If you have decided to learn about the stock market you have come to the right place, this site is dedicated to provide free finance knowledge. You might have heard some people are making good money by stocks. But you are not sure how, the answer for this is financial literacy. When you are financially educated you know what a stock is and how to invest money in it. Before you start trading or investing let us learn what is the stock market for beginners and how it works.
Primary market is a market where a company Issues public shares for the first time as an initial offering. Which is also called an IPO. An investor can buy an IPO from a bank, which also acts as an underwriter for the company.
For example, if a private limited company has decided to raise capital through equity, It hires an underwriter. Who does the process of valuation and determines the price of the stock. Then investors both individual and institutional investors can buy the shares from the initial offering.
Secondary market is a market where an investor trades with the existing share in the market is also known as Stock Market. Once the shares are bought then the shares enter the secondary market where shares are bought and sold among investors.
The purpose of this blog is to learn about the stock market. Let’s dive into it. There are a million stories on how people got rich in the stock market and people lost everything in the stock market. Before knowing how to invest in a stock you need to know what a stock is.
What Is Stock?
A stock or share is a piece of ownership having some value that you own in a company. Which appreciates in value when the company is growing with consistent profits and reduces when the company is in losses. For example, Reliance is a company worth ₹100 crores, it has issued 10000 shares in the market. The value of one share is ₹ 100,000 (100 Cr/10000). Shares are bought and sold in the market daily due to varied reasons.
Usually listed companies’ shares are traded on stock exchanges of the respective countries such as National stock exchange, London stock exchange etc. Stock brokers act as an intermediary between buyer and seller in the market.
Your View On Stock Market As A Beginner
Before you decide to invest one might have some opinion on the country’s economy on how it is performing, business, would you want to invest in stocks or bonds. Whether you would like to invest for short term or long term, what would you do at the time of market crash. It is important to decide and make a note of your intention and attitude towards the market. If not you might be the market victim where you would sell everything in panic at the worst moment. The point I want to make here is it is not the companies or markets that decide the investors fate. But it is just the investor himself through self-preparation.
Types Of Investments In Stock Market
As this article is specifically to understand the stock market for beginners, Now you know what the stock market is, it is really important to know the types of investments present specially for stock market for beginners. let’s find out what kind of investments are there in the stock market.
Equity (Shares In Stock Market)
Equity represents money belonging to shareholders at the time of liquidation where all the debt has been paid off. It is also called shareholders equity because no other stack-holder has ownership of equity. In terms of accounting, if you subtract liabilities from assets then you arrive at Equity. In simple words Equity is residual ownership of assets after subtracting all debts in the firm.
The equity shares are valued as total equity share capital of a company divided by the number of shares which gives you the value of each share. These shares are traded in the stock market among investors. If you invest in equity shares where the fundamentals seems reasonable, most of the times after few years the stock becomes a multibagger.
Bonds
Bonds can simply be classified as debt. In other words when a company wants to raise funds through debt either they go to the bank to borrow some funds. They can also offer some bonds to the public in exchange for money. The only difference is when a company issues bonds they are corporate bonds where the government is issuing then they are gilts or G-Secs (Government securities).
Most bonds have a fixed period till the maturity, with a coupon rate and appreciates in accord with the market interest rate which is also called yield. Let me explain with an example. If a bond has a face value of $100 with a coupon of 6% this means, At the time of maturity you receive $100 back which you have invested in the bond and every year you receive interest of $6 (6% of $100) from the bond till maturity. Depending on the credit worthiness of the bonds the rating has been given to them such as AAA, BB etc.
Derivatives In Stock Market
Derivatives are financial instruments traded in the stock market. Whose value is determined by the value and performance of the underlying asset that could be stock, bond etc. A speculator can trade on various derivatives without owning the asset or stock. For example If you want to trade on Tata Motors derivatives, Let’s say you predict the stock might go up in the short term in next 2 weeks then you get into a position by just paying a premium not eh full price of the stock. Depending on the performance of Tata Motors in the next few weeks your profit or loss is calculated.
In theory it is easy to explain how it works, however, in practical it is a complex system. Many beginners lose money just by buying and selling without any proper vision and strategy. Even though your prediction has a 50-50 chance to be true if you have proper knowledge on how these derivatives work. With robust strategy you can make profit and minimise your losses, you can become efficient by practising a lot.
Futures In Stock Market
Future contracts are a type of agreement to buy an asset on a specified date at specific price. For example, if a farmer is producing rice which has a current market value of $10 per unit and he is expecting his crop to be ready after 3 months. Meanwhile he is sceptic that the price might fall to $7 per unit, so gets into a contract with the dealer or buyer to pay a price of $8.5 and agrees to deliver the product after 3 months on specific date.
If the price goes down the farmer is in no loss as he is getting $8.5 if the price goes up the farmer is in loss. In a way he is hedging it from risk, not to sell below $8.5. Similarly in the stock exchange a buyer and seller meet through the help of a broker. Get into the future contract as the buyer agrees to buy the asset on a specific date for a certain price, similarly the seller agrees to deliver the asset on a specific date for a certain price.
Future Contract Characteristics
- There are specific contractual details for every contract. Such as lot size (as in how many shares), specific delivery date, specific price.
- In the above case the buyer acquired a long position and farmer acquired a short position. In other words, the buyer or dealer promised to buy on the future date for a certain price. Similarly the farmer agreed to deliver on the agreed future date for a certain price. In the stock exchange broker acts as an agent between buyer and seller.
- Every speculator needs to maintain some amount of margin to trade depending on the size of the contract which acts as a collateral.
- When you enter into a future contract the gain and loss will be settled every day as there is no obligation to deliver the product physically. Instead the gain or loss can be transferred to the respective trader into their account based on market closing price.
Options
Options is a type of derivative contract where it provides the holder the right but not the obligation to buy or sell a specific asset or share on a future date. You do not have to own the shares to get into an option contract. Instead you pay a premium on a stick price anticipating it will reach the stick price. There is a premium paid the option buyer to seller for the right to buy or sell the underlying share or asset. There are 2 types of options
Call option: Call option is when a trader buys the call option by paying a premium anticipating that the price of the underlying asset might increase or reach the strike price in the future till the maturity date.
Put option: Put option is when a trader buys the put option by paying a premium anticipating that the price of the underlying asset might reduce or reach the strike price in the future till the maturity date.
Currency Markets (forex)
Currency markets are dynamic and complex in understanding, they play a major role in international trade and business among different economies and different governments. Currency markets are an ocean in itself, trading with one currency for different reasons is called currency trade.
Banks act as an intermediary in the currency exchange they buy for less and sell at high prices to make a profit. International companies and multinational companies do operate globally so they have currency trade to hedge in the market. Individual traders and institutional traders play a major role in trading with currencies as their motive is to make profit. Finally, central banks of different countries maintain foreign currency reserves to support countries foreign trade.
Commodities Markets
Commodity markets play a major role in providing fair price for the raw materials based on demand and supply. For example, how oil is traded in the commodity market worldwide. Commodity prices are determined by various factors such as demand and supply of the product, geopolitical issues, weather conditions, economic growth and inflation. Futures and options can be traded in currency and commodity markets as well.
Difference Between Trading And Investing
Now that you know types of investments in stock market, in this stock market for beginners guide I am going to discuss the basic difference between trading and investing which is critical. Investing is buying an asset in the hope of capital appreciation in the long term whereas trading is speculation in the short term in hope of making some quick money. In other words, Investing is bought and held, trading is bought and sold or sold and bought.
Individual investors and institutional investors follow different techniques and strategies to analyse an asset before putting money in it. Although people have different options in investments when things are right people do speculation or investing with confidence. But at the time of recession or depression, economy will go through a hard time in turn companies perform poorly which reflects on stock price. Most of the market participants rush towards bonds to get safer returns as interest for their investments. But ultimately stocks outperform every other investment in the long run.
Although individual investors have access to all the information related to the asset or stock still, they lose money in trading. Half of the time they are late to the party. The rest they have to pay for brokerage and charges. On the other hand, Institutional investors make money consistently by maintaining portfolios not just by trading single stock. Institutional investors have proper strategies and resources.
Fundamental analysis
Fundamental analysis is analysing the securities intrinsic value by using the company’s financial statements. Analysing the balance sheet and income statement of the company to find out how well the company is performing. Using different valuation techniques to determine the future prediction of the company. Analysing relevant sectors as whole and micro and macro-economic conditions also determine the performance of the business.
Technical analysis
Technical analysis is analysing an asset’s past data such as price of previous 10 years or so. This helps to forecast future trends for trading opportunities. There are many indicators which help in reading the charts to predict future trends namely MACD, head and shoulder, RSI. Market psychology plays a major role in technical analysis.
Conclusion:
Great, this is the basic overview of what the stock market is for beginners. Advice from me is not to rush into anything yet there is a lot available on the internet for free. Try to grab some knowledge on stock market for beginners. Stock market is a phenomenal human invention as it gives capital appreciation to millions of people directly and billions indirectly. Understanding the stock market makes you financially educated, which helps to make money and grow your money forever.