Trading & Investing Fundamentals
TRADING & INVESTING TERMS
What is Trading?
Generally, trading is defined as a procedure of purchasing, selling, or exchanging goods and services, at either wholesale or retail. It can be done within a country or at an international level. Trading is the primary reason that we can buy products that are produced or made in other countries.
In financial markets, individuals can trade securities such as commodities, stocks / shares, derivatives, and currencies that include cryptocurrency or bitcoins as well. Stock exchanges facilitate the trading of Stocks and Options. There are different exchanges for Futures / Commodities trading. Forex trading happens through a decentralized exchange model. The key goal of a trader is to buy at a wholesale price and sell at a retail price.
Short Term Trading vs Long Term Trading:
Short-term trading, also known as active trading, is a trading strategy that includes taking an entry or exit position which can last from a few minutes to a few weeks. The main focus of this trading type is on price action, which means making a profit from rapid changes in the market prices. The main styles of short-term trading are scalpers, Day Trading, and Swing Trading. Intraday Trading involves entry and exit on the same day.
On the flip side, in the long-term trading style, a trader holds the assets for an extended period of time. The trade can last for as little as one year or for as long as 20 years or more. As it focuses more on the future view, the position trading largely depends on the fundamental analysis. The traders are usually not concerned about bullish and bearish market trends that happen every day and instead concentrate on the factors that are affecting the long-term trend. However, understanding the supply & demand is critical to find the right entry levels for better longer-term growth.
What is Investing?
Investing means apportioning money or other resources to make more profit or income. It is a common way to potentially increase the wealth a person or an institution currently possesses. The most usual method to invest is to save money in a savings bank account, retirement accounts (e.g., 401k, RRSP, IRA) or hold physical assets, e.g., Gold. Investment can also be done by putting money in business or buying a property. Risk and return in investing go side by side; lower risk usually brings lower return and higher risk means higher expected returns. In investing also, the right entry point is critical for better returns on investment.
Trading vs Investing:
To create and enhance wealth opportunities, people and institutions either trade or invest. Trading emphasizes short-term profits. Traders monitor the markets closely. They buy and sell the shares within seconds, days, and even weeks to make higher profits. Investing, on the other side, is about buying and holding. Investors purchase shares or commodities for a long time, sometimes more than a decade. They follow a long-term approach rather than the intraday changes. The primary target of an investor is to generate wealth over a longer period.
Risks in Trading & Investing:
Trading and investing both involve a certain amount of risk. Trading has higher risk because prices go up and down in a short period of time. Hence a trader may not get the expected profit in that time period. Investment has relatively lower risk as compared to trading as small events or daily ups and downs do not make a significant impact on the value of assets in the long run. But it does not mean that investing is risk-free. Investors may not get desired returns if they sell their assets after a short time. The risk depends on the market you are investing in and generally, the risks are changes in interest rates, exchange rates, downfall in the company’s financial health, the economic conditions of the country to name a few.
Trading & Investing Terms
- Day Trading: is purchasing Stocks to sell them on the same day.
- Swing Trading: Contrary to day trading, in swing trading a trader holds stocks overnight or longer.
- Equity Index: It is a weighted average of various Stocks traded in a particular Stock Market. For example, Dow Jones, Nasdaq, S&P500.
- Dow Jones Industrial Average (^DJI) is the weighted average of 30 US Industrial Company Stocks. Similarly
- Nasdaq is the weighted average of 100 Technology Stocks in the US.
- S&P 500 is the weighted average of 500 stocks of the largest US companies.
- Bullish: A market when most of the stock prices are moving up. It is normally tracked on an Equity Index level.
- Bearish: A market when most of the stock prices are moving down. It is normally tracked on an Equity Index level.
- Initial Public Offering (IPO): In an IPO, businesses sell a set sum of stocks to raise capital for the purpose of investing in the business.
- Crossed Market: Transient condition in which the bidding value is more than asking value.
- Dividend: A profit share provided to the shareholders of the organization, as decided by the board.
- Divergence: When asset value is going in the opposite direction to what it depicts in the technical indicator.
- Support Level: A level at which price can be anticipated to pause from going down further.
- Resistance Level: A level at which price can be anticipated to pause from going up further.
- Short Selling: An act of borrowing shares from a lender/broker and selling them with an expectation to buy it back lower and generate profit. The trader has to buy the stocks to return to the broker.
- Pump and Dump: In this, rumors are spread about a Stock to enhance their value, only to sell (dump) the positions at the higher level and profit from it. This is an illegal practice and the retail traders (who buy based on the rumor) lost their investments.
- Bond: Similar to a loan, a bond buyer approves to lend capital to a corporation or government. In return, they will get an interest rate on the amount they are lending.
- Mutual Funds: Mutual Funds are made up of a group of individual securities such as stocks, bonds etcetera. These funds are managed by professional portfolio managers who divide the assets to generate more wealth on the behalf of an investor. Mutual Funds charge a fee for managing the portfolio.
- Exchange Traded Funds (ETF): Funds (like Mutual Funds), which are traded in an exchange are called Exchange Traded Funds. The advantage of an ETF over a Mutual Fund is the immediate liquidity to buy and sell the funds.
- Hedge Funds: These funds are created to lower the risk of market uncertainty. In these funds, investors generate good results in up as well as down markets.
- Options: Option is a type of contract in which a trader (who buys the Option) has the right to purchase or sell the assets, but not the obligation, at a fixed price until the expiration of the contract.
- Bond Rating: Bonds are generally rated by various rating agencies to indicate the overall quality of the Bond. These ratings depend upon credit rating or the issuer, business type, risks involved, type of Bond and historical performance. The ratings vary from AAA to D, based on the rating agency. Some of the major rating agencies are Moody’s, S&P, Morningstar etc.
- Management Expense Ratio: In a Mutual Fund, the management of the fund charges a fee to manage the funds in terms of their allocation, deployment, accounting, legal and other obligations. This fee is generally called Management Expense Ratio (MER) or Mutual Fund Fee or Management Fee. Exchange Traded Funds (ETF) also charge a management fee, which is generally smaller compared to the Mutual Fund MER.
- Capital Gain: The profit obtained from trading or investing in financial securities is generally termed as Capital Gain. The inclusion and exclusion of instruments into Capital Gain varies widely from country to country. Also, some countries distinguish between short term capital gain and long term capital gain. There are different tax benefits and tax treatments for each of these, which also varies by countries.