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Why you need to focus on the basics of equity trading

Why you need to focus on the basics of equity trading

Understanding the basics of equity trading can go a long way in helping in help you become a better equity trader. While the equity trading screen appears to be quite simple and elementary, there are nuances that you need to understand. Finer points like the order type you choose, the type of trading you want to do, the way you monitor your trades, understanding of order book and trade book; all make a big difference to your eventual trade. It is only when you get the basics of these trades right that you will be in a position to be profitable in trading.

Key points to understand about equity trading

  • First understand about the nature of the orders that can be placed on the screen. You can place limit orders or market orders. Market orders will work when you are buying in a falling market or selling in a rising market. Limit orders will work best when the markets are volatile. In the event of flash orders, Immediate or Cancel (IOC) orders will work best.
  • When trading in equities, it is very important to understand risk. The first risk is more general in nature and it arises from market volatility, inflation, interest rates etc. The second risk is more company or industry specific. This distinction is important because you can diversify the second risk but you cannot diversify the first risk.
  • There are two approaches to researching stocks. There is the fundamental approach which looks at cash flows of a company. Then there is the technical approach which focuses more on charts and trading levels. Typically, traders use fundamentals to understand the risks of a company and technicals to time their entry and exit in the stock.
  • Equity investments are by default more risky than debt because debt assures you returns but there is no assurance of returns on equities. However, it has been seen that over the longer run equities give the best returns. Also, over the longer run, the risk of losses in equities reduces substantially making them more meaningful than debt for creating wealth.
  • Intraday trades are essentially leveraged trades. Just as profits can be magnified in intraday trading, your losses can also get magnified in intraday trading. This is more so when you are taking on higher leverage through cover orders or when you are trading intraday in futures and options. In such cases, the losses get multiplied by another factor.

Equity trading – points to ponder

There are some basic rules that need to be followed when you are trading equities. These pertain to the conceptual side and the execution side.

  • When you trade equities, you must always trade with a perspective. Every stock is good at a certain price and bad at a certain price. Hence you need to always find out if the stock is offering value at the current price or not. Both fundamentals and technicals are approaches to equity trading but they are not perfect sciences. You must treat them as such.
  • Your performance in equity trading always has to be benchmarked to adopt the right approach. For example, if you earned a ROI of 20% in a year on trading and if you could have earned 35% in an index fund, then you have actually wasted time and money trading. You need to really be able to beat a passive approach for trading to be meaningful.
  • There are 3 aspects to equity trading viz. identifying the stocks to trade, actual execution of trades and risk management. It is only when you get all these 3 pegs of trading right that you can actually be successful in equity trading!
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