Financial Market and Basics of Trading an Insight to the Share Market

1. Introduction:

As we are all familiar with, in today’s era, some people require or want a dynamic environment to work in to test their abilities or to work out of their comfort zone. So that they can know about their abilities and increase their risk-taking ability. The same approach made people dive into the stock market and work or earn through it. This new wave of the stock market has hit the financial market differently and is helping boost economies. Today, people are no longer using conservative approaches and are on their toes and ready to take risks. Furthermore, the financial market is a dynamic ecosystem where investors, traders, and institutions interact to buy and sell financial assets. At its core lies the stock market, also known as the share market, which serves as the primary platform for trading ownership stakes in publicly listed companies. Understanding the basics of trading in the financial market, particularly in the share market, is essential for both novice and seasoned investors alike. A financial market is a marketplace that provides an avenue for the sale and purchase of assets such as bonds, stocks, foreign exchange, and derivatives. This article aims to provide a comprehensive insight into the financial market, the fundamentals of trading, and navigating the intricacies of the share market.

2. Understanding the Financial Market:

The financial market includes any place or system that provides buyers and sellers with the means to trade financial instruments, including bonds, equities, various international currencies, and derivatives. The financial market makes it easier for people who have money to invest and those who need it to interact. The financial market is a link between investors with surplus units and business enterprises with deficit units. These markets serve as the foundation of the global financial system, facilitating the allocation of capital, price discovery, and risk management. Financial markets can be classified into several categories based on the type of assets traded, the maturity of the instruments, and the platforms used for trading.

Financial markets can be categorized into primary and secondary markets:

1. Primary Market: In the primary market, new securities are issued and sold for the first time through mechanisms like initial public offerings (IPOs), private placements, or bond issuances. Companies and governments raise capital directly from investors in the primary market. The primary market directly contributes to the capital of the company as it involves the transfer of funds from surplus units to deficits.
2. Secondary Market: The secondary market involves the trading of existing securities among investors. Stock exchanges, over-the-counter markets, and electronic trading platforms facilitate the buying and selling of securities in the secondary market. Prices in the secondary market are determined by supply and demand dynamics and can fluctuate based on various factors. The secondary market indirectly contributes to the capital of a company as it involves an exchange of funds between surplus units only.

Financial markets play a crucial role in the global economy, influencing economic growth, investment decisions, and overall financial stability. They are regulated by governmental and non-governmental organizations to ensure fair and orderly operations, investor protection, and financial stability. Here are some key types of financial markets:

1. Stock Market (Equity Market): This market enables the buying and selling of ownership stakes in publicly traded companies. Investors purchase shares of stock, which represent ownership in the company and may entitle them to dividends and voting rights.
2. Bond Market (Fixed-Income Market): In the bond market, issuers such as governments, corporations, and municipalities sell debt securities to investors. Bonds represent loans made by investors to the issuer, who promises to repay the principal amount plus interest at a specified future date.
3. Foreign Exchange Market (Forex Market): The forex market is where currencies are traded. At predetermined exchange rates, participants—banks, financial institutions, businesses, governments, and individual traders—swap one currency for another.
4. Commodity Market: Commodity markets involve the trading of physical goods such as agricultural products (e.g., wheat, corn), energy resources (e.g., crude oil, natural gas), metals (e.g., gold, silver), and other raw materials. Participants use commodity markets for hedging, speculation, and investment purposes.
5. Derivatives Market: Derivatives are financial instruments whose value is derived from an underlying asset, index, or reference rate. Derivatives include options, futures, forwards, and swaps, which allow investors to hedge risk, speculate on price movements, and gain exposure to various asset classes.
6. Money Market: The money market deals with short-term debt securities with maturities typically ranging from overnight to one year. Participants in the money market include banks, corporations, governments, and financial institutions seeking to borrow or lend funds for short durations.

3. The Basis of Trading in the Share Market:

Trading in the share market involves the buying and selling of shares of publicly listed companies. The primary objective of trading is to buy shares at a lower price and sell them at a higher price, thereby making a profit. To engage in trading, one must understand the various types of orders, the trading process, and the role of stock exchanges.

Types of Orders

1. Market Orders: A market order is an instruction to buy or sell a security immediately at the current market price. This type of order ensures that the transaction is executed quickly, but the exact price may vary depending on market conditions.
2. Limit Orders: A limit order is an instruction to buy or sell a security at a specified price or better. For buying, the order will only be executed at the limit price or lower, while for selling, it will be executed at the limit price or higher. This order type provides more control over the execution price.
3. Stop Orders: A stop order becomes a market order once the stop price is reached. A stop-loss order is placed to sell a security when it reaches a certain price, limiting potential losses. Conversely, a stop-buy order is placed to buy a security when it reaches a specified price, often used to enter the market or protect short positions.
4. Stop-Limit Orders: A stop-limit order combines features of stop orders and limit orders. Once the stop price is reached, the order becomes a limit order instead of a market order. This allows for precise control over the entry or exit price, although there is a risk the order may not be executed if the market moves quickly.

Trading Process:

The trading process in the share market involves several steps:

1. Opening a Trading Account: To trade shares, an individual must open a trading account with a brokerage firm. The brokerage provides the platform for executing trades and may offer additional services such as research and advisory.
2. Research and Analysis: Before making any trades, it is essential to conduct thorough research and analysis of the companies, industries, and market trends. This can involve fundamental analysis, which examines a company’s financial health and growth potential, and technical analysis, which uses historical price and volume data to predict future price movements.
3. Placing Orders: Once a trading strategy is developed, orders are placed through the brokerage’s trading platform. The type of order and timing will depend on the trader’s objectives and market conditions.
4. Execution and Settlement: After an order is placed, it is matched with a counterparty’s order on the stock exchange. Once matched, the trade is executed, and the ownership of shares is transferred. The settlement process, which involves the transfer of funds and securities, usually occurs within two business days (T+2 settlement cycle).
5. Monitoring and Managing Investments: Post-trade, it is crucial to monitor investments and adjust as needed. This includes tracking market conditions, company performance, and economic indicators that could impact the portfolio.

4. Factors influencing share prices:

Several factors influence share prices, which can be broadly categorized into fundamental factors, technical factors, and market sentiment.

Fundamental Factors:

1. Company Performance: A company’s financial health, profitability, revenue growth, and future earnings prospects significantly impact its share price. Strong performance often leads to higher share prices, while poor performance can result in declines.
2. Economic Indicators: Macroeconomic indicators such as GDP growth, inflation rates, interest rates, and employment data influence investor sentiment and share prices. Positive economic indicators generally boost market confidence and share prices, whereas negative indicators can have the opposite effect.
3. Industry Trends: Trends within specific industries can impact the share prices of companies operating in those sectors. Technological advancements, regulatory changes, and shifts in consumer preferences are examples of industry-specific factors that can drive share prices.

Technical Factors

1. Market Liquidity: The liquidity of a stock, or the ease with which it can be bought or sold without significantly affecting its price, impacts share prices. Highly liquid stocks tend to have more stable prices, while illiquid stocks can be more volatile.
2. Trading Volume: The volume of shares traded influences price movements. High trading volume often indicates strong investor interest and can lead to price increases, while low volume may suggest a lack of interest and price declines.
3. Historical Price Trends: Technical analysts study historical price trends and patterns to predict future price movements. Support and resistance levels, moving averages, and chart patterns are common tools used in technical analysis.

Market Sentiment

1. Investor Sentiment: Market sentiment, or the overall attitude of investors toward a particular market or asset, can drive share prices. Positive sentiment leads to buying activity and higher prices, while negative sentiment results in selling pressure and lower prices.
2. News and Events: News events, such as earnings announcements, mergers and acquisitions, product launches, and geopolitical developments, can cause significant price fluctuations. Investors react to news based on their perceptions of its impact on a company’s prospects.
3. Market Trends: Broad market trends, such as bull or bear markets, influence share prices. In a bull market, rising investor confidence leads to higher prices, while in a bear market, declining confidence results in lower prices.

5. Strategies for Successful Trading: 

Successful trading in the share market requires a well-thought-out strategy, discipline, and continuous learning. Here are some common strategies used by traders:

Fundamental Analysis

Fundamental analysis involves evaluating a company’s financial statements, management, competitive position, and market conditions to determine its intrinsic value. Traders using this strategy seek to identify undervalued or overvalued stocks based on their intrinsic value and market price. Key components of fundamental analysis include:

1. Earnings Per Share (EPS): EPS is a measure of a company’s profitability, calculated as net income divided by the number of outstanding shares. Higher EPS indicates better profitability and is often associated with higher share prices.
2. Price-to-Earnings (P/E) Ratio: The current share price of a corporation is compared to its earnings per share using the P/E ratio. A stock may be cheap if its P/E ratio is lower, while it may be overvalued if it is greater.
3. Dividend Yield: Dividend yield is the annual dividend payment divided by the share price. Stocks with higher dividend yields can be attractive to income-focused investors.

Technical Analysis

In order to predict future price changes, technical analysis focusses on historical price and volume data. Traders use various tools and indicators to identify trends and make trading decisions. Common technical analysis tools include:

1. Moving Averages: Moving averages smooth out price data to identify trends over a specific period. The exponential moving average (EMA) and the simple moving average (SMA) are two types of moving averages that are frequently employed.
2. Relative Strength Index (RSI): The RSI is a momentum oscillator that measures the speed and change of price movements. It ranges from 0 to 100 and indicates overbought or oversold conditions.
3. Support and Resistance Levels: Support levels are price points where a stock tends to find buying interest, preventing it from falling further. Resistance levels are where selling pressure tends to emerge, preventing the price from rising further.

Day Trading

Day trading involves buying and selling securities within the same trading day to capitalize on short-term price movements. Day traders typically use technical analysis and high-frequency trading strategies to profit from intraday volatility. Key aspects of day trading include:

1. Intraday Charts: Day traders use short-term charts, such as one-minute, five-minute, or fifteen-minute charts, to analyze price movements and make quick decisions.
2. Risk Management: Day trading involves significant risk, so traders use risk management techniques such as setting stop-loss orders and position sizing to protect their capital.
3. Scalping: Scalping is a day trading strategy that involves making numerous small trades to profit from tiny price movements. Scalpers aim to hold positions for only a few seconds or minutes.

Swing Trading

Swing trading is the practice of maintaining positions for a few days or weeks in an effort to capitalise on short- to medium-term changes in prices. Swing traders use a combination of fundamental and technical analysis to identify trading opportunities. Key elements of swing trading include:

1. Chart Patterns: Swing traders look for chart patterns, such as head and shoulders, triangles, and flags, to predict price movements.
2. Momentum Indicators: Momentum indicators, such as the Moving Average Convergence Divergence (MACD) and the stochastic oscillator, help swing traders identify potential entry and exit points.
3. Position Sizing: Swing traders determine the size of their positions based on their risk tolerance and the potential reward of the trade.

6. Regulatory Framework:

The regulatory framework governing the financial market is designed to ensure fair and orderly operations, protect investors, and maintain financial stability. Regulatory bodies oversee market participants, enforce rules and regulations, and promote transparency and integrity in the market.

Key Regulatory Bodies

1. Securities and Exchange Commission (SEC): The SEC is the primary regulatory body overseeing the securities markets in the United States. It enforces securities laws, regulates brokerage firms, and protects investors by ensuring fair and transparent markets.
2. Financial Industry Regulatory Authority (FINRA): FINRA is a self-regulatory organization that oversees brokerage firms and their registered representatives. It enforces rules governing the conduct of its members and aims to protect investors.
3. Commodity Futures Trading Commission (CFTC): The CFTC regulates the commodity futures and options markets in the United States. It aims to promote market integrity, protect market participants, and ensure fair competition.

Key Regulations

1. Securities Act of 1933: The Securities Act of 1933 requires companies to provide investors with significant information about securities being offered for public sale. It aims to prevent fraud and ensure transparency in the securities market.
2. Securities Exchange Act of 1934: The Securities Exchange Act of 1934 established the SEC and regulates secondary trading of securities. It includes provisions for periodic reporting by publicly traded companies and insider trading regulations.
3. Dodd-Frank Wall Street Reform and Consumer Protection Act: The Dodd-Frank Act, enacted in response to the 2008 financial crisis, aims to promote financial stability, enhance consumer protection, and prevent future financial crises. It includes provisions for increased oversight of financial institutions and the creation of the Consumer Financial Protection Bureau (CFPB).

7. Challenges and Risks:

Trading in the financial market involves various challenges and risks that investors must be aware of to protect their capital and achieve their financial goals.

Market Volatility

Market volatility refers to the rapid and significant price movements in the financial markets. While volatility can create trading opportunities, it also increases the risk of substantial losses. Traders must be prepared to navigate volatile market conditions and use risk management strategies to protect their investments.

Information Asymmetry

When certain market actors have access to information while others do not, there is an information asymmetry. Inefficiencies in the market and unfair advantages may result from this.

 Regulatory bodies aim to reduce information asymmetry by enforcing disclosure requirements and promoting transparency.

Emotional Bias

Emotional bias can significantly impact trading decisions, leading to irrational behavior and poor investment choices. Common emotional biases include fear, greed, and overconfidence. Traders must develop discipline and stick to their trading plans to avoid being swayed by emotions.

Regulatory Risks

Changes in regulations and government policies can impact the financial markets and affect the profitability of investments. Traders must stay informed about regulatory developments and understand their potential impact on the market.

Technological Risks

The increasing reliance on technology in trading introduces risks such as system failures, cyberattacks, and technical glitches. Traders must ensure they use reliable trading platforms and implement cybersecurity measures to protect their investments.

8. Conclusion:

The financial market is a dynamic and complex ecosystem that offers numerous opportunities for investors and traders. Understanding the fundamentals of trading, the factors influencing share prices, and the various trading strategies is essential for success in the share market. Additionally, being aware of the regulatory framework and the challenges and risks involved in trading can help investors make informed decisions and protect their capital. As the financial market continues to evolve, continuous learning and adaptation are crucial for navigating its intricacies and achieving financial goals.