Today, anybody with a bit of money can become a trader, and so far too many people jump to trading without adequate preparation. There are a few things you will need to be familiar with before you can be a successful trader. These include knowing how the markets work, understanding the tools and software, and learning how to develop your own trading style and strategy. There are far too many things to be covered in a short article, but having a basic understanding of the way the market works will be necessary, whatever else you do.
Buying and Selling Shares
Buying and selling shares
When you start trading, you will buy and sell shares. This is known as going long and short (respectively) on the market. You do not have to buy and sell in that order. You can sell shares that you do not own, if you think the price is going to fall, allowing you to buy them for less (at a profit), when the buyer comes to collect. This is known as short selling.
Prices
You will need to know the price that you are entering and exiting the market. Market prices are quoted in pairs, the bid price (buying price) and the ask price (selling prices). The difference between the two is known as the spread, and is sometimes referred to as the liquidity cost, or cost of making transactions without delay. This spread is very small in highly liquid exchanges and markets, such as the big stock exchanges, and the forex market.
Options
Trading in options allows you to simulate long and short positions, without actually trading in the stocks. There are many reasons why you might want to do this, including the potential to leverage your capital to allow you to trade a larger position than you could normally afford. While this can give you phenomenal returns, it does come with a higher risk of losing your money though. Buying a call option gives you the right to buy a share, at a future time, at a price set today. If the share price has risen, you exercise your option, and the difference in price (less option and exchange costs), is your profit. Conversely, buying a put option gives you the right to sell a share in the future at a price set today. You therefore want to buy put options when you think the price will fall.
That’s about it. Well almost. 99% of all the trades in all exchanges will involve assets (shares) and/or options, traded at a price. Fully studying and understanding those three key elements, puts you well on your way to becoming a successful trader. Everything else will differ from one market to another, or one trading strategy to another, but the three key element above remain.
An example of this variation are stop loss limits used with many options trades. This allows you to limit the amount you can lose if the markets move against a particular trade you have made by automatically closing the position when a certain level is reached. While some might look down on this forced sale at a loss, there is no limit to the potential size of your losses in certain trades, and it is often better to lose a bit, and keep trading, than to lose all your capital in one trade.
Another variation, is differing opinions on how to identify market movements before they happen. The two main schools today are the fundamental and the technical analysts. Technical analysts study the charts. They study previous and current market movements. The belief is that you can predict what the market will do in the future, (i.e. predict a trend and so trading opportunity) by studying the current and historic movements in price. These are usually expressed in a graph, hence the expression charting. Fundamental analysts on the other hand, argue that you can predict the movements in a market by studying the overall business cycle and economic indicators (such as interest rates, inflation, joblessness), as well as the outlook and prospects of an individual company. Instead of studying charts, fundamental analysts study economic reports, and income statements. Knowing these facts they argue, will tell you whether prices will go up or down. The truth is all traders use some combination of the two in their strategies.
The two examples, while simple, illustrate the inescapable fact that whatever the market condition, technology, risk management or trading strategy you use, each trade will always involve an asset (or option on that asset), and a price. Learn and understand those three key elements before you start trading.
Investment/Trading