The Stock Market has always been a contentious topic. People are usually divided between two schools of thought – some think of the markets as gambling while some are attracted to it as legitimate business with huge earning potential.
If you are reading this article, then you most probably belong to the latter group. But in case you subscribe to the idea that the stock markets is just one big casino, then I will try to convince you otherwise in this article. Let’s go.
Even among those who believe that stock markets make you money, there exists different schools of thought – most commonly known as a “trader” or “investor”.
The basic difference between a stock market trader and a stock market investor is that a trader usually tries to look for short-term opportunities to make money based on the price movement of the stock, while an investor researches the core fundamentals of the company thoroughly before making any investment with a long-term time horizon.
The general public with little capital fall under the category of Retail Investors and big financial institutions like banks, asset management companies, mutual funds etc. with huge capital are called Institutional Investors.
SKILLS NEEDED IN STOCK MARKETS:
In order to beat the market or at least be competitive in it, you need to possess the skills required to perform stock market analysis. These skills are:
Technical Analysis
It is a process based on the price movement and volume of a stock. There are various candlestick patterns (like flags, triangles, head and shoulders etc.) and indicators (like moving averages, RSI, VWAP, MACD, etc.) that are used in conjunction with the stock price to get an entry and target price for a trade. Though it sounds complex, it is an easily learnable skill.
I have written a detailed articled article on how to learn technical analysis which you can read here.
Fundamental Analysis
This method of analysis is used to arrive at the long-term potential of a company rather than making intraday trades. The holding period here is much longer than in trading and involves forecasting the long-term earning potential of the company. This is a more detailed way of analysis which requires good understanding of financial statements of a company and how to connect it with macro-economic factors, if any. Using this information, valuation professionals built financial models which help arrive at the value of the company which investors can then use to make a BUY/HOLD/SELL decision.
I have written a detailed articled article on how to learn fundamental analysis which you can read here.
TYPES OF MARKET INSTRUMENTS:
Now, let us look at some instruments that can be traded in the stock market based on the analysis.
Equity
Equity is a share of a company that a person can own. If a company has 1000 shares in the market and you buy 10 shares, then you are 1% equity or share holder of that company i.e. you own 1% of that company. Once you have purchased an equity share, you can own the shares as long as you wish or till the company exists. The return on investment in equity shares can come in 2 ways – a) through dividend payments or; b) through capital appreciation.
Dividend is a portion of profits shared by the company with its shareholders, whereas on capital appreciation is the increase in price of the shares over time.
Derivatives
These are instruments that derive its value from the underlying assets. For example: An equity derivative derives its value from the underlying respective equity shares. Similarly, a commodities derivative will derive its value from the various tradable commodities like gold, silver, crude oil, etc.
Following are the types of derivatives –
1. Futures – It is an agreement where the buyer/seller has the obligation to buy/sell the underlying asset on a pre-determined date at a pre-determined price. A lot size defines the quantity of shares in 1 futures contract. The advantage of trading in futures is the leverage and liquidity that it offers.
For example: Reliance Industries Ltd (RIL) has a lot size of 505, which means if you trade in futures of RIL, you will have to trade in multiples of 505. 1 lot = 505 shares, 2 lots = 1010 shares, and so on.
If you buy 505 equity shares of RIL from the market at CMP of Rs. 2225/share, you will have to invest approx. INR 11.20 lacs. On the other hand, 1 lot of RIL costs approx INR 2.90 lacs.
Though the use of leverage makes futures an attractive investment tool, it also makes it riskier than an equity share. So, in case of RIL, a Re.1 increase in stock price will result in a profit of Rs. 505 and a Re.1 decrease will result in a loss of Rs.505. You also have to pay some upfront money as a margin amount to buy a futures contract and if your position in the market bears losses, you will receive a margin call from your broker to add additional funds into your account in order to maintain the required margin. Failing to do so will lead to automatic squaring–off of your trade by your broker to prevent further losses.
Futures contracts are generally available for a three-month period – near-month, mid-month and far-month; Eg: for RIL futures contract in October 2020, near-month contract: OCT 2020, mid-month contract: NOV 2020 and far-month contract: DEC 2020 as shown in the image below.
Futures contracts also have an expiration date which in India is the last working Thursday of that month on which either you can square-off your position ie. close out your current position; or rollover your position ie. close your current position and take same position in next month’s futures.
2. Options – It is an agreement similar to futures where the buyer/seller agrees to buy/sell the underlying asset on a pre-determined date at a pre-determined price. The difference is that the buyer does not have any obligation to buy but the seller does have the obligation to sell if the buyer decides to exercise the option to buy.
The option buyer has to pay a premium to the option seller before buying the options contract. A Call Option gives the option holder the right to buy while a Put Option gives the option holder the right to sell.
An added advantage of options trading apart from leverage and liquidity is that the loss for option buyers is capped to the premium amount while the profit has no limit. This is because when the options position makes losses, the option buyer has the liberty to let the option contract expire on the expiry date as he does not have an obligation to buy.
So, all he will lose is a small option premium paid to the seller. But same cannot be said for the options seller as he is under an obligation. Though the risk-to-reward appears very attractive for options buying, amateur traders are advised not to trade in options as it involves knowledge of many other complex concepts such as option Greeks.
Understanding these concepts require in depth explanations and hands-on training which are covered in detail in our stock market course.
OPENING A TRADING ACCOUNT:
The next requirement to start trading is to open a trading account with broker who suit your trading needs. There are two types of brokers in the market – a discount broker and a full-service broker.
Some of the leading discount brokers are Zerodha, Upstox, 5paisa etc. and some full-service brokers are Kotak Securities, ShareKhan, Motilal Oswal, etc. Discount brokers charge cheaper brokerage fee than full-service brokers and it is highly recommended that you start your trading journey with a discount broker.
I personally use Zerodha as for my trading as well as investing needs since their user interface and brokerage charges suit my needs perfectly. You can open your account with Zerodha by clicking here.
There are also some websites which provide trading platforms for free. Some of them are tradingview.com. Their basic free plan provides all the features for charting and technical analysis that any beginner would need. For fundamental analysis, you can refer to screener.in. This website provides various fundamental parameters and ratio-based analysis of different companies which can aid in taking a position from a fundamental point of view.
Shown below is a screenshot of Nifty chart as seen on Tradingview.com
Even after collecting all kinds of information pertaining to stock market, the biggest dilemma that a person faces is with how much capital must he invest in stock market. My advice to newbie traders/investors will be to start with an amount which is not more than 10% of your monthly income. Under no circumstances must you trade with borrowed money or with money which you cannot afford to lose. I have written a separate article covering trading tips for beginners which you can read here.
This was a small effort to answer the most commonly asked queries and doubts we get from students, and I hope this article makes it a little easier for you to start your trading journey.
