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Basics of Trading Research Team | Posted On Saturday, July 18,2009, 07:01 PM

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Basics of Trading



What is Trading?

In the financial market, buying and selling of stocks is referred as trading. But all types of buying and selling are not trading. In stock market two types of buying and selling are happening, i.e. Long Term and Short Term. Only short term buying and selling are called as trading. Long term is known as investing. In order to trade you have to approach a broker. You can trade either electronically or on the exchange floor. Exchange floor picture must be well-known to you. In exchange floor trading your broker arranges for your shares to be ordered. . The floor clerk locates the floor trader from whom the shares can be bought. Once the price is agreed upon, the deal is finalized.

Electronic transaction is very common today. It is a well-organized and fast method of stock trading. Here too you require a broker but you receive confirmations almost immediately .In online investing your broker will connect to the exchange network and search for a buyer or seller according to your order.

Trading Basics

Following are the Trading basics for beginners. To become a successful trader you should do so many exercises. Before entering into trading, you should complete the following procedures;

  • Set Your Investment Objectives
  • Estimate short term needs
  • Create an emergency fund
  • Repay debt
  • Set priorities in a chronological order
  • Practice Asset Allocation

1. Set Your Investment Objectives

The starting point for achieving financial freedom starts with a financial plan. You should have a clear picture about your current financial position, available resources and immediate fund requirements. This will help you in setting the long term financial goals. Also keep in mind your risk-taking ability, current lifestyle, occupational profile and family background, the number of dependents and their own financial status. Your trading pattern and style should match to these characteristics. A working spouse can give you a greater degree of financial independence.

See Also: Long term investing in stocks

A financial plan helps you to design realistic goals and then work towards them over a period of time. Since each individual has unique needs and characteristics, there is no standard formula for setting the objectives. This article only makes broad recommendations that should apply to everyone before starting an investment programme.

2. Estimate Short Term Needs

Many investors jump into the wonder world of stock market without assessing their short term fund needs. If you start investing without having an estimate of short term needs, you will end up with selling stocks much earlier with loss. Because no one can predict the future, if some emergency arises you won’t be having enough cash balance to face that at that time you will sell the stocks at prevailing market price. This might cause for huge loss. By estimating short term needs and preparing for them, the painful decision of selling shares before time can be avoided.

3. Create an Emergency Fund

Emergencies happen when least expected, it might force you to alter your investment plan. Therefore, having a cash reserve to meet situations like a medical emergency or a layoff, ensure that your fund needs are met without affecting the investment plan. A cash reserve of at least six months worth of living expenses or a medical or disability insurance is must for all individuals.

4. Repay Debt

You can increase your net worth by repaying the debt. Start by repaying the most expensive debt, usually credit card debts and unsecured personal loans are the most expensive. If you are getting tax benefit for some debts, keep those debts like housing loans, education loans etc. If the return on investment is greater than the amount of interest paid on debt, then keep the debt and start investing. But if the risk-adjusted return is still less than the amount of interest being paid on the loan, you are obviously better off clearing the loan.

5. Set Priorities in a Chronological Order

Categorize your own priorities and that of your family members based on their time of happening. For example, paying a lump sum donation for getting admission to school is a more urgent need, than providing for higher education. College education is still years away compared to school. Thus, school education can be provided for by investing in fixed income instruments like short term bonds or fixed deposits. For college education, a mix of equity and debt, with more in equity, can be taken to fight with inflation and the higher risk is spread across a number of years.

See also: How To Open Demat Account?

6. Practice Asset Allocation

Investment plan won’t be complete without an asset allocation. Different types of assets are there; cash and bullion are the most liquid asset class. Then, there are fixed income instruments, like bonds and fixed deposits, which are less risky, but returns are less compared to equities, and are less liquid too. Mutual funds come next, their risk profile depends on the type of fund like equity, debt or balanced and the investment philosophy. Equities are the most aggressive investment option, with high returns and proportionate risk.

There is no perfect asset allocation, a one size fits all plan. You have to make a plan that suits you best, by allocating weights to various asset classes and then designing an investment plan accordingly. After designing an asset plan, it is very important to monitor it to ensure that changes in asset prices have not skewed your allocation.

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