Stock Market For Beginners-Free Guide is not only about the basics of stock market like what is stock market, who can buy and sell etc.
But this guide will help you to increase your knowledge by understanding advanced topics described below.
Advanced topics covered in this guide:
- FII’S and DII’S
- Risk management
- Arbitrage etc
Basic topics covered in this guide:
- What is a stock market
- How the stock market operates
- Stock exchange
- Indices or index in stock markets
- Stock Brokers
- Sector-wise classification
- Sector index
- Buyers and sellers
- Buying and Selling
- Advance and decline ratio(upgrades/downgrades)
- Upper circuit
- Lower circuit
- Stock classification
- Trade structures
- Long-term investments
- Positional trading
- Swing trading
- Day trading
- What is Short selling and much more…
My question to you is can you become experienced by just reading this guide ??
The answer is “no”.
But you can definitely go to the next stage in understanding stock markets.
So let’s start now with the stock market for beginners free guide!
What is the stock market ??
The stock market is a marketplace where a transaction (buying or selling) of financial instruments like stock or share of a company, any commodity, currency etc happens.
Other names for stock market
You can also call the stock market as an equity market or capital market or share market.
How the stock market operates ??
Stock market operates through its stock exchange.
Companies and other financial securities lists themselves inside a stock exchange.
And Listing shares of companies and other financial products inside a stock exchange helps investors and traders to transact directly.
You can directly buy or sell any of the listed financial assets.
Some financial assets might have few obligations where you cannot simply sell them without owning it.
Few examples of the biggest stock exchange are NYSE, DOW JONES, NASDAQ etc.
The stock market cannot operate on its own.
And to function automatically, it will be programmed.
One completely automated stock exchange example is NASDAQ.
Every transaction automatically happens in electronic form.
Buying and selling in stock markets
So if you are wondering how do buying and selling happen automatically in the stock market, let’s break it down.
Let’s assume like this.
You want to buy ABC company stock.
Let’s say current prices of a stock are at $10 and I own 1000 quantity of those shares.
For this example, we can assume that I purchased them at $8.
I would like to book my profit of $2 each share.
You on the other end want to buy 1000 quantity of same shares at $10.
So I place my sell orders for 1000 quantity at $10.
And you place 1000 quantity buy order for same shares.
The moment you place your order and I place my orders, it will automatically match with each other.
So my shares will transfer to you at $10.
Now once the transaction is complete, you will become the owner of these shares.
And we call this auction in the stock market.
The price at which you want to buy is called a bid rate.
Your bid was $10 for each share.
On the other end, I want to sell the same share at $ 10 which we call as ask rate or ask price.
This entire transaction happens within a fraction of seconds.
Millions of market participants like you and me will be present online.
Ask price and bid price will match automatically to complete a transaction.
The next question that could arise in your mind is what will happen if no one is available to match your bid prices.
Orders will not complete till someone fills the opposite order.
And your stock orders will be in pending status.
This asks and bids price variation is the main reason behind price fluctuation.
Index or indices in stock markets
Index of a given stock exchange is a barometer to understand the overall sentiment of the market.
Investors who invest in the global market will look at the best performing index to make an investment decision.
If they feel that a particular countries stock market will do good in the future, they will closely analyze its index.
Value of stock index or indices is measured by the collective average of top companies listed inside them.
If you don’t understand how good a company will be for investment right now, the best thing you could do is buy ETF of a particular index.
You can not invest directly in the index of a market. For this purpose, you have exchange-traded funds(ETF).
By buying or investing in an index ETF, you have indirectly invested in top companies of those markets.
An index value of a particular market increases, if companies listed inside the index perform well and there stock prices increase.
The basic requirement for buying and selling financial instruments in the stock market
These requirements might vary depending on the different stock exchange rules and regulations.
Every country has its own stock exchange.
5 Basic requirements to participate in stock markets is
- You should be 18 years of age
- Should have government verified address proof and Id proof
- You need a bank account
- If you want to trade in derivatives product, you need to provide your bank statement
- Account with a stockbroker or brokerage firm
We won’t go much in detailed requirements for now and lets further learn about brokerage firm or stockbroker.
Who is a stockbroker or brokerage firm ??
To put it simply, stockbroker or brokerage firm is a legal entity who will place orders on behalf of you.
A stock market participant may ask there brokerage firm to transact on behalf of them.
They charge a commission based on transaction value.
Every brokerage firm has different commission structures.
And it’s also called brokerage.
Why you need to open an account with brokerage firm ??
In simple term, you need an account with the brokerage firm to make your buying and selling process easy.
Nowadays all the financial securities which you buy are held in electronic form.
In earlier days shares of a company were issued with physical certificates.
It has completely changed now.
Physical forms of financial assets are dematerialized now into electronic form.
This is why we call the account where your financial securities are held safely as the demat account.
So to open a demat account, the easiest way is a brokerage firm.
Can you trade without stockbroker or brokerage firm ??
Yes, you can trade or invest without stockbroker.
If the listed financial security like stock, is also available for direct purchase from the company, then you can.
Now let’s move further and look how stock markets can be classified.
Classification of stock markets
It is classified based on the type of financial security.
3 Major segments are classified as
- Capital market
- Derivative market
- Debt instruments
These major segments are further classified into subcategories.
Inside the capital market there are subcategories like Equities, Indices, Ipo, Mutual funds, Exchange traded funds(ETF) and bonds.
Few other financial instruments can also be included inside the capital market.
It depends on individual stock exchanges.
Inside derivative markets, you have products like equity derivative, currency derivative, commodity derivative etc.
Price of these derivative products is derived from an underlying asset.
An exchange might derive additional products from an underlying asset like stock and create a derivative product like a stock option or stock future.
These derivatives have an expiry date and can not be traded after expiry.
Debt segments include corporate bonds, debentures or other official papers which promises buyer of assured returns.
The issuer of a debt instrument can be public or private corporations.
The main purpose of these debt instruments is to raise capital by the issuer.
They can use it for there own development.
Benefit for you as a buyer of these debt instruments is no risk and fixed returns.
These assured returns could be a yearly basis or might vary.
Now let’s look at sector wise classification of stock markets.
Sector-wise classification of stock markets
For each of the above-mentioned segments, we can further create sector wise classification.
Let’s look at how we can classify stocks or equities based on sector.
All listed companies which deal with information technology products are classified as IT sector stocks.
Same way you can classify automobile related stocks as the automobile sector.
Below you can see all the major sectors which you can use for classification.
Manufacturing sector etc
The sector classification list goes on.
Now lets further look at how stocks can be further classified based on its market size.
Stock classification based on market capitalization
To keep it simple, capitalization of any company is the multiplication of its outstanding shares and current market price.
Based on capitalization you have 3 categories
Depending on different stock exchanges, these large caps, mid caps, and small caps value could vary.
I hope, now you are aware of how stock markets are classified.
Now let’s learn what is trading and investing in stock market.
Investing in stock markets
Investing in stock markets is similar to any other investments.
For example in real estate, if you buy a property and hold it for some time and then sell it for profits, you make money.
Same way in the stock market if you buy companies stocks and hold it for a long period of time like 1 year-5 year or even more it is called as investing.
Your profits depend on how well the stock prices have increased from the moment you bought it.
For example, if you buy 1000 quantity of ABC company stock at price $100 and sell it for $ 1000 after 5 years, you have grown your wealth by 10 times.
You may also receive dividends or bonus from companies during these 5 years.
What are dividends
Dividends are profits offered to individual shareholder’s when a company makes a profit in their business.
Same way bonus is also sharing of profit but instead of money, you receive additional stocks.
Dividends and bonus could drastically grow your wealth over time.
Trading in stock markets
When we talk about trading, we are talking about speculation in stock markets.
Buying or selling any listed financial security for a short period of time is called trading.
When you buy or sell any listed financial security and exit the position on the same day, its called as day trading.
If you hold any position(buy or sell) for more than 1 day, its called as swing trading. Ideally, we can call holding till one month as swing trading.
If you hold more than one month till 1 year, I classify this as positional trading. Positional trading is a little conservative approach than swing trading and day trading.
Day trading is the riskiest, as you have only limited time to close your positions.
Now let’s learn what are buy orders and sell orders.
Buy and sell orders explanation for stock market beginners
If you want to buy any financial security through your trading platform, you can place a buy order.
In most of the trading terminal, the keyboard shortcut for a buy order is “F1” key.
To place a sell order, you can simply press “F2” key.
Types of orders in a stock market
There are various types of order you are going to deal with. The most basic type of order is a market order.
Market order gets executed immediately. Whatever the current price is, your market order gets filled at that price.
The second type of order is limit order.
In limit order, you can fix the price at which you want to buy or sell. Unlike market order, the limit order will not get executed until your referred price is reached.
Stop loss order
Stop loss order is little similar to a market order, but with a different purpose. Investors and traders use stop-loss orders to limit their losses.
You can create a price band using a stop-loss order to exit your positions.
Stop loss order helps in limiting the risk.
There are many more types of orders depending on the validity of orders like GTD, GTC, IOC etc.
Apart from this, you will also come across orders like bracket order or cover order, bracket order with trailing stop-loss orders etc.
Using bracket/cover order, you can place a buy or sell order with stop loss and target.
This is why its called bracket/cover order.
Now let’s learn a new term-Short selling
In stock markets, you don’t need to own a financial security to sell it. If you think the prices of a given security is going to fall in the coming days, you can sell it and make money.
This is called short selling.
We are not going to discuss the logic behind short selling for now, as this is a stock market guide for beginners.
Derivatives in stock markets
Derivatives are financial products derived from another general product like a company stock.
In professional terms, we call this general product as the underlying asset.
So derivatives are products derived from an underlying asset.
Derivatives are in contract form which has an expiry date. This means, if you buy or sell a derivative product, you have to exit the positions before its expiry date.
Traders speculate with derivatives as it gives them the advantage of leverage. You will read more about leverage later in this post.
Types of derivatives
There are 4 major types of derivatives
Let’s understand futures derivative with an example. Assume that you own a gold shop and you buy physical gold biscuits for production of ornaments.
You feel that gold prices might be high from now in the next two months and current prices are cheap to buy.
So you buy one future contract of gold worth 1 kg at current prices. You don’t have to pay the entire price of physical gold initially when buying a future contract.
During the day of expiry, you need to pay the entire amount of 1 KG physical gold. You only pay the price at which you bought gold future contract.
If current prices of physical gold are increased from the date you bought the futures contract, you make a profit.
You can exit before expiry if you want and book your profits.
When taking physical delivery you will pay less, as the value of physical gold increased from the day you bought a futures contract.
Futures contracts have monthly expiry.
Options contract are similar to the futures contract. Options are more used for speculation and as a tool for protection.
You will be paying a cheaper price to buy an option contract than compared with the futures contract.
The pricing model of an options contract is different from a futures contract.
Options is a large topic to discuss and we will limit its discussion for now.
Unlike a futures contract, an option has daily, weekly and monthly expiry contracts.
Swaps are mainly used by companies to exchange there interest rates for a benefit.
If a company takes a loan from outside for variable interest rates, it can opt to swap their interest rates with other financial institution for a fixed interest rate.
This will help the company from paying higher interest rate if the interest rates increase in the future.
Warrants are directly issued by companies listed in stock exchange. Its mainly used for hedging and arbitrage purpose.
Investors can protect their investments by creating counter positions to there existing positions using warrants.
We have seen basic topics inside stock markets till now.
Stock market for beginners free guide-Advanced topics
Every stock or any financial security has a limit set by exchange or any other regulatory body.
The upper price limit is called as an upper circuit.
Normally circuit price limits are applied to stocks which don’t have a derivative product.
Usually, the circuit price limit is like 10 %,15 % or 20 % within a given period of time.
When a financial security reaches the upper circuit price limit, it gets frozen i.e no trading happens in it.
We call such stocks as circuit breakers.
It depends on the exchange when to reopen the trading sessions for circuit breaker stocks.
Lower circuit is just the opposite of the upper circuit. It is the lower price limit set by exchange or regulatory body.
Once the stock reaches a lower price limit, trading stops in it.
Advance and decline ratio(upgrades and downgrades)
It’s very easy to understand advance and decline ratio.
Any stock is said to be advanced when it’s trading above previous days close price.
Same way declined stocks are the ones which trade below the closing price of the previous day.
Importance of advance and decline
It gives you a clear indication of where the market is heading for the day.
If you see the majority number of stocks as advanced than its an indication of a positive market.
It can change any time.
Any stock which is in the advanced category can drop in price and move to the declined category.
It is been noted that, whenever the advance and decline ratio don’t have much difference, the market tends to behave in a sideways trend.
Trends in the stock market
I used this word “trend” at the end of advance and decline explanation. But what is a trend ??
Trends are the current direction of price.
If any given market or security like a stock is increasing in price, we say its in an uptrend for now.
When a particular stock or any other financial security moves continuously up or prices keep on increasing, it is said to be in an uptrend.
When you see a stock decreasing in prices continuously, you can call it downtrend stock.
Sideways trend or no clear trend
When there is no significant upside movement or downside movement, we call it a sideways trend.
Volatility is the most important term in the stock market. It gives you an idea of what market participants are willing to do with a financial asset.
If a stock has a more increased number of participants at any given time, it will have high volatility.
As it has more traders and investors involved in it, either buying or selling, chances of huge price change are there.
A stock with low volatility will move less in prices as compared with stocks having high volatility.
Every exchange has its own volatility index. It gives a measure of how much can a given market change within a short period of time.
Value of volatility in measured by using various factors like how many buyers and sellers are currently there on a particular security, previous history of price change etc.
You might have heard about hedge funds. All major hedge funds are involved in hedging.
But what is hedging ??
Hedging is a way of protecting your current positions in the market by creating a counter position.
For example, let’s say you have two stock
Let’s assume that both stocks move opposite to each other in prices, but with a variation in price movement.
If ABC stock moves up by 2$, XYZ stock will move down by 1 $.
So assume that you have 1000 quantity of ABC stock bought a $10 each
You feel in upcoming days, the value of ABC stock can come down to $8.
If the price of ABC stock drops to $8 from $10, you will lose $2*1000=$20,000.
So how can u protect your losses ??
This is where hedging comes in.
We assumed that for every $2 movement of ABC stock, you will see an opposite move in XYZ stock by $1.
So if ABC stock is reduced by $2, XYZ stock will increase by $1.
Now to protect your losses, you can simply buy 2000 shares of XYZ stock.
Let XYZ stock be at any price. We are just looking at how much it changes with respect to ABC stock.
This rate of change can also be called the delta value.
You will learn more about delta value in the options module.
So when ABC stock falls by $2 you will make $1 in profit from XYZ stock.
Total loss in ABC stock at $8=$ 2000($2*1000)
Total profit in XYZ stock =$2000($1*2000)
This is how you protect your losses through hedging.
Whenever you make use of a difference in prices of the same product its called arbitrage.
To understand this in simple ways, assume that you bought a product for $1 from a store.
And you saw another store where the same product is sold for $2.
You decide to sell your product bought at $1 in the other store for $2.
So you make $1 in net profit.
When you do this simultaneously, buying for $1 and selling for $2 in another store, its called arbitrage.
Above example was to make you understand in simple terms.
Now let’s look at below example how arbitrage works in the future market.
Arbitrage example in the stock market using stock and stock future contract
Assume an ABC stock has a price of $10.It has 3 different future contracts.
Each contract expires on a different date. On expiry, the price of ABC future contract will become same of ABC stock.
There will be a difference in price of a stock and its future contracts.
If there are 3 different expiry contracts of ABC stock
ABC DEC contract at price $ 11
ABC JAN contract at price $12
And ABC FEB contract at price $13
As ABC stock price is $ 10, at the end of DECEMBER, ABC DEC contract price will change from $11 to $10.
So how can you make money now using this price difference ??
By arbitrage i.e selling ABC DECEMBER contract and buying ABC stock at the same time, with a difference of $1 together.
By doing this you are locking the $1 difference in prices as your profit.
You will not face any major loss by the further price change.
If price increase by $5 at the end of DECEMBER, you ABC stock, and ABC stock future will increase by $ 5.
As you have a selling position in ABC future contract, you will make $5 loss in it.
But you make same $5 profit in ABC stock, as you were in buying position in ABC stock.
So the price of your ABC stock changes to $15 from $10 and ABC DECEMBER future contract also changes from $11 to $16.
On expiry, you will make $1 as net profit.
This is the use of arbitrage.
Financial Institutions-FII’S and DII’S
Major market price change happens because of big financial institutions.
There are two major types of financial institutions.
FII’S stands for Foreign Institutional Investors.
Financial companies which invest globally, in different countries markets.
DII’S stands for Domestic Institutional Investors.
They are big financial institutions inside a country.
The best example is mutual fund companies inside your country.
As a retail trader, you can not compete with them.
But you can surely understand institutional order flows and make a profit by trading in the direction of institutions.
Stock market-Types of analysis
You need to do an analysis before making an investment or trading decision.
There are two major types of analysis in stock markets.
When you analyze a financial asset based on its facts, like for a company stock you look at its facts like annual statements, or quarterly statements, its called fundamental analysis.
Fundamental analysis involves of analyzing companies profit comparisons, reading the balance sheet, looking at dividend yield and many more key ratios like PEG ratio, debt to equity, PE ratio etc.
Best way to make a decision is combining fundamental with technical analysis.
Technical analysis is studying the price of financial security.
Prices are plotted in the form of charts for better understanding.
You can buy and sell purely based on technical analysis and avoid fundamentals if you want.
Types of charts
There are various types of charts in stock markets. We are not going to look into much details of price charts.
3 Major types of charts
As the name suggests, prices are plotted in the form of candlesticks.
Traders use patterns of combined candles to make a buy or sell decision.
To plot candlestick charts, closing price, opening price, high and low in a given time frame is considered.
Take a look at below image for understanding candlestick chart.
Bar charts are vertical line representation of prices. It is similar to candlestick charts.
Representation of bar charts is slightly different from the candlestick charts. Body is not drawn like candlestick charts.
Below image represents bar charts.
A line chart is the most simple. As prices move, a line is drawn up and down in a horizontal way.
To plot line charts, closing price in a given time frame is considered.
See below image for line chart example.
Software which you will use to execute an order in stock markets is called a trading terminal.
My trading terminal looks like this
Indicators in the stock market
When you use an additional study or tool with the price charts, which are built using the change of price, its called an indicator.
Many retail traders use indicators. The best example of an indicator is moving average.
Check below how a moving average looks in price charts.
A simple strategy of moving average is to buy when the candle closes above moving average line and sell when the candle closes below the moving average.
Stock market investment and trading involve high risk. If you don’t manage your risk properly, chances of your capital eroding are more.
Before taking any investment or trading decision, think about risks involved in it.
Best investors and traders are the ones who manage there risk well.
Let whatever the strategy you use, if you are not good at managing risk, chances of losing your money are more.
Diversification and money management
Instead of investing your entire capital in 1 stock, you can invest in a bunch of different stocks.
This will spread the overall risk.
We call this diversification of the portfolio.
A portfolio is a combined list of your investment.
You need to know how to manage your money well in stock markets.
It comes by experience or either learning from experienced traders.
If you are looking to learn more about stock markets than take a look at our stock market training online course.
7 Quick tips for stock market beginners
1.Learn before you invest or trade
2.Invest a small capital which you can afford to lose
3. Start with 1 segment at a time. Like if you start with stocks, don’t jump into the derivative.
4. Follow a 90-day plan
Learn 1 good strategy and follow it for 90 days. This will develop your discipline.
5.Learn risk management
6.Maintain trade logs
You should maintain all your trades in excel sheets.
After 90 days, you will have clear statistics to evaluate your performance.
If you wish you can download our trade log excel sheet for free from below.
7. Avoid day trading and penny stocks
Day trading is the biggest reason why a majority of stock market beginners to lose their capital.
This stock market for beginners free guide is just an overview of different contents of markets.
The stock market in itself is a wide topic to cover.
Use the comment section to write what else you want to learn in stock markets.
Thank you for reading this post.