Here are 9 Important terms on Share trading that you should be aware of:
Trading in Stocks refers to buying and selling equity shares in stock markets. In contrast to investing, trading is focused on making profits out of the differences in bid-ask prices and often has a short-term orientation as opposed to long-term goal-oriented investing. To make these short term gains out of stock market, you need to have a strategy in place, and of course you need to keep continuous track of market movements.
The article deals with some of the important terms that you need to be aware of before venturing into share trading:
Order & Execution
Order refers to participant’s offer to buy or sell a fixed amount of equity shares. When the participant’s order to buy or sell the stock is completed, it is known as execution. Orders can be of various types based on the time and price of execution. In a market order, the action to buy or sell the security needs to be completed immediately at the prevailing market price. Whereas in a limit order, the participant places an order to purchase a security at a price no more than a particular limit or to sell a security at a price no less than a specific limit. Suppose Mr X places a limit order to buy shares of ABC Ltd. at Rs 50. The order will be executed when a comparable ask price of Rs 50 or less is received.
Averaging is an act of buying more number of equity shares on account of a gradual fall in the market price of the shares. It is considered as contrary to usual trading behaviour and is a comparatively long-term approach than stop-loss. Such an act helps in reducing the average cost of purchasing shares. Suppose Mr C bought 100 shares of Excel Ltd at Rs 50. Subsequently, when stock prices fall to Rs 40, he again purchased 100 shares in addition to the earlier acquisition. After some time, when the price of shares rose to Rs 49, he sold the shares to record a potential gain which is computed as follows:
100 shares * (49-50) = -Rs 100
100 shares * (49-40) = Rs 400
Net Gain = Rs 400- Rs 300 = Rs 100
A Stop-loss order refers to the sale of a particular security if its price reaches the prescribed level. This kind of order is mainly triggered to contain the losses occurring due to plummeting of stock prices in the market. The stop-loss strategy is just the opposite of averaging approach because, in the latter approach, the participant keeps buying the selling upon a fall in the price of shares. Suppose Mr Y, a short-term trader, who bought shares of XYZ Company at Rs 100, may place a stop-loss order at Rs 95. When the price reaches Rs 95, Mr Y’s order to sell automatically gets executed.
Day Trading involves purchase and sale of securities by the participant within the same trading day which leads to closure of all trading positions on the same trading day. The primary objective of day trading is to take advantage of volatility in the prices of highly-liquid stocks. The profit is earned by buying at the lower bid price and selling at a higher ask price. The day trader needs to be sound in technical analysis of stocks and research tools coupled with a vigilant eye and insightful decision-making.
Short Position & Long Position
In a short position, the participant first sells borrowed securities in the market and then repurchases the same when there is a fall in the prices of the security. Actually, in short selling, the participant is not assuming any position as such as nowhere he holds the ownership of the securities. Short selling often becomes a disastrous proposition if the prices do not fall as per the expectation of the participant. After his sale, if the prices of shares increase, then he is forced to buy them at higher prices due to the compulsion to close the trade within the same day.
In the long position, the participant buys the securities and then sells the same when there’s a rise in the prices of the security. Here too, the participant may incur a loss when the price of shares falls in contrast to his expectation.
Selling Freeze & Buying Freeze
The participant may encounter a situation called Freeze wherein the trading activity of a particular stock may be interrupted due to violation of certain trading parameters. There may be buying freeze or selling freeze.
In case of selling freeze, although the participant may buy the security, he is not allowed to sell it. Similarly, In case of buying freeze, although he may sell the security, he is not allowed to buy it.
When the index or stock prices reach a particular pre-defined value known as a circuit breaker in either of the directions, the stock exchange stops the trading activity for a specified duration. It is done to take control of the situation when there is surge or slump in the prices in an uncontrolled manner. On expiry of Circuit Breaker Session, there is pre-open call auction session wherein participants place their orders to buy or sell securities at particular prices.
The following table shows the duration of circuit breaker and pre-open session:
In India, Market-wide Circuit Breakers are triggered either at Sensex or Nifty. Circuit Breakers allow the participants to cool down and absorb any developments that affected a particular security which caused them to behave irrationally. Conversely, it prevents the security from attaining its true price either upwards or downwards.
Technical Analysis assumes that market prices reflect the collective knowledge of all participants and thus represent the fair intrinsic value of the company. It entails a detailed analysis of charts and patterns of price movements. It provides the participant with an insight into the current trends prevailing in the market and the direction in which the market is headed in near future. It helps in avoiding the adverse consequences of buying in too early or exiting too late. It seldom provides the reason behind why the prices are behaving in such a manner.
Futures and Options
Futures and Options fall into the category of derivatives which refers to a contract between two parties wherein the price or value of the consideration is based on one or more underlying assets like stocks, precious metals, commodities, currency, bonds, etc. These are standardised contracts capable of being traded on a stock exchange. These are used to hedge the risk inherent in particular security like counter exchange rate risks while buying stocks from international stock exchanges.
In future contracts, one party contracts to sell the asset at an agreed price to another party at a future date. Herein, the seller believes that there will be a fall in the value of the security while the buyer foresees a rise in its price. Suppose the price of the security held by A is Rs.100 as on 6 September 2016, and she enters into a futures contract to sell the security on 6 September 2017 to B at the current market price. If on the agreed date, the price of the security falls to Rs 95, then A stands to gain Rs 5 per share as she had got the selling price locked under the futures contract. As the contract can be traded on the exchange, so A may execute the contract even before the pre-determined future date.
Unlike futures, options contract provides a right to the participant to buy or sell an asset at a future date on pre-determined price. The participant is under no obligation to fulfil terms of the options contract.
Although stock trading is a risky affair, it is possible to make money provided you are disciplined, vigilant to market dynamics and understand how these changes affect market prices of your shareholding. Usually, fear and greed drive people crazy while trading. As long as an emphasis is given on correct execution of strategy, emotions won’t cloud your wisdom, and you will not return empty-handed.