While many investors like to buy dividend-paying stocks for the long term, it is possible to use the effects of dividend payments on stock prices to find short-term patterns that can be profitably traded. When you understand how stock dividends work, you can then look for a pattern in the prices of these stocks that allow you to earn more profits than with a buy-and-hold strategy.
Most U.S. companies pay dividends quarterly, or four times a year. For each payment the company will declare the amount of the dividend along with a record date and payment date. To receive the dividend an investor must own the shares on the record date. Stock market rules dictate that it takes three business days for a stock trade to "settle," or become official. This means an investor must buy shares at least three days before the record date to earn the distribution and the stock goes "ex-dividend" two days before the record date.
When the stock market opens on the ex-dividend date, the share price will start trading at the previous day's closing price minus the amount of the dividend. This prevents traders from buying the day before the ex-date, qualifying as the shareholder of record, selling the next day and collecting the dividend without risk. This sequence of buying one day and selling the next allows an investor to be the owner for one day -- the record date -- but there is no profit in the trade because of the ex-dividend share price drop.
To buy a stock to both collect the dividend and invest for the short term, you must buy before the ex-dividend date and hold the stock until the share price recovers to your purchase price or higher. Different stocks take different time periods to recover. The price of a specific stock may also show a pattern before the ex-dividend date. For example, a specific stock increases by several percent in the days before going ex-dividend. With this stock, the price is usually cheaper if you would buy a week before it goes ex-dividend.
Due to the ex-dividend share price drop, to practice a short-term, dividend-capture investment strategy will involve buying a stock and holding it for a few weeks up to 60 days. If the stock pays qualified dividends, you must own the shares for at least 60 days to get the lower qualified tax rate on the dividend. Since stocks pay dividends four times a year, you need to work with two to four different stocks to spread the dividend payment dates throughout the year. Your research will reveal historical price patterns for each stock around the ex-dividend date.
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