Indian-stock-market trading explained

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As with any of the previous modules in Varsity, we will again make the same old assumption that you are new to options and therefore know nothing about options. For this reason we will start from scratch and slowly ramp up as we proceed. Let us start with running through some basic background information. The options market makes up for a significant part of the derivative market, particularly in India.

Internationally, the option market has been around for a while now, here is a quick background on the same —. Clearly the international markets have evolved a great deal since the OTC cheap option trading software indian stock market with example. However in India from the time of inception, the options market was facilitated by the exchanges. The badla system no longer exists, it has become obsolete.

Here is a quick recap of the history of the Indian derivative markets —. Though the options market has been around sincethe real liquidity in the Indian index options was seen only in !

I remember trading options around that time, the spreads cheap option trading software indian stock market with example high and getting fills was a big deal. However inthe Ambani brothers formally split up and their respective companies were listed as separate entities, thereby unlocking the value to the shareholders.

In my opinion this particular corporate event triggered vibrancy in the Indian markets, creating some serious liquidity. However if you were to compare the liquidity in Indian stock options with the international markets, we still have a long cheap option trading software indian stock market with example to catch up.

There are two types of options — The Call option and the Put option. You can be a buyer or seller of these options. In fact the best way to understand the call option is to first deal with a tangible real world example, once we understand this example we will extrapolate the same to stock markets. Consider this situation; there are two good friends, Ajay and Venu.

Ajay is actively evaluating an opportunity to buy 1 acre of land that Venu owns. The land is valued at Rs. Ajay has been informed that in the next 6 months, a new highway project is likely to be sanctioned near the land that Venu owns.

If the highway indeed comes up, the valuation of the land is bound to increase and therefore Ajay would benefit from the investment he would make today. So what should Ajay do? Clearly this situation has put Ajay in a dilemma as he is uncertain whether to buy the land from Venu or not. While Ajay is muddled in this thought, Venu is quite clear about selling the land if Ajay is willing to buy.

Ajay wants to play it safe, he thinks through the whole situation and finally proposes a special structured arrangement to Venu, which Ajay believes is a win-win for both of them, the details of the arrangement is as follows —. So what do you think about this special agreement? Who do you think is smarter here — Is it Ajay for proposing such a tricky agreement or Venu for accepting such an cheap option trading software indian stock market with example Well, the answer to these questions is not easy to answer, unless you analyze the details of the agreement thoroughly.

I would suggest you read through the example carefully it also forms the basis to understand options — Ajay has plotted an extremely clever deal here! In fact this deal has many faces to it. Now, after initiating this agreement both Ajay and Venu have to wait for the next cheap option trading software indian stock market with example months to figure out what cheap option trading software indian stock market with example actually happen. However irrespective of what happens to the highway, there are only three possible outcomes —.

Remember as per the agreement, Ajay has the right to call off the deal at the end of 6 months. Now, with the increase in the land price, do you think Ajay will call off the deal? This means Ajay now enjoys the right to buy a piece of land at Rs. Clearly Ajay is making a steal deal here. Venu is obligated to sell him the land at a lesser value, simply because he had accepted Rs.

Another way to look at this is — For an initial cash commitment of Rs. Venu even though very clearly knows that the value of the land is much higher in the open market, is forced to sell it at a much lower price to Ajay. The profit that Ajay makes Rs. It turns out that the highway project was just a rumor, and nothing cheap option trading software indian stock market with example is expected to come out of the whole thing. People are disappointed and hence there is a sudden rush to sell out the land.

As a result, the price of the land goes down to Rs. So what do you think Ajay will do now? Clearly it does not make sense to buy the land, hence he would walk away from the cheap option trading software indian stock market with example.

Here is the math that explains why it does not make sense to buy the land —. Remember the sale price is fixed at Rs. Hence if Ajay has to buy the land he has to shell out Rs. Which means he is in effect paying Rs. Clearly this would not make sense to Ajay, since he has the right to call of cheap option trading software indian stock market with example deal, he would simply walk away from it and would not buy the land.

However do note, as per the agreement Ajay has to let go of Rs. For whatever reasons after 6 months the price stays at Rs. What do you think Ajay will do? Well, he will obviously walk away from the deal and would not buy the land. Why you may ask, well here is the math —. Clearly it does not make sense to buy a piece of land at Rs. Do note, since Ajay has already committed 1lk, he could still buy the land, but ends up paying Rs 1lk extra in this process.

For this reason Ajay will call off the deal and in the process let go of the agreement fee of Rs. I hope you have understood this transaction clearly, and if you have then it is good news as through the example you already know how the call options work! But let us not hurry to extrapolate this to the stock markets; we will spend some more time with the Ajay-Venu transaction.

I would suggest you be absolutely thorough with this example. If not, please go through it again to understand the dynamics involved. Also, please remember this example, as we will revisit the same on a few occasions in the subsequent chapters.

Do note, I will deliberately skip the nitty-gritty of an option trade at this cheap option trading software indian stock market with example. The idea is to understand the bare bone structure of the call option contract. Assume a stock is trading at Rs. You are given a right today to buy the same one month later, at say Rs.

Obviously you would, as this means to say that after 1 month even if the share is trading at 85, you can still get to buy it at Rs. In order to get this right you are required to pay a small amount today, say Rs. If the share price moves above Rs. If the share price stays at or below Rs. All you lose is Rs. After you get into this agreement, there are only three possibilities that can occur. Case 1 — If the stock price goes up, then it would make sense in exercising your right and buy the stock at Rs.

Case 2 — If the stock price goes down to say Rs. Case 3 — Likewise if the stock stays flat at Rs. This is simple right? If you have understood this, you have essentially understood the core logic of a call option. What remains unexplained is the finer points, all of which we will learn soon.

At this stage what you really need to understand is this — For reasons we have discussed so far whenever you expect the price of a stock or any asset for that matter to increase, it always makes sense to buy a call option! Now that we are through with the various concepts, let us understand options and their associated terms. Hi Sir, Options is like greek and latin to me.

Thanks for the analogies. No, all derivative contracts are routed via the exchanges. You cannot enter into an OTC arrangement, even if you do, it would not be regulated hence quite dangerous. What benefit would Ajay get by calling off the deal before the expiry of 6 months?

He will instead wait for the whole 6 months for any chance of the highway project. My first question Karthik is this: The dropdown value on the NSE website does not contain all months expiries — after 18th May we have 25th June followed by 24th Sept and then 31st Dec What happened to the other months?

For to only June and Dec contracts are available. What happened to the remaining? Saurabh, glad you noticed it! For all stocks options the expiry is very similar to futures.

Hence we have current month, mid month, and far month contracts. However for Nifty there are several different expiry options. Leaps are good if you have a super long term view on markets. However the problem with leaps in India is that they are not liquid, there are hardly any trading activity here.

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Day trading is speculation in securities , specifically buying and selling financial instruments within the same trading day. Strictly, day trading is trading only within a day, such that all positions are closed before the market closes for the trading day. Many traders may not be so strict or may have day trading as one component of an overall strategy. Traders who participate in day trading are called day traders. Traders who trade in this capacity with the motive of profit are therefore speculators.

The methods of quick trading contrast with the long-term trades underlying buy and hold and value investing strategies. Some of the more commonly day-traded financial instruments are stocks , options , currencies , and a host of futures contracts such as equity index futures, interest rate futures, currency futures and commodity futures.

Day trading was once an activity that was exclusive to financial firms and professional speculators. Many day traders are bank or investment firm employees working as specialists in equity investment and fund management. However, with the advent of electronic trading and margin trading , day trading is available to private individuals. Some day traders use an intra-day technique known as scalping that usually has the trader holding a position for a few minutes or even seconds.

Most day traders exit positions before the market closes to avoid unmanageable risks—negative price gaps between one day's close and the next day's price at the open. Another reason is to maximize day trading buying power. Day traders sometimes borrow money to trade. This is called margin trading. Since margin interests are typically only charged on overnight balances, the trader may pay no fees for the margin benefit, though still running the risk of a margin call.

The margin interest rate is usually based on the broker's call. Because of the nature of financial leverage and the rapid returns that are possible, day trading results can range from extremely profitable to extremely unprofitable, and high-risk profile traders can generate either huge percentage returns or huge percentage losses. Because of the high profits and losses that day trading makes possible, these traders are sometimes portrayed as " bandits " or " gamblers " by other investors.

The common use of buying on margin using borrowed funds amplifies gains and losses, such that substantial losses or gains can occur in a very short period of time. In addition, brokers usually allow bigger margins for day traders. Because of the high risk of margin use, and of other day trading practices, a day trader will often have to exit a losing position very quickly, in order to prevent a greater, unacceptable loss, or even a disastrous loss, much larger than his or her original investment, or even larger than his or her total assets.

Originally, the most important U. A trader would contact a stockbroker, who would relay the order to a specialist on the floor of the NYSE. These specialists would each make markets in only a handful of stocks. The specialist would match the purchaser with another broker's seller; write up physical tickets that, once processed, would effectively transfer the stock; and relay the information back to both brokers.

One of the first steps to make day trading of shares potentially profitable was the change in the commission scheme. In , the United States Securities and Exchange Commission SEC made fixed commission rates illegal, giving rise to discount brokers offering much reduced commission rates. Financial settlement periods used to be much longer: Before the early s at the London Stock Exchange , for example, stock could be paid for up to 10 working days after it was bought, allowing traders to buy or sell shares at the beginning of a settlement period only to sell or buy them before the end of the period hoping for a rise in price.

This activity was identical to modern day trading, but for the longer duration of the settlement period. But today, to reduce market risk, the settlement period is typically two working days. Reducing the settlement period reduces the likelihood of default , but was impossible before the advent of electronic ownership transfer.

The systems by which stocks are traded have also evolved, the second half of the twentieth century having seen the advent of electronic communication networks ECNs. These are essentially large proprietary computer networks on which brokers could list a certain amount of securities to sell at a certain price the asking price or "ask" or offer to buy a certain amount of securities at a certain price the "bid".

The first of these was Instinet or "inet" , which was founded in as a way for major institutions to bypass the increasingly cumbersome and expensive NYSE, also allowing them to trade during hours when the exchanges were closed. Early ECNs such as Instinet were very unfriendly to small investors, because they tended to give large institutions better prices than were available to the public. This resulted in a fragmented and sometimes illiquid market. The next important step in facilitating day trading was the founding in of NASDAQ —a virtual stock exchange on which orders were transmitted electronically.

Moving from paper share certificates and written share registers to "dematerialized" shares, computerized trading and registration required not only extensive changes to legislation but also the development of the necessary technology: These developments heralded the appearance of " market makers ": A market maker has an inventory of stocks to buy and sell, and simultaneously offers to buy and sell the same stock.

Obviously, it will offer to sell stock at a higher price than the price at which it offers to buy. This difference is known as the "spread". The market maker is indifferent as to whether the stock goes up or down, it simply tries to constantly buy for less than it sells.

A persistent trend in one direction will result in a loss for the market maker, but the strategy is overall positive otherwise they would exit the business. Today there are about firms who participate as market makers on ECNs, each generally making a market in four to forty different stocks. Another reform made was the " Small Order Execution System ", or "SOES", which required market makers to buy or sell, immediately, small orders up to shares at the market maker's listed bid or ask.

In the late s, existing ECNs began to offer their services to small investors. New brokerage firms which specialized in serving online traders who wanted to trade on the ECNs emerged. Archipelago eventually became a stock exchange and in was purchased by the NYSE. Moreover, the trader was able in to buy the stock almost instantly and got it at a cheaper price. ECNs are in constant flux. New ones are formed, while existing ones are bought or merged. As of the end of , the most important ECNs to the individual trader were:.

This combination of factors has made day trading in stocks and stock derivatives such as ETFs possible. The low commission rates allow an individual or small firm to make a large number of trades during a single day. The liquidity and small spreads provided by ECNs allow an individual to make near-instantaneous trades and to get favorable pricing. The ability for individuals to day trade coincided with the extreme bull market in technological issues from to early , known as the Dot-com bubble.

In March, , this bubble burst, and a large number of less-experienced day traders began to lose money as fast, or faster, than they had made during the buying frenzy. The NASDAQ crashed from back to ; many of the less-experienced traders went broke, although obviously it was possible to have made a fortune during that time by shorting or playing on volatility.

In parallel to stock trading, starting at the end of the s, a number of new Market Maker firms provided foreign exchange and derivative day trading through new electronic trading platforms. These allowed day traders to have instant access to decentralised markets such as forex and global markets through derivatives such as contracts for difference. Most of these firms were based in the UK and later in less restrictive jurisdictions, this was in part due to the regulations in the US prohibiting this type of over-the-counter trading.

These firms typically provide trading on margin allowing day traders to take large position with relatively small capital, but with the associated increase in risk. Retail forex trading became a popular way to day trade due to its liquidity and the hour nature of the market. The following are several basic strategies by which day traders attempt to make profits. Besides these, some day traders also use contrarian reverse strategies more commonly seen in algorithmic trading to trade specifically against irrational behavior from day traders using these approaches.

It is important for a trader to remain flexible and adjust their techniques to match changing market conditions. Some of these approaches require shorting stocks instead of buying them: There are several technical problems with short sales—the broker may not have shares to lend in a specific issue, the broker can call for the return of its shares at any time, and some restrictions are imposed in America by the U. Securities and Exchange Commission on short-selling see uptick rule for details.

Some of these restrictions in particular the uptick rule don't apply to trades of stocks that are actually shares of an exchange-traded fund ETF. Trend following , a strategy used in all trading time-frames, assumes that financial instruments which have been rising steadily will continue to rise, and vice versa with falling. The trend follower buys an instrument which has been rising, or short sells a falling one, in the expectation that the trend will continue.

Contrarian investing is a market timing strategy used in all trading time-frames. It assumes that financial instruments which have been rising steadily will reverse and start to fall, and vice versa. The contrarian trader buys an instrument which has been falling, or short-sells a rising one, in the expectation that the trend will change. Range trading, or range-bound trading, is a trading style in which stocks are watched that have either been rising off a support price or falling off a resistance price.

That is, every time the stock hits a high, it falls back to the low, and vice versa. Such a stock is said to be "trading in a range", which is the opposite of trending. A related approach to range trading is looking for moves outside of an established range, called a breakout price moves up or a breakdown price moves down , and assume that once the range has been broken prices will continue in that direction for some time.

Scalping was originally referred to as spread trading. Scalping is a trading style where small price gaps created by the bid-ask spread are exploited by the speculator. It normally involves establishing and liquidating a position quickly, usually within minutes or even seconds. Scalping highly liquid instruments for off-the-floor day traders involves taking quick profits while minimizing risk loss exposure. The basic idea of scalping is to exploit the inefficiency of the market when volatility increases and the trading range expands.

When stock values suddenly rise, they short sell securities that seem overvalued. Rebate trading is an equity trading style that uses ECN rebates as a primary source of profit and revenue. Most ECNs charge commissions to customers who want to have their orders filled immediately at the best prices available, but the ECNs pay commissions to buyers or sellers who "add liquidity" by placing limit orders that create "market-making" in a security.

Rebate traders seek to make money from these rebates and will usually maximize their returns by trading low priced, high volume stocks. This enables them to trade more shares and contribute more liquidity with a set amount of capital, while limiting the risk that they will not be able to exit a position in the stock. The basic strategy of news playing is to buy a stock which has just announced good news, or short sell on bad news.

Such events provide enormous volatility in a stock and therefore the greatest chance for quick profits or losses. Determining whether news is "good" or "bad" must be determined by the price action of the stock, because the market reaction may not match the tone of the news itself.

This is because rumors or estimates of the event like those issued by market and industry analysts will already have been circulated before the official release, causing prices to move in anticipation.

The price movement caused by the official news will therefore be determined by how good the news is relative to the market's expectations, not how good it is in absolute terms. Keeping things simple can also be an effective methodology when it comes to trading. These traders rely on a combination of price movement, chart patterns, volume, and other raw market data to gauge whether or not they should take a trade.