Basics of Stock Market
What is a stock ?
A stock is a partial ownership in a company or an industry, with rights to share in its profits. When an investor buys a stock of a company, he is called a shareholder or a stockholder of that company. The benefit of buying a share is that when the company profits, the shareholders also profit. The company distributes the profit among its shareholders, which is called the ‘dividend‘.
How do you make profits with stocks ?
But many traders make real profit in stocks using the market price of the stocks. Stocks are traded in the stock markets. The face value is the nominal value of the stock that is determined by the issuer of the stock. ‘Market price‘ of a stock is the price at which currently a stock is traded in the market. This price may be at premium or lesser than the ‘face value’ of the stock, depending on the company’s performance and prospects, investors’ interests in the company and a lot of other factors.
Market price of a stock keeps varying as traders trade the stock in the market. Traders often make money using these variations in the market price of the stock. Stocks are bought at lower market prices and sold at higher prices later. This is referred to as ‘long‘ positions in market terms. Similarly stocks can be sold at a higher market price and bought at a lower price later. Thiis is referred to as ‘short‘ positions in market terms. In these cases, the difference in the market prices at the time of buying and selling will be seen as profit by the traders.
What is the Stock Market ?
Basically it is an exchange place or a market that facilitates the trading of stocks. People participating in the stock markets range from some casual traders and investors who trade as a hobby, to large fund traders.
In India the most famous exchanges or markets are the Bombay Stock Exchange(BSE) and the National Stock Exchange (NSE). Globally there are many markets including the famous New York Stock (NYSE), NASDAQ, London Stock Exchange, Hong Kong Stock Exchange etc..
Any market can be thought of with two functionalities:
Primary Market: Here the companies and industries raise long term funds for their operations by issuing shares. Companies come up with an initial price, mostly with premium for the face value of the shares, which will be distributed to the investors. This is called the Initial Public Offer or the IPO.
Secondary Market : After a Company has finished its IPO, it is listed in the markets. After getting listed and issued shares to investors, the shares can then be sold to other investors in the stockmarket. Here the people can buy the shares at a current price as determined by other investors in the market.
What is the Demat Account ?
Like opening a bank account for doing your personal financial transactions, you have to open a Demat account to trade in the stock market. Demat account refers to Dematerialized account. This account helps you to buy and sell stocks without the need for physical paper shares.
A Demat Account is a must for trading the stocks these days. To open a demat account, you should select a Depository Participant (DP). These days most of the banks are also DPs. So you can contact any of the DPs with your identity, address proof and PAN documents for opening a demat account for a prescribed fee by the DP. The registered DPs are also listed in NSDL (http://www.nsdl.co.in/) and CDSL (http://www.cdslindia.com/) websites.
Who is the Stock Broker ?
Stock Brokers are members of the Stock Exchanges. Only these members can conduct transactions in the exchange on behalf of the individuals and companies. So if you want to buy or sell shares in the exchange, you have to contact a stock broker for doing so. This normally requires the individuals to open an account with the Stock Broker. So the individual becomes a client for the stock broker.
Once the client wishes to buy a stock, the broker would place the order in the stock exchange on behalf of the client. When the transaction is done, the broker places the price to the client. The client pays for the stocks he bought and the broker transfers the stocks into the demat account of the client by following the transaction and settlement procedures.
Essentials of Trading - Share Market Tutorial
Basics of Stock Trading
Where can I trade Stocks ?
Stocks are traded in the Stock Market or the Stock Exchange. In India, the two most popular exchanges are the Bombay Stock Exchange (BSE - Located in Mumbai) and the National Stock Exchange (NSE - Located in New Delhi).
Do I have to be physically present in the stock market to trade stocks ?
Not necessarily. You do not have to be physically present in the stock market to start trading. For trading in stocks, you can open an account with a Stock Broker, who is a registered member of the BSE or the NSE. Once you have opened the account, you can start trading in the stocks through your local Stock Broker. The Broker charges a fee called the Brokerage or Commission from you for every trade that you do in the stock market.
What is Online Trading ?
Online Trading is a fairly new and popular mechanism for trading Stocks, wherein the you can buy and sell the stocks over the Internet. With the flexibility that Online trading offers to the clients, this mechanism of trading has become hugely popular among the investors and traders in the recent times.
When you buy or sell stocks online, you will be interacting with an Online Stock Broker, in contrast to the Human Broker in the conventional trading system. The Online system places the orders on your behalf, gets them executed in the exchange and inform the order status to the clients. Like the older system of trading, a fee is charged as Brokerage or Commission for every trade executed using the Online system.
What other services are offered in Online Trading ?
Apart from providing a platform for trading stocks, many Online systems provide integrated packages that link your Trading account with your Bank Account.
This helps you to buy and sell stocks and get the money transferred to your Bank account in a hassle free manner.
Apart from this, many Online Systems also offer Stock Research and Tips from Market Analysts to the clients, over the Trading Platform. This will help you to choose and value your trade calls in the Stock Market.
Basics of Online Trading
How do I Buy / Sell Stocks with my Online Account ?
Buying or Selling stocks is done by placing ‘Orders‘. You can place a ‘Buy Order‘ to buy the stocks at a particular price. Similarly to sell a stock at a particular price, you have to place a ‘Sell Order‘.
Each Online platform has different ways to place these orders. But generally, all of these provide the following basic options when placing an order:
1. Option to choose whether you wish to Buy or Sell a particular stock
2. The name / symbol of the particular stock which you want to either Buy or Sell
3. The Number of stocks (Quantity) that you want to either Buy or Sell
4. The Price at which you would like to either Buy or Sell this stock.
After you have confirmed the order, it is placed in the Stock Exchange through the Online System. Your stocks are actually bought or sold once this order gets executed in the exchange.
What is a Limit Order / Limit Price ?
A Limit Order is a Buy / Sell order which you want to get executed at a pre-determined desired price. This is the most common type of order that investors and traders place in the market.
Buy Order with Limit Price
For example, if you want to buy the stocks of company ‘A’ at a price of Rs.300. However the current price of the stock might be higher than your desired price. But you feel that the price of this stock would come down sooner and reach Rs. 300. In such a case, you can place a Buy order with a limit price of Rs. 300. This means that you are instructing the system to buy the stocks of company A, only if the price reaches Rs. 300 or lesser.
So if a Buy Order gets executed with the Limit Price specified, then you could be assured that the actual price at which the stocks are purchased by you will always be either equal to or lesser than the Limit Price specified by you.
Sell Order with Limit Price
Similarly you may have the stocks of company ‘B’ in your demat account, which you would like to sell at a price of Rs.500. But currently the market price of the stock is lesser than 500 and you expect that sooner the price will reach Rs. 500. In such a case you can place a Sell order with a limit price set to Rs. 500. In this case, the stocks will be sold only if the price reaches Rs.500 or above.
So if a Sell Order gets executed with the Limit Price specified, then you could be assured that the actual price at which the stocks are sold by you will always be either equal to or greater than the Limit Price specified by you.
What is a Market Order ?
Market Orders are placed, when you are not concerned too much about the current price of the stock, but you want to get assured that the stocks are either bought or sold immediately. So a Market Order can be placed only during the Market Trading Hours. You cannot place a Market Order when the Markets are closed.
Market Order for Buying
For example, consider an instance where in you know the fact that company ‘A’ will be making a big announcement in the afternoon today and so the price of the stocks of this company will definitely rise after this event. So you are looking for buying this stock desperately now, irrespective of its current traded price. In such a case, you can place a ‘market order’ for this stock. This will place an order for buying the stocks at the Last Traded Price in the Stock Market. So the chances of buying the stocks increase, as you are trying to buy the stock very close to its Last Traded Price in the market.
Market Order for Selling
Similarly suppose that you know the price of stocks of company ‘B’ will go down later in the day when the company comes out with its Earnings report of Losses for the Quarter. So you would want to sell the stocks of this company immediately, before the price of the stocks fall drastically. In such a case, you can place a Market Order for Selling. This will place an order for selling the stocks at the Last Traded Price in the Stock Market. So the chances of selling the stocks increase, as you are trying to sell the stock very close to its Last Traded Price in the market.
Basics of Technical Analysis
What is Technical Analysis ?
Technical Analysis (TA) is one of the methods used to predict the movement of the price of a stock or an index in the future. The prediction is derived based on a careful analysis of the previous price movements of the stock or index. To put is simply, the future trend is derived based on the past movements of the stock.
Technical Analysis does not yield absolute results always. As is the case with any forecasting system, the TA can give you a hint on what might be expected. But the expectations might prove to be false in extreme market conditions.
So TA will not help you totally overcome the risks involved in the markets, but if used properly, it can help you to predict and take precautionary measures to a large extent.
What are Charts ? Why do we need them ?
Charts are graphical representations of the movement of the stock price or the index value, over a period of time. Along with the price or value, the charts can also be used to depict other related indicators such as the Volume or total traded quantity of stocks. Based on the stock prices or values, statistical indicators are used to obtain values, which can also be plotted on the charts.
Charts offer a very convenient way to visually analyze the movement of the stock price or value. Rising and Falling trends can be easily found out looking at the charts. Repeating Visual Patterns in the charts are also used to forecast the movement. Charts can also be used to spot and trace the effect of key events in the history of the price of the stock.
How are Charts Plotted ?
Financial Charts are generally 2D Charts. There are of course 3D and other higher dimensional charts used in advanced analysis.
The X-axis (Horizontal axis) is generally used to depict the Time Frame. The Y-Axis (Vertical Axis) is used to depict the price or the value that varies with time.
What are Technical Indicators ?
Technical Analysts often rely on some Statistical and Mathematical functions that are applied on the price or value of the stock. These are generally called as ‘Technical Indicators’ . The resultant values, after applying these functions to the price of the stock, are again plotted on the Chart. Analysts can get further hints from analyzing the movement of these indicator values.
There is no consensus or a prescribed set of indicators that have to be used. Each Technical Analyst uses a custom set of these indicators depending upon his / her Trading strategy.
Some of the most commonly used indicators include Relative Strength Index (RSI), Moving Averages (MA), Moving Average Convergence Divergence (MACD) and others.
Moving Averages
Moving Average (MA)
Moving Average is probably one of the most frequently used indicators in technical analysis. This is a statistical indicator which indicates the average movement of the price of the stock for a specified period. This can be calculated for any time series. Generally this will be used to indicate the overall movement of the stock price for the specified time frame range and thus smoothes out the short term variations and fluctuations.
Simple Moving Average (SMA)
The Simple Moving Average (SMA) is one of the simplest indicators to calculate. It gives the average price of stock over a specified period of time. Generally Moving Averages are calculated for the closing prices of the stocks at the end of the day. But you may also calculate for the High, Low, Close and even on the traded Volumes of the stock.
For example, the 9 period SMA gives the average closing price of the stock for the past 9 days. It is calculated as follows:
If P1 represents the price on day 1; P2 represents the price on day 2 and so on, then SMA for period n is calculated as follows:
SMA (for period n) = ( P1 + P2 + P3 + …… + Pn ) / n
So for example, if the close prices of a stock for 4 consecutive days are as follows: 120, 121, 122 and 123.
Then the SMA (for period 4) = (120 + 121 + 122 +123) / 4
So SMA (for period 4) becomes 486/4 = 121.5
Exponential Moving Average (EMA)
Exponential Moving Average (EMA) statistically applies exponentially decreasing weighting factor to the data. Thus EMA results in providing more importance to the recent variations in the data. So EMA reacts sharply to the recent data when compared to the SMA.
EMA for the Close price of a security is calculated as follows:
EMAc = (ClosePrice x Factor) + ( EMAp x (1-Factor) )
where:
EMAc = Current EMA
EMAp = Previous EMA
ClosePrice = Current Closing Price
Factor = 2 / (n+1) , where n is the period for which EMA is calculated
How to make profit with Moving averages
How to trade with Moving Averages ?
Moving Averages are particulary useful in identifying the direction of an uptrend or downtrend of stocks and markets in general. They are based on the previous data and hence are generally referred to as lagging indicators which help us in locating the trend and following on in the trend . Since they do not allow you to predict the trend, you have to use other technical indicators in conjunction with them during trading.
Generally, the most common way to trade with the Moving averages is this - If the price crosses above the moving average, it means that a buying interest has set in - and thus indicates a buy signal. Similarly when the price crosses down the moving average, it means that a selling pressure has set in - thus indicates a sell signal.
Although it helps in indicating the current trend, it does not indicate for how long this trend would continue or when does the reverse trend begin. So traders should be cautious about this when using the moving averages for planning trades. It is also important to consider the volume for the security in question before trading. Sporadic movements with low volumes can generate erratic signals.
Example :
Look at this chart of Reliance capital shown below. The bold yellow line indicates the price and the thin blue line indicates the 9-day Simple Moving Average of the Close price of this stock.
moving-average-example
As you can see from the above chart, when the price has crossed above the SMA, then it indicates that buying interest has set in. From then on, the stock price is on a rise with minor dips. The downtrend is indicated at the point after the price crosses down the MA line. This indicates a down trend and becomes a candidate for sell signal. As can be seen the prices come down in the downtrend.
Longer and shorter Moving Averages
Moving averages can be configured any period of your choice. The most common ones are 9 Day, 30 Days, 50 days and the 200 Day Moving averages. The longer the period, smoothing will be more. Thus in stocks which display a great deal of sharp glitches and breaks, longer moving averages would make sense, as smoothing would be better. Choosing short period moving averages in such cases would result in erratic signals.
Short trends are identified by short period MAs - like the 9 day and 15 day MAs. A medium term trend is given by the 30 - 50 day moving averages. 100 and 200 day moving averages can indicate the intermediate long term trends.
Trading with Moving average Crossovers
Plotting both long term and short term Moving averages for the same security can lead to crossovers. This can also indicate some trading signals in some cases. A buy signal is generally assumed if the short term moving average crosses over the long term moving average. Similarly a sell signal can be indicated when the short moving average falls down the long term moving average.
Example: Look at this chart of the stock ABB in the NSE. The bold yellow line signifies the price movement of the stock. The blue line is the 30 day EMA and the brown line is the 200 day EMA.
moving-average-crossover-example
As can be seen from the chart, when the short term MA i.e the 30 day EMA (blue line) crosses over the long term MA ( 200 day EMA - brown line), then an uptrend is identified and thus a buy signal is generated.
As indicated earlier, MA can help in identifying trends and can give late trading signals. When used with other technical indicators, they can be very helpful in determining trading strategies.
Relative Strength Index (RSI)
RSI Definiton and Calculation
RSI is a popular technical indicator that was developed by Welles Wilder. It is very popular because its very simple to interpret this indicator. It is an oscillator indicating the overbought and oversold conditions of the stock.
RSI is based on the comparison of the magnitude of the gain to the loss. It is the ratio of the EMA of Upward(U) and Downward(D) movements, which is then normalized to values between 0 to 100.
So, if
Pc represents the current Closing price
Pp represents the previous Closing price,
then on a day when the stock has closed up, U = Pc - Pp and D = 0
Similarly on a day when the stock has closed down, D = Pp - Pc and U = 0
Then EMA is calculated for U and D for a period n , represented respectively by EMAup and EMAdn.
Now RSI is calculated as follows:
RSI = 100 x (EMAup / (EMAup + EMAdn) )
How to make profit using RSI
How to trade with RSI ?
Generally a 14 period RSI is plotted for the close prices of the stock. RSI Value of 70 and above is considered to indicate that the stock is in Over Bought condition. Similarly an RSI value of 30 and below is considered to indicate that the stock is in Over Sold condition.
The Over Bought condition indicates that the stock price may be getting over valued and in the next trend may be a candidate for pullback in the downward direction. Similarly the over sold condition indicates that the stock may be getting under valued and in the next trend may be a potential candidate for a pullback rally in the upward direction.
Example : Consider this chart of the Infosys Technologies stock in the NSE:
rsi-example
The yello line at the top indicates the Close price of the stock over a period of time. The bottom line in torquoise blue indicates the 14 day RSI for the Close price of the stock.
As you can see in the chart, when the RSI values have crossed the 70 value, the stock enters the Overbought zone and becomes a candidate for pulldown thus giving a sell signal. Thus a downtrend in the price of the stock is seen after this condition.
Similarly when the RSI values have come below 30, the stock enters the Oversold zone and becomes a candidate for pullback thus giving a buy signal. Thus an uptrend in the price of the stock is seen after this condition.
However large surge and drops in the price of the stock will affect the RSI heavily and can lead to erratic buy and sell signals. So RSI should always be used in conjunction to other technical indicators to confirm the buy and sell signals.