Basic Terms of Investment and Trading
In my last tutorial I discussed about basic terms of stock market, in this tutorial I will discuss about basic terms of investment and trading. I’m going to explain everything as much simpler way as possible, so anyone can understand. However if you have not gone through the previous tutorials yet, I would suggest you to go through with them, as those tutorials cover the basics, on which I’m going to discuss this tutorial. Those tutorials are Few questions you need to ask yourself before your first step in stock market and Basic Terms of Stock Market.
What is Demat/ brokerage account?
Demat or brokerage account is an account provided by your bank or broker to trade or invest in stocks or shares. It would be typically linked with your personal savings/ current or checking account which you have in your bank.
Who is Broker?
You cannot purchase or sell shares directly from the stock exchanges, you can purchase and sell share through brokers authorized by the stock exchanges. A broker is a medium between you and stock exchange, who executes your purchase and sales orders on your behalf. A bank could be broker as well.
What is Brokerage?
In order to execute your orders, a broker charges small fee for rendering the service, this charge is being called brokerage. Every broker has a set of fixed brokerage, which they charge for executing various types of orders.
When you will trade, you will find usually there are two options to place an order, those are delivery and another is intra-day or same day. For theory, we segregate trades and investment in more categories. In investment category we have long term, middle term and short term investment. And in trade category we have intra-day or same day and buy today sell tomorrow or BTST. In this tutorial I will discuss about them.
What is delivery?
When you buy or sell shares and you do not want to square them off (explained later in this tutorial) within that particular trading day, then you need to place your orders as delivery. Delivery orders are applicable for long term, middle term, short term investments and buy today sell tomorrow or BTST. It means if you want to invest or trade except intra-day trading, you need to place the order as delivery. For delivery orders you are not bound to square them off within any particular time.
In delivery order the shares you bought would be delivered by your broker in your DEMAT or brokerage account within two to three working days. And that means you are owner of those shares you bought, now it’s your choice when you want to square them off.
What is Long Term Investment?
Investing on particular share or stock for more than 10 years time could be called as Long Term Investment. If you purchase some shares of ABC Co. today and you do not intend to sell them within next 10 years, then you can call it long term investment.
What is Middle Term Investment?
Investing on particular shares for 5 to 10 years span of time could be called as middle term Investment. As above example, you bought shares of ABC Co today, intending you will not sell them within next 10 years. However after eight years you find out that the share price has quadrupled, so you decide to sell them, now that can be called middle term investment.
What is Short Term Investment?
Investing on particular shares for 1 week to 5 years time could be called as short term investment. For an example, you bought some shares today intending to sell them tomorrow, however next day you find out the price of those shares have decreased. So, you continued to hold the shares and finally sell them after six months for the profit you were looking for, so this investment could be called as short term investment.
In here I would like to clarify there is no such definition of long, middle and short term investment, however for our convenience we segregate investment timings into those categories.
What is Buy Today and Sell Tomorrow or BTST?
When you buy or sell shares on a particular day and square those share off on next trading day, it is called by buy today sell tomorrow or BTST. Depending upon brokers, many brokers might charge you different brokerage than delivery (typically it's less than delivery) for BTST orders and many might charge you same as delivery. BTST trades are also one type of delivery order, where you are not bound to square those shares off in next day. You can hold them as long as you want.
What is Intra-day Trading or day trading?
When you buy or sell shares and you want to square them off and get the profit or loss within that particular trading day, then you would require to place your order as intra-day. And this kind of trading is being called as Intraday or same day trading. For same day trading you must square off your shares before given time by your broker or they would be squared off automatically.
What are the advantages of Intra-day or same day trading?
1. In Intra-day trading, you do not require to wait for long time and you get the result of your trade within same trading day.
2. Most of the brokers offer 5x or 10x rule for intra day trading. That means five or ten times more capital usage capacity for intra day or same day trading.
For an example, you have $100 in your account and you want to go for day trading, in this case your broker would allow you to trade/buy/sell share up to $500 or $1000 depending upon their 5x or 10x rule. In this case you would not require to submit $500 to buy or sell shares worth $500, you can buy or sell them only for $100.
What are the disadvantages of Intraday?
Now please let me explain the tricky and vital parts.
1. Once you buy those shares you have to square them off within the day, before a particular time given by your broker. If you don't, your shares would be squared off automatically by your broker. That particular time is called by square off time. No matter you are losing or gaining you have to square your shares off within the given square off time.
2. So if your predictions are wrong then you stand to lose big and it would be 5 times bigger. Most of newcomers make this mistake. I always say that intra day is not at all for the beginners. It is very risky, even for experienced traders. Many experienced traders also lose their money many times, while doing same day trading.
What do you mean by buy or sell then square?
This is the fun part of the stock market. If your predictions and calculations are correct, you will make money no matter the stock price goes up or down. Many newcomers have the idea that you have to buy a share first then you can sell it later. It’s not true actually. In stock market you can buy a stock first then you can sell it and vice versa, you can sell it first then you can buy it. That is the only reason I do not like to call the second part as buy or sell, I like to call it as squaring or squaring off as per intra day term.
What is shorting?
Selling a stock first then buying/squaring them off later, this method is called shorting, and this one is very scarier and controversial among many investors and traders.
What are the disadvantages of shorting?
Have you ever seen the movie The Big Short? The movie clearly explains the disadvantages of shorting. If you haven’t, do not worry I will explain. In shorting you stand to loose infinity amount of money.
Let me explain normal trading where you buy first then sell.
As an example, your prediction and calculation says the price of XYZ company will double within a year. Currently the share is trading at $50. If you buy the stock and the price of the share price starts declining the maximum you stand to loose is $50, as the stock price cannot go beyond $0.
However for shorting the same scenario would be very scary. Imagine your calculation and prediction says that, the share price of XYZ company will come down at $50. Currently the stock is trading at $100. Now you short/ sell the stock at $100. If the price comes down to $50, you stand make $50 each shares as profit. However if the price of share starts increasing, and you keep holding those share you bought, then logically you stand to loose infinity amount of money as there is no limit and the price of a share can go to $10000 even or more.
When you are placing your orders you need to mention if you want buy/sell as market or Limit.
What is buying or selling as market?
When you are placing an order if you select buy or sell as market then the stock would be bought or sold at current market price. And it is not recommended for the traders at all.
What is buying or selling as limit?
Personally I like this option a lot. When you are placing an order you need to put a trigger price to buy or sell, if the stock price reaches that target price then the stock would be purchased or sold automatically. As an example I have decided to buy one stock of ABC company and the current price of the stock is $100. I have decided to buy it for $95, so I will place the limit order accordingly. Now if the price reaches at $95 or lower during the day, then the stock will be purchased automatically. Stock market is dynamic, and stock price changes very frequently within a minute or so. If you want to place best order logically, then I would recommend you to place your orders in limit with stop loss. I will also discuss elaborately why you should use limit and stop loss in later tutorials.
What is Stop loss?
Stop loss is a function for delivery or intra day orders to reduce your loss. It’s also a trigger like buying or selling as limit, which you place while purchasing or selling any stock, to reduce your loss. Where you decide in case things go south, the maximum amount of price of a stock, you are willing to hold on to.
As an example, I placed an order to buy a stock at $10 and when I was ordering I placed it as stop loss and I entered stop loss amount as $9. Now after the purchase, if the price of the stock rises, then nothing will happen. However if the stock price decreases and goes at $9 or lower, the stock would be squared off automatically at $9 to reduce my loss. The stock might go till $5, now I have saved $4 for by stop loss. So it would be wise practice, if you place your orders with stop loss whenever you are placing any order. But unfortunately many broker's system might not allow you to place stop loss orders for delivery depending their system. Or the system may allow you to add stop loss however, the trigger might not work after that trading day. So please consult your broker for delivery related stop loss.
Further reading for basics Basic FAQs for the beginners in stock markets, Few preliminary basic terms of Trading and Basic homework for beginners for stock market. Then you need to acquire advance knowledge in How to read Candlestick Chart without any complication, How to calculate support and resistance level, How to read financial report or Balance-sheet, When Why and How stock price changes, and Few things need to care about while trading.