A stock market is an intriguing place if you dedicate your time to learning and implementing. It is rightly said that “Practice leads to perfection”, and it is the same which needs to be implemented here as well. Even the mighty Superman had to first learn how to use his powers to use them while fighting the villains. So, what makes us any different when it comes to learning about the stock market?
To become successful in the markets, you need to understand and learn three most important things –Behavioural Finance, Fundamental Analysis, and Technical Analysis.
Behavioral finance is a combination of Psychology and Finance amalgamated together to profiteer in the stock markets. The concept explains stock market cycles together with human emotions and provides reasoning to figure out why investors buy or sell, and whether we should buy or sell at a particular point or patiently wait.
Fundamental Analysis means analyzing the company’s financial sheets, product portfolio, management, etc. to decide whether to buy a stock or not. It also attempts to find out whether the stock is undervalued, overvalued, or fairly valued. Fundamental analysis is meant for the long term.
Technical Analysis helps in identifying trading opportunities using historical price and volume patterns. It is meant for the short term.
In this blog post, we will mainly be discussing the trading aspect of stock markets.
What is trading?
In stock markets, trading simply means for a definite period. Unlike Investing, the primary goal is to profiteer using the momentum and not generate wealth with accumulation and appreciation. If you bought 20 shares of Hindustan Unilever Ltd. and sold them after 3 months, it means you completed a trade
Is it compulsory to trade?
Before acquainting you with the benefits attached to trading, we would like to make it clear that it is completely okay if you only invest and not trade. It depends on one’s ability to control emotions and time. Many have become successful in the markets only by trading, many only by investing, and many by trading as well as investing. Also, trading doesn’t imply that you do Intraday. If you can’t do it Intraday due to time or any other reason, it is totally fine enough.
Benefits of Trading –
⦁ It helps in earning considerable returns in a short time.
⦁ You can even short-sell stocks (a concept called ⦁ short selling in which you sell at high first, then buy back at lows) in trading when the market or stock is correcting.
⦁ You can also invest the profits earned from trading into socks which helps in increasing capital.
However, trading also has its own problems. If you do not trade with the right strategy, take irrational decisions, or overtrade you might lose all your capital. So, when you’re starting, begin our trading journey with a small capital, which even if you lose, will not harm your emotional or financial well-being. Thus, it is better to gain knowledge about trading before beginning.
How not to lose money in trading?
The chances of you winning a trade are only 50-55% even if you’re using a good strategy. However, this win should be big enough that it wipes out some of your small losses. So, firstly it is crucial to know how not to lose money in trading than how to earn. By using these simple concepts, one can reduce losses to a great extent.
⦁ Risk to reward ratio – Whenever you trade, there can be only 5 trading outcomes. Either you will make a large profit, small loss, no profit no loss, small loss, or large loss. You must make sure that you are not suffering large losses. Therefore, it is advisable to keep a risk-reward ratio of 1:3 to avoid large losses .
⦁ Stoploss – Stoploss is a methodology to limit or restrict losses. Let’s understand this through an example. Suppose you entered a trade at Rs. 500. Your target is Rs. 530. To maintain a risk-reward ratio of 3:1, your stop loss should be at Rs. 490. This means that whenever the stock price hits Rs. 490 you must close your trade, and not wait any longer!
⦁ Position Sizing – Position sizing refers to adjusting your entry position and quantity of stocks in the trade as per your risk tolerance. Let’s understand through an example.
CASE 1 – You should never take positions whose loss exceeds the calculated risk of 2% on the capital.
CASE 2 – If your calculated risk is 2.5% you will have to reduce the number of stocks you were going to buy to manage risk.
What are some trading strategies?
A trading strategy is a plan to buy or sell shares to generate profits by capitalizing on the momentum. There are several trading strategies on different chart time frames. Let us explain two such strategies.
⦁ Simple Moving Average – Simple Moving Average (SMA) is a type of trend indicator. It tells the average price of a stock over a specified period. If the price cuts a significant SMA from the bottom, then there is a high chance that the price will move upwards. So, it acts as a Buy signal. If the price cuts a significant SMA from the top, then there is a high chance that the price will move downwards. So, it acts as a Sell signal. Simple moving averages of 200 or a combination of 50 and 200 are the most used and effective moving averages.
⦁ Support and Resistance – It is a widely popular trading strategy used by all traders. Support refers to the level where buyers might push the price upwards again. If the support breaks, the price experiences a downtrend. So, one can initiate a short trade. Resistance refers to the level from which the stock price resists going upwards due to sellers. If the resistance breaks, the price experiences an uptrend. So, one can initiate a long trade.
These were some of the simplest strategies that one can apply to trade. Trading is a very broad concept that cannot be learned in a blog post, or just in some days. It is meant to be learned consistently throughout with simultaneous implementation. You need to tweak it unless it is perfect, and it can be achieved with back-testing and forward testing.
