However, there are some resources and platforms where you can find ESG scores or related information for free:

• Yahoo! Finance: Yahoo! Finance provides sustainability scores for companies, powered by Sustainalytics. You can search for a specific stock or exchange-traded fund (ETF) on Yahoo! Finance and then click on the “Sustainability” tab to see the ESG scores.
• MSCI ESG Ratings: MSCI offers a free search tool that allows you to check the ESG rating of select companies or funds. Visit the MSCI ESG Ratings website, and enter the company or fund name in the search bar.
• Corporate sustainability reports: Many companies today elect to publish annual sustainability reports, which often include ESG-related data, policies, and achievements. You can usually find these reports on a company’s website in the “Investor Relations” or “Sustainability” sections.
• CDP: CDP runs a global disclosure system that enables companies, cities, and regions to measure and manage their environmental impacts. While CDP scores are not ESG scores per se, they provide valuable insights into a company’s environmental performance. You can access CDP’s public disclosure data for free on its website.
• Brokerage websites: Many online brokers today have ESG analytics and ratings available to their customers, although the metrics and scores featured may vary between platforms and may only be available to active customers.

Keep in mind that, while these resources can provide access to some ESG information for free, they may not offer the most comprehensive, in-depth data and analysis provided by paid ESG rating services.

What Is Considered a Good ESG Score?

Many ESG scores range from 0 to 100, with scores below 50 considered poor and scores above 70 deemed good. Other schemes feature a leaders-average-laggards scoring system that ranges from AAA to CCC.

Most scoring is carried out so that a company is comparable to peers in the same industry. Investors should research the specific rating agency’s methodology to understand how these scores are calculated and their implications.

What Can ESG Scores Tell Investors?

Investors use ESG scores to make informed investment decisions, evaluate a company’s long-term prospects, and assess the sustainability of its operations. High ESG scores indicate that a company is effectively managing environmental, social, and governance risks, which can lead to better financial performance and lower investment risk. Investors who are interested in socially responsible investing or who value ESG can use these scores to identify which potential investments are worthwhile and which should be avoided.

What Are Some Limitations of ESG Scores?

One limitation of ESG scores is the lack of standardization in methodologies and criteria used by the various rating agencies, which employ different approaches to assess and weigh ESG factors. This can lead to inconsistent results and make it difficult for investors to compare scores across different providers.

Another limitation is the potential for greenwashing, where companies may misrepresent or exaggerate their ESG efforts to improve their scores and attract SRI investors. Additionally, ESG data may be self-reported by companies, which raises concerns about data quality, accuracy, and reliability. ESG scores may also not capture all relevant aspects of a company’s sustainability performance, as certain issues may be overlooked or underestimated due to limitations in data availability or methodology.

Finally, ESG scores often focus on larger-cap companies and may not provide adequate coverage of small-cap and midcap companies, which could limit the investment universe for responsible investors.

In conclusion, while ESG scores can be a valuable tool for assessing companies’ sustainability performance, investors should be aware of their limitations and consider them as one of several factors in their investment decision-making process.

What Is the Most Popular ESG Reporting Framework?

For ESG scores to be calculated, companies must report and disclose relevant information and data. The Global Reporting Initiative (GRI) Standards are considered the most popular and widely adopted ESG reporting framework globally. Established in 1997, the GRI is an independent international organization that provides a comprehensive set of sustainability reporting guidelines for organizations of all sizes and sectors.

The popularity of the GRI Standards can be attributed to their flexibility, relevance across industries, and global recognition by various stakeholders, including investors, nongovernmental organizations (NGOs), and regulators. By adopting the GRI Standards, organizations can demonstrate their commitment to sustainability, identify and manage ESG risks, and communicate their progress to stakeholders.

Other notable ESG reporting frameworks include the Sustainability Accounting Standards Board (SASB) Standards, the Task Force on Climate-related Financial Disclosures (TCFD) Recommendations, and the United Nations Global Compact (UNGC).

The Bottom Line

ESG scores serve as a valuable tool for investors to assess companies’ environmental, social, and governance performance, enabling them to make informed, responsible investment decisions. By evaluating factors such as carbon footprint, energy efficiency, labor practices, and corporate governance, ESG scores provide insights into a company’s long-term sustainability and resilience.

However, due to the lack of standardization, potential for greenwashing, and other limitations, investors should consider ESG scores as one aspect of their investment decision-making process, rather than relying solely on them. ESG scores can be found online for free in some cases, or by subscription. Financial portals and brokerage websites may also contain ESG ratings and analytics.

By using ESG scores in combination with other financial and nonfinancial factors, investors can better identify companies that align with their values and contribute to a more sustainable global economy.

Reviewed by Somer Anderson

While the terms pre-qualification and pre-approval are sometimes used interchangeably, they have distinct meanings and purposes. Typically, getting pre-qualified is more of a preliminary step to determine the size of a mortgage you could get. Meanwhile, being pre-approved means receiving conditional approval for the loan amount you’re going to borrow.

Key Takeaways

• Pre-qualification is typically based on data you submit and is more of a preliminary estimate of the mortgage size you could qualify for.
• Pre-approval is usually the more involved step and signals what a lender can offer you, though it isn’t an actual guarantee.
• While both have their purposes, pre-approval tends to be more useful for showing sellers you’re ready to buy.

Pre-Qualified

“Pre-qualification is a less involved step, with less verification steps completed in most cases,” said Phil Crescenzo Jr., Southeast division president of Nation One Mortgage Corporation. “A pre-qualification may be given with information entered from an applicant but not yet verified, such as with income or assets.”

Using this information, the lender can determine the mortgage amount that you’d likely be eligible for, without doing a hard credit pull that could hurt your credit score. It might then issue a formal pre-qualification letter or simply state the amount it’s willing to lend you. This process can take anywhere from a few minutes to a couple of days.

Warning

Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report with the Consumer Financial Protection Bureau (CFPB) or the United States Department of Housing and Urban Development (HUD).

A pre-qualification letter usually doesn’t carry the same weight to home sellers as a verified pre-approval letter. Still, sometimes buyers prefer to start with getting pre-qualified, as this can be useful for narrowing down lenders.

“If a buyer may not be ready to move forward immediately, but wants a preliminary review to get an idea of where they stack up financially while providing less information, they might only want or need pre-qualification,” Crescenzo said. “If a client didn’t want a credit inquiry, but wanted a soft pull, this could also be a reason to ask for a process that’s less involved.”

Pre-Approved

Pre-approval typically requires completing a mortgage application and the lender doing a hard inquiry to determine creditworthiness. With that information, the lender can give a more accurate estimate of what the borrower will be approved for once they’re ready to complete a mortgage application. This offer is usually good for a period of up to 60 days.

Important

A pre-approval doesn’t guarantee the final loan amount, as the lender may learn new information during the full underwriting process that changes what it’s willing to offer.

“A pre-approval is what I call ‘show me.’ What I mean by that is let me see the real documents that I—or underwriting—will need for an approval: pay stubs, W-2s, bank statements, credit report, tax returns, etc.,” said Kevin Leibowitz, president and CEO of Grayton Mortgage. “We’re not completely underwriting the file, but it is a thorough review of a borrower’s profile.”

This thorough review can be valuable for prospective buyers, and some borrowers may prefer skipping right to the pre-approval process rather than getting pre-qualified first.

“A pre-approved buyer is more likely to win an offer over a less prepared buyer or realtor,” said Crescenzo. “The more information and detail that can be confirmed in advance, the smoother the process will be once an offer is accepted and processing begins. I would recommend a full pre-approval process whenever it’s possible and time allows.”

By pulling your credit, the lender can also better tailor the interest rate to suit your creditworthiness. Additionally, a pre-approved borrower may be able to qualify for an interest rate lock under certain circumstances, potentially in exchange for a fee. Most of the time, however, the lender will offer you a floating rate that’s tied to market conditions. You can still lock in a fixed rate after you’ve secured your mortgage, though the original rate may have changed by the time you close on the loan.

You may be able to lower the interest rate you’re offered by taking certain steps before you apply for a mortgage. “I’ve seen way too many what I call ‘skeletons in the closet’ on credit reports. Many of these items can be incorrect, and some can be addressable,” Leibowitz added. “It’s better to start the process early so that there’s time to fix/address items that were unknown or not discussed.”

Key Differences

How the pre-qualification and pre-approval processes work can vary by lender. Typically, however, getting pre-qualified and being pre-approved will differ in the following ways:

	Pre-Qualification	Pre-Approval
Mortgage Application	Not required	Required
Application Fee	None	Varies
Credit Check	Soft inquiry	Hard inquiry
Financial Data	Self-reported	Lender review
Estimated Down Payment	Varies	Required
Loan Amount	Estimate	Specific
Interest Rate Information	Not provided	Provided

Special Considerations

In some cases, buyers can benefit from getting both a pre-qualification and pre-approval. If it’s still early in the homebuying process, a pre-qualification could be worth it in order to get a rough estimate of what you’ll be able to borrow. Then, once you’re ready for a more in-depth review of your finances, you could move forward with a pre-approval. In other cases, it could make sense to skip pre-qualification.

“From our process, we only issue pre-approvals. We want to do a bit of the heavy lifting upfront to make sure that our clients are set up for success and don’t have surprises later on in the process,” Leibowitz said.

Once you’re ready to make an offer on a home, the buyer and seller typically enter into a purchase agreement. Borrowers would then provide a copy of this and any other documents that the lender may request as part of the full underwriting process. Additionally, the lender will then hire someone to conduct a home appraisal to help them ascertain the value of the home. 

Finally, if all goes well, you’ll receive a mortgage commitment letter. This is a formal offer from the lender to loan you a certain amount, though this can be retracted if your financial situation changes or either you or the property are later found to have fallen short of the lender’s qualifications.

The Bottom Line

Getting pre-qualified and pre-approved can help you determine what kind of home you can afford. Pre-qualification is usually the simpler step, but it offers less certainty over how much the lender will actually approve you for. As such, consider getting a pre-approval before you start trying to negotiate with a home seller.

Reviewed by Ebony Howard

A Master Limited Partnership (MLP) is a hybrid between a partnership and a publicly traded company. There are significant tax advantages to owning MLP units. However, despite these benefits, MLPs may not be the ideal investment for an Individual Retirement Account (IRA).

Understanding Master Limited Partnerships

MLPs offer significant liquidity for investors. An investor can buy and sell units through a national stock exchange. Many MLPs operate capital-intensive businesses, such as oil and gas pipelines and storage facilities—the energy sector. Congress limited the use of MLPs to entities operating in certain sectors in 1987. This limitation includes those operating businesses associated with natural resources. MLPs issue units, as opposed to shares, as standard companies do. An investor who buys units in an MLP is considered a limited partner in the business. The business end of the MLP is operated by the general partner.

Distributions from MLPs to unit holders receive favorable tax treatment under the IRS code.An MLP is a pass-through entity, and partnership income is only taxed at the level of the partner. Distributions are not taxed when they are received, unlike stock dividends, which are taxed the year they are realized. Instead, the distributions are considered a reduction in the cost basis of the MLP investment. If you hold the MLP long enough and your cost basis reaches zero, distributions are taxed as capital gains in the year of distribution.

Tax Liability

The tax liability from the distributions is only realized when the interest in the MLP is sold. The delay in taxation causes the MLP to be a tax-deferred investment. When you eventually sell all of your shares, appreciation of the units will be treated as capital gains, not ordinary income.

Since MLP tax liability is deferred, it is not the best candidate to hold in an IRA. Income from an MLP is not taxed at the corporate level, which avoids the common problem of double taxation for corporations. At tax time, the investor receives a K-1 schedule from the MLP stating the investor’s portion of the MLP’s net income. This MLP income is not tax-deferred if the units are held in an IRA. Holding this security in an IRA account eliminates the tax benefits of an MLP investment.

A downside of holding MLPs is that many of them invest in pipelines that run through several states. You may have to pay state income taxes, but some states offer exemptions.

What Are the Tax Benefits of Owning an MLP?

MLPs offer significant tax advantages because they are pass-through entities. This means that income generated by the MLP is only taxed at the investor’s level, not at the corporate level.

How Are MLP Distributions Taxed?

MLP distributions are not taxed when received. Instead, they reduce the investor’s cost basis in the MLP. When the investor sells the MLP units, any appreciation of the units is taxed as capital gains. If the cost basis reaches zero, distributions are taxed as capital gains.

Do I Need to Worry About State Taxes With MLPs?

Yes, MLPs that operate across multiple states may trigger state income taxes, depending on the location of the MLP’s operations. Some states offer exemptions, so it’s important to be aware of state tax rules when investing in MLPs.

The Bottom Line

Master Limited Partnerships can offer attractive tax advantages, making them a popular investment choice for those seeking income-generating assets. Because of how taxes are structured, MLPs are not suitable for all investment accounts, especially IRAs. It’s important for investors to understand the federal and state tax implications before investing in MLPs.