Stock market basics for beginners

Well done for making it this far!

The goal of Stoxbox is to assemble a wide selection of market-related educational resources. The content will cover fundamental analysis, technical analysis, derivatives, trading strategies, risk management, financial modelling, etc. Each subject area is categorised as a module; think of it as if you were reading a book with multiple chapters inside.

It may be hard to understand how each idea works together. Let me help by asking you a different question – what, in your opinion, is the most important factor for success in the markets? It’s simple – if you consistently make money, you have succeeded, and if not, then you haven’t.

If you were asked to explain the recipe for success in trading, risk management, discipline and market timing are likely to come up as critical components. Whilst their importance cannot be overlooked, the development of one’s own point of view (POV) is even more fundamental.

Having a perspective on a stock or an index is the key to understanding your direction in the market. If you predict that the stock will increase, then your point of view is considered bullish, and you should buy. Conversely, if you expect the stock to go down, then your opinion would be deemed bearish, and you ought to sell. 

Without a point of view, it is hard to know what action to take. Once you build up your opinion, other elements such as risk management, timing, and macro & micro factors can come into play in order to fortify your trade. Having a viewpoint is essential for making any headway in the market; it’s my utmost priority.

Given that, what would be the best way to form an opinion about a stock’s activity? How can you determine whether the stock is going to rise or fall?

One must take a systematic approach to analysing the markets and formulating an opinion. Several methods can be used to determine what to buy or sell, such as: 

1. Fundamental Analysis (FA) 
2. Technical Analysis (TA) 
3. Quantitative Analysis (QA) 
4. Outside views

This is an example of what might be going through a trader’s head while they make decisions on whether to purchase or sell stocks with the aid of a certain method of analysis. In other words, it provides a glimpse into the thinking process.

FA-based POV: 

The quarterly numbers reported by the company are remarkable, with a 25% increase in the top line and 15% growth in the bottom line. The guidance they have provided also looks positive. All fundamental factors point to a bullish outlook for the stock, which makes it an ideal buy.

TA-based POV:  

The MACD indicator and a bullish engulfing candlestick pattern both point to a bullish sentiment; additionally, the stock is currently trading at its support level. Based on these findings, it appears the stock is an attractive buy.

QA-based POV: 

The stock’s recent price-to-earnings (PE) ratio reaching the 3rd standard deviation is rare, with just a 1% chance of occurring. It may be wise to consider selling, given it is likely to revert back to the mean.

Outside view:  

Analysts on TV recommend a buy on the stock, making it a viable choice.

You should always form your point of view based on your own analysis, instead of accepting the opinion of someone else. Taking action based on another person’s thoughts usually doesn’t lead to desirable outcomes.

Once a POV has been established, there are options of what to do next. It may be that the investor wishes to act on their view straight away – though markets can be tricky, and so there is certainly more to consider.

If you are optimistic about the market, you have a few possible courses of action. You can choose either: 

1. Invest in the spot market for stock.
2. Invest in the derivatives markets by purchasing stock.

1. When it comes to derivatives, futures are an option that can be purchased.
2. Opt for trading through the options market.

1. The options market provides traders with two choices, call options and put options.
2. Using both call and put options, you can construct a synthetic bull trade.

When you’ve established a novel point of view, the next step is to find an appropriate tool with which to make trades that will prove profitable. Selecting the right instrument for your perspective is essential.

If I’m strongly optimistic about the stock over the long term, then a delivery trade would be best. But if my outlook is more immediate, say a week or less, I’d opt for a futures instrument instead.

If I’m optimistic considering considerations (such as looking to a positive budget announcement but wanting to play it safe), then an option instrument would be the wiser choice.

The message here is clear: for success in the market, it is essential to have a well-researched point of view and the correct trading tool. Utilizing both together will guarantee market achievement.

In the following modules, we will tackle concepts that can be used to create an opinion based on Technical and Fundamental Analysis.

Once these two modules have been completed, you should have formulated a viewpoint regarding the markets. Subsequent sections will discuss the varying financial instruments which can be selected to add to your insight.