So, What Actually Happens When You "Buy a Stock"?
"The stock market is a device for transferring money from the impatient to the patient."
- Warren Buffett
Here's a strange truth: millions of people invest their money everyday, and most of them wouldn't be able to tell you what it really means when they hit that "buy" button! They might know a thing or two about the app and the green and red colors, but why would the share prices go up and down? Who are we trading with? Why are so many beginners losing money doing something that seems so easy? If you've ever felt like everyone around you understood what it means to trade and you're the odd one out, then this blog is for you. Nobody starts off knowing this stuff, no one trader is smarter than the other!
This blog aims to clear up some common misconceptions about trading.
First, Let's Kill a Myth: Trading Is Not Gambling
As much as many people try to compare it to gambling, trading is not gambling
. Both may have odds stacked against the participant, but the odds are set in gambling while it can be manipulated in trading. The main difference is that in a casino, the dealer always wins, while in trading the odds could either fall in your favor or against you; depending on your knowledge.
"In the short run, the market is a voting machine. In the long run, it is a weighing machine."
- Benjamin Graham
That's essentially the whole reason behind what makes stocks fluctuate! The short term (minutes, hours, days) price changes are dictated by the opinion of the market; people voting whether a stock should go up or down. The long term (weeks, months, years) price changes reflect value; the true worth of what you're trading.
In a simple sense, that's it! Trading is simply a matter of buying what you think will rise or selling what you think will lower in value, in a relatively short period of time. Every trade needs a buyer and seller; someone who thinks the stock will go up and someone who thinks it will go down.
Trading vs. Investing
- A Common Mistake
Many people confuse trading with investing, here's the basic difference;
Trading refers to the buying and selling of assets in a relatively short amount of time, within days or sometimes even minutes!
Investing refers to buying assets and holding on to them for an extended period of time, for years maybe even decades!
It doesn't matter how right or wrong you are, it all boils down to if you're taking the proper precautions before starting! A trader and an investor play very different games, a trader can expect to play with a higher risk than an investor. In fact, many people trade the very assets that they invest in!
The Words That Confuse Everyone (Explained Simply)
There are a number of trading related terms that confuse everyone when they start:
Bid & Ask
The Bid is the maximum a buyer is willing to pay for an asset, while the Ask is the minimum a seller is willing to sell for. The amount by which the Bid exceeds the Ask is the Spread , which essentially reflects the amount that the market maker stands to make by facilitating the transaction
Volume
This refers to the amount of shares/units being traded, the higher the volume the more popular the stock is considered to be
Liquidity
Essentially refers to how easily something can be bought or sold
Volatility
This basically means "degree of variation", a stock with high Volatility has a price that varies quite drastically with time
Once you've understood these 4 terms, half the mystery of how trading works gets lifted!
Why Do Prices Even Move?
This essentially boils dow nto a conflict between demand and supply; more people want to buy a stock (higher demand) than sell (lower supply), the price increases. If there are more people selling (higher supply) than buying (lower demand), the price will drop.
News reports about a particular stock, market fluctuations, interest rate changes and other economic factors all serve to influence buyer and seller sentiment, as do political and personal events.
Markets can remain irrational longer than you can remain solvent.
- John Maynard Keynes
The Different "Speeds" of Trading
As far as trading speeds are concerned, there are a few different methodologies, here are some common trading styles from fastest to slowest:
Scalping
- Buying or selling in tiny positions, entering and exiting within seconds or minutes of each other.
Day Trading
- Entering and exiting positions within the same day, no overnight positions are held.
Swing Trading
- Holding positions for several days, capturing price swings.
Positional Trading
- Similar to Swing Trading but positions are held for longer periods of time, anywhere from weeks to months.
Investing
- Buying and holding an asset for significantly longer periods of time, often years at a time, similar to Positional Trading but with a different goal and ideology.
"The goal of a successful trader is to make the best trades. Money is secondary."
- Alexander Elder
The Two Lenses Traders Use To Read The Market
There are two primary ways to analyze and predict the movement of the market, they are as follows:
1. Technical Analysis
- The study of price action and patterns through charts to predict future performance. This assumes a degree of predictability in chaotic price movements.
2. Fundamental Analysis
- The study of business performance and other factors influencing an asset's value, to predict future performance. This looks more deeply into factors influencing an asset's value, such as debt, revenue, market share, etc.
In reality, most experienced traders combine the two; using Fundamental Analysis to pick assets to trade and Technical Analysis to determine timing.
The Concepts That Actually Protect Your Money
Nobody is perfect, and trading is a risky business; which makes risk management concepts all the more important! As important as it is to have a strategy, having the proper tools and knowledge to prevent huge losses is paramount to success in trading!
Stop-Loss
This is an exit order that is placed when the trade you've opened moves against you, thus limiting losses by automatically closing your position when it hits a certain price. It is important not to ignore this tool because it could cost you!
Take-Profit
This works opposite to a Stop-Loss by taking profits when a certain price is reached by your position, thereby closing your position and booking a profit. Greed often leads people to not using this.
Risk-Reward Ratio
This refers to how much you stand to make vs. how much you stand to lose. It boils down to a simple concept
- risking ₹1 to make ₹2 or ₹3. It becomes extremely important to not let emotions get in the way of sound judgement when it comes to this.
Position Sizing
This simply refers to how much of your capital you are allocating towards a single trade. A commonly followed risk management strategy is to not risk more than 1-2% of your capital in a single trade.
Leverage
Leverage refers to having a higher value position than your capital indicates, allowing more profitable trades but at the expense of higher risk, thus making it a double-edged sword! It serves as an amplifier, it can amplify small gains into big ones but also magnify small losses into massive ones
"Risk comes from not knowing what you're doing."
- Warren Buffett
The Real Enemy Isn't the Market
- It's YOU!
One very important fact that many people overlook or fail to consider, is that trading is a psychological game. While your trading strategy may seem airtight from one perspective, it could be failing because of your psychology! Many traders make one or more of the following psychological mistakes:
Fear
- Leading to cutting losses quickly but also taking profits too fast
Greed
- Leading to booking profits slowly but holding on to losses
Revenge
- Taking bigger and bigger risks to get back what you've lost in a previous trade
Overconfidence
- Becoming overly aggressive with trades and positions after you've mastered a particular strategy
Strategy takes only a few minutes to pick up, market psychology often takes a lifetime to truly master. Here's a piece of advice that many successful traders live by:
"The market is a device for transferring money from those who cannot control their emotions to those who can."
Mistakes That Quietly Wreck Beginners
Going live on the market without any fundamental or technical analysis
Lack of Stop-Loss orders and exits
Trading out of boredom
Adding to a losing position to "turn it around"
Trading based on the opinions of strangers on social media
Fees and tax implications that eat into your trading profits
These are just a few concepts that could prevent you from becoming a successful trader. These mistakes may seem minuscule but oftentimes compound, leading to disaster in the long run!
How to Actually Start (Without Blowing Yourself Up)
Learning everything you can about trading
Paper trading till you gain confidence
Starting out small once you begin to have confidence
Keeping a trading journal to track your progress
Monitoring and analysing your performance not based on results but based on your decisions and reactions
"Amateurs think about how much money they can make. Professionals think about how much money they could lose."
- Jack Schwager
The Bottom Line
Trading is not an in-depth and complicated stratefy that only the masters of the world can understand and execute, it really boils down to the person and his or her approach. The market has one simple rule: It doesn't care how intelligent you are, it only rewards those that have the skills to stay in the game! There's always more to learn, concepts that can be mastered with time and patience. One must also recognize that they do not know everything and apply the concept of risk management in everyday trading life. At the end of the day, risk management rules trading, and the most important rule of risk management is to protect your capital at all costs!
It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong.
- George Soros
Disclaimer: This blog is for educational purposes only and does not constitute financial or investment advice. Trading involves substantial risk of loss and is not suitable for everyone. Please consult a licensed financial advisor and conduct your own research before making any trading or investment decisions.So, What Actually Happens When You "Buy a Stock"?
