What is Trading?
Trading is essentially the exchange of goods and services between two entities. It is the basic principle which forms the core of all economic societies and financial activities.
Trade governs the wheels of progress in any society and allows for wealth creation. A place where any form of trade takes shape is called a market. Depending on the kind of products, the market is defined. For instance, a place where stock trading takes place is called the stock market.
There are primarily two forms of the market – organized and unorganized. Organized market is constituted with a set of rules and regulations which every entity operating in the market needs to adhere to and usually consists of a regulatory body to supervise such adherence. An unorganized market does not contain any strict rules and regulations, and even if it does, adherence is not mandatory.
With online trading and investing, the process has become much more convenient, where most markets have been simulated on the internet.
History of Trading?
Trade has existed for as long as the human civilization, i.e. the agricultural revolution. The form of trading, however, has varied across different societies. Primarily due to isolated human communities which did not allow the unification into a single system.
In the past, however, a form of trading which was prevalent across different societies was the barter system where services and goods were traded in exchange for other services and goods.
However, the barter system was found inconvenient given the lack of any basic standard of measure of the value of products. This inconvenience forged the way for money which acted as a standard against which the values of all products are measured. This invention triggered a chain of economic and financial developments such as the introduction of the credit facility, share trading, etc.
Stock trading came into existence with the formation of joint-stock companies in Europe and played an instrumental role in European imperialism. Informal stock markets started mushrooming in various European cities. The first joint-stock company to publically trade its shares was the Dutch East India Company who released its shares through the Amsterdam Stock Exchange.
After the success of joint-stock companies in fostering economic development along with geographical expansion, those were made a mainstay of the financial world. The first exchange for online trading in India and Asia was the Bombay Stock Exchange which was established in 1875.
BSE, along with the National Stock Exchange in India are the two main houses where stock market trading takes place.
Different Types of Trading
Based on Trading Strategies:
- Momentum Trading:
Momentum trading is a technique in which traders buy and sell according to the strength of recent price trends.
Here the traders look to find stocks that are high percentage and volume movers over a particular period of time, moving significantly in one direction and try to acquire the desired profit by taking positions in such stocks.
Momentum trading strategies seek to profit from buying stocks that are moving in an uptrend and selling stocks moving in a downtrend.
- Trading based on Mean Reversion:
The opposite of Momentum trading is trading based on the concept of mean reversion. This stems from the concept that stocks which deviate from their historic mean price will tend to revert back over a period of time to their mean value.
Traders can take long or short positions to profit from the mean reverting behavior of stocks. In contrast to momentum following strategies which work on the principle of buying high and selling higher (in an uptrend) and selling low and buying lower (in a downtrend), mean reversion strategies seek to capitalize on the classic buy low, sell high principle.
In general, momentum trading results in trades with low probability of success but high profit potential and trading based on mean reversion results in trades with high probability of success but low profit potential.
Based on Timeframe:
The trading wherein the trader “scalps” a small profit from each trade by exploiting the bid-ask spread by darting in and out of a stock or other asset classes, multiple times a day to reap a small profit on each trade to add up to the big dough at the end of the day.
- Day Trading: Intraday
It is the act of buying and selling a financial instrument within the same trading day, or even multiple times over the course of a day, taking advantage of small price moves, such that all positions are closed before the market closes for the trading day.
Intraday trading and scalping provide traders with an opportunity to take leveraged trades and make more profits than usual. Leveraged trading is also the primary reason behind almost all of the intraday traders being unsuccessful over a longer period of time.
- Swing Trading:
Swing trading is a type of trading style wherein short-term strategies are played in the most liquid stocks or indices to take advantage of price swings, either reverting back to the median or fading a rally and last from one day to a few days to a few weeks.
- Positional Trading: – Delivery
As opposed to swing trading, the length of the trades is much larger for positional trading. Positional trading consists of trades lasting from a few weeks to a few months and sometimes a few years as well. Positional trading is as close to long term investing as trading gets.
In general, the probability of success keeps on increasing from day trading to positional trading. Since the long term market structure is upwards for most of the markets, positional trades have a pretty decent probability of success.
Based on Analysis Technique:
- Technical Trading:
Trading obsessed with charts and graphs, monitoring lines on stock or index graphs for signs of convergence or divergence that might indicate buy or sell signals. Technical trading relies on technical analysis and is purely based on the price action depicted by an asset class.
- Fundamental Trading:
Trading based on fundamental analysis, which examines things like corporate events such as actual or anticipated earnings reports, stock splits, reorganizations or acquisitions. Fundamental analysis is more appropriate for longer term trades which avoid the short term price fluctuations or noise.
- Techno-fundamental Trading:
Trading based on both the technical and fundamental analysis is techno fundamental trading. In techno fundamental trading, a trader shortlists a few stocks based on fundamental analysis and strategically determines the entry and exit levels based on technical analysis.
Based on Asset Class:
- Equity Trading:
Equity trading is the buying and selling of company shares or stocks, also known as equities, on the financial market. Most equity trading refers to the buying and selling of public company shares through a stock exchange or as over-the-counter products.
- Derivative Trading:
As suggested by the name, derivatives are contracts that derive their value from an underlying asset. The underlying asset can be stocks, currencies, indices, etc. Derivative trading involves buying and selling of derivatives in a stock market.
Derivatives essentially enable a trader to bet on the future price movement of the underlying assets and are much more volatile than the underlying assets.
An interesting feature of derivative trading is that it lets a trader take much larger speculative bets and is therefore a lot riskier than equity trading. The two most common types of derivative trading include futures and options trading.
- Currency Trading:
Currency trading or forex trading refers to the process of buying and selling currency pairs. Currencies are usually traded in pairs for e.g: EUR/USD is the most liquid currency pair which provides the relative value of Euro to the U.S. Dollar at any particular period of time.
Other commonly traded currency pairs include USD/JPY, USD/GBP, USD/CHF, USD/CAD, AUD/USD, NZD/USD and USD/INR. A massive benefit of currency trading is that the forex markets are open all the time. Liquidity and the corresponding bid ask spread may vary at different time instances though.
- Commodity Trading:
Similar to equity and currency, commodities are widely traded assets. Commodities that are traded are typically sorted into four broad categories: metal, energy, agricultural and livestock and meat.
- Metals commodities include gold, silver, platinum, and copper.
- Energy commodities include crude oil, heating oil, natural gas, and gasoline.
- Agricultural commodities include corn, soybeans, wheat, rice, cocoa, coffee, cotton, and sugar.
- Livestock and meat commodities include lean hogs, pork bellies, live cattle, and feeder cattle.
- Crypto Trading:
Crypto trading or cryptocurrency trading refers to the process of speculating the future price movement of cryptocurrencies in an attempt to profit. As compared to the other asset classes discussed above, crypto trading is a relatively newer concept.
There are two routes to trading cryptocurrencies: speculating on their prices using CFDs or buying the digital currencies in the hope they increase in value.