While investing in the stock market you have to decide what is your target or goal, which type of or how much returns you expect from the stock market. If you want small and regular income then you can follow the trading route and if you expect massive multibagger returns then you should focus on long term investing. Here we will discuss different types of trading methods generally used in the stock market.
5 types of trading in stock market
Generally we know about 5 types of trading in stock market and most of the traders use these trading techniques. In this chapter we will discuss about the basic concept of these trading types used in our stock market.
- Intraday Trading
- Futures & Options Trading
- Swing Trading
- Momentum Trading
- Positional Trading
Table of Contents
- 5 types of trading in stock market
- What is Intraday trading
- What is Futures and Options trading
- What is Swing trading
- What is Momentum trading
- What is Positional trading
What is Intraday trading
If we take any trade and exit it or close it on the same day before market closes then that trade is called intraday trade. For example we buy any stock today and sell it after one hour or during this day before market close, that is before 3.15 pm (this is intraday position closing time, 15 min before the market closing time that is 3.30 pm) then it is an intraday trade.
In intraday trade we can also first sell shares without having those shares in our holdings and then buy it on the same day to close our position. This is known as short selling. Other methods of short selling on a positional basis are made on Futures & Options trading.
In intraday trades traders book profits the same day, hence it is considered as a regular income way from stock markets and attract most of the beginners. But it is not so easy, in the short run many factors affect the price movement of any stock like any news or events related to the stock or sector, positions of big players in it, broader market sentiments, international market sentiments etc. you have to track a lot of things.
You can take trade on the basis of technical analysis, traders believe that charts tell everything because market factors in everything in the price and if you can read the price chart properly then you can guess its future movements. So to be successful in intraday trades you require good technical analysis skills and good experience, hence beginners should avoid it or can take small trades for learning and practice.
Generally traders use Candlestick charts for intraday trading because it gives a more clear picture of price movements. A 5 minutes or 15 minutes candle time frame is best for intraday. You can also use 1 hour and 1 day time frame while analyzing to select stocks for intraday and to analyze their long term trend.
There are various technical indicators and tools that traders use for intraday trading. Different traders have different trading psychology and techniques, so their tools are also different. Generally VWAP, MACD, ADX etc are used for intraday.
You have to first analyze the price action of the stock before selecting it to trade. You have to set the entry level, target price and stop loss that is the exit price if the trade went against your expectations.
Generally traders choose high beta stocks for intraday, because high beta stocks show higher fluctuations, which is preferred for intraday trades. Low beta or consolidating stocks would not give much more moves and you may not achieve your target profit. Generally 1% to 2% profit is enough for intraday.
Few months ago brokers were providing some leverage to intraday traders by which you can trade 5 to 10 times more than the amount you have in your account, for example if you have 1000 in your account then you can buy or sell 5000 to 10000 amount of stock in intraday, but due to SEBI’s new guidelines, now most of the brokers are not providing any leverage in intraday. So now most of the intraday traders are focusing on swing trading and many of them are shifted to the FnO (Futures and Options) market.
What is Futures and Options trading
Futures and Options are derivative contracts. Here buyers & sellers make contracts of buying for which buyer pays some premium money and sellers have to deposit margin money. In futures, both the buyer & seller have to deposit margin money.
The duration of the contract is from one week (weekly contracts) to a maximum of three months (monthly contracts). Weekly contracts expire on every Thursday and monthly contracts expire on the last Thursday of every month. You can also exit the contract at any time before expiry, you can also trade intraday in futures & options.
You can trade in both Index (like Nifty 50 or Banknifty) or stock options and futures (those are available in the derivative segment, there are nearly 150 stocks in the derivative segment).
There are two types of options, Call options (CE) and Put options (PE).
If you think the price of a stock or index will go upward in the next week or month then you can buy the Call (CE) of the stock or you can sell the Put (PE) of the stock.
You have to buy or sell in lots and could not buy or sell in small amounts. The lot size is decided by the exchanges.
If you buy an option of any stock or index then you have to pay the premium multiplied by the lot size of that stock or index and if you sell the option then you have to deposit the margin money.
Before buying or selling an option you have to choose the strike price.
For example – Suppose currently Nifty 50 is at 17100 level and if you think it will go above 17200 within the next week (within next weekly expiry that is thursday) then you can buy the CE that is
Nifty 3rd Feb 17200 CE
Here Nifty 50 is the underlying asset.
3rd February is the date of expiry (weekly contract).
17200 is the strike price.
CE stands for Call option.
You have to pay the premium of Rs.199 multiplied by the lot size here is 50.
= 199 X 50 = 9950 (as shown in the picture)
If you think Nifty 50 will not go above the 17200 range then you can sell the 17200CE.
Here for selling you have to pay a margin of Rs.98,450 (as shown in the picture)
[All the charts and screenshots we have used here are on Zerodha web platform]
Here you can notice the margin required for selling is much higher than buying. This is because the risk involved in option selling is much higher than option buying. Let’s understand.
In this case if Nifty 50 goes above 17200 then the option buyer will get profit. For example if it go to the level of 17300 then the buyer will get a profit of Rs.100 (17300-17200) multiplied by lot size (50) that is
= 100 X 50 = 5000
And the seller has to bear the same amount of loss of Rs.5000.
If Nifty 50 did not go above 17200 and remain below or equal to 17200 then the buyer will lose the total premium amount paid (that is Rs.9950.) because till the expiry the premium amount will become Zero (0) if the price of Nifty 50 did not go above the strike price due to the time decay. And this premium amount will be the profit for the option seller.
If Nifty 50 go down then the buyer has not to pay any additional amount, the premium paid is the maximum liability for the buyer but if Nifty 50 go 500 points higher then the seller has to pay
500 X 50 = 25000
to the buyer. Hence the risk involved for the seller is much higher than the buyer, because you can not set a definite range on how much higher Nifty 50 can go. Therefore the seller has to pay more margins.
So for option buyer, liability is limited and profit is unlimited and for seller profit is limited and liability is unlimited. But in reality most of the time the option buyer makes losses because of the decrease of premium price due to time decay and the seller makes profit because he decides the strike price after proper analysis.
But for futures both the buyer and seller have to deposit margin money because here the risk factor is almost equal for both of them.
For example if you buy Nifty Feb Fut (monthly contract) then you have to deposit a margin of Rs.1,01,620. and if you sell Nifty Feb Fut (monthly contract) then you have to deposit a margin of Rs.1,01,222.
Traders select high beta or highly volatile and momentum stocks or index for option buying because if price will not move with higher momentum then the premium will decay rapidly and become zero till the expiry and for option selling the case is directly opposite.
Big investors use these futures & options contracts for hedging purposes, in order to protect their portfolio they use it as insurance, but due to high volatility and higher price fluctuations it became attractive for traders to make money in a short period.
But Futures and Options trading require more expertise and analysis skills and the risk and reward ratio is also very high. You can earn a multifold return or you may lose all of your capital in a short time in Futures and Options trading.
You have to learn about the F&O Greeks like
- Theta (rate of change of premium price due to time decay),
- Delta (rate of change of premium price compared to the price change of the underlying asset),
- Vega (change of price due to implied volatility),
- Gamma (change of delta compared to the price change of underlying asset)
etc. to know the basics of Futures and Options trading, we will discuss about options greeks in a separate article.
Most of the beginners trade in F&O without knowing the basics and the risks involved in it, and sometimes may earn good profits but maximum time makes huge losses. Trading without knowledge is more like a gambling, not a trading, hence if you want to trade in F&O then first learn the basics otherwise beginners should avoid F&O.
What is Swing trading
If you look at the chart of any stock, none of them moves in a straight line. Always stocks move in an up and down manner, whether it is in uptrend or in a down trend. So charts look like waves. These waves are called swings.
Swing trading is the technique to buy the stock in the lower part of its chart swing and sell it to book profit when it touches the upper part of the swing. This is simply the buy low and sell high technique.
In swing trading you book profits within a few days or may be in a week or a month. Hence it is also a regular income strategy. Generally 5% to 10% profit target is preferable for swing trading.
You don’t require deep technical analysis skills for swing trading. To select stocks for swing trading you must know the basics of support and resistance.
[All the charts and screenshots we have used here are on Zerodha web platform]
In technical analysis support is that point at which the stock price takes a pause, might not come below it and may consolidate for some time or may bounce back in upward direction and Resistance is that point reached at which the stock price may retrace and may not go upward or may come down.
So traders buy the stock when it touches it’s support levels or some traders make a position when the stock starts moving upward from its support levels, then hold it for some days and book profits when the stock reaches its resistance levels or you may book profit if you have achieved your expected target price.
There are various technical indicators to determine the support and resistance, like moving averages, pivot points etc. You can also draw trend lines or channels to find the support and resistance.
Moving averages are the best tool for swing trading. If you see, many stocks move on the support of their 20 Day EMA (Exponential Moving Average) and many stocks take support on their 50 Day EMA. Stocks running below their 50 DEMA are considered as short term bearish hence don’t be considered for swing trading. There are various chart indicators you can use to analyze stocks for swing trading like RSI, MACD, Bolinger band etc.
What is Momentum trading
Momentum trading is buying or taking a position in the stock which is in a strong momentum and exiting it when the momentum fizzles out or the stock reaches its peak. For example when the price of a stock is rising rapidly with heavy volumes then traders buy it and when it’s price peaks out then sell it to book profit. It is similar to swing trading but the difference is here you select those stocks who are in momentum and take position mostly when they break their resistance level with good volumes and momentum. This is a buy high and sell higher strategy. The same chart indicators are used that are used in swing trading stock analysis. Trading Volume plays an important role in momentum trading. Also you can use Bollinger bands to find out breakout in stocks and RSI to find out the strength of it.
What is Positional trading
Positional trading is buying a stock or taking a position in it for a certain period and selling it after the targets are achieved.
For example, if you find a stock is available at a good price and it’s price is going to rise in the near future due to any good news or events related to the stock, then you buy it and hold for some days or weeks or maybe for some months until it fulfills your target and then exit it to book profits. This is called positional trading.
Generally traders take positions in those stocks in which there may be any corporate action going to happen like bonus, split, buyback or the stock may give a good amount of dividend etc.
Sometimes traders expect there might be some good news for any stock like it may post good results or govt may give any incentives or tax reduction for the sector, hence they buy it for a certain period and sell it when they achieve their target.
The major risk in positional trading is if the event will not happen in the way you have expected then the stock may show a huge fall. So it is good to select fundamentally strong stocks for positional trading, because in case your expectations go wrong then it will not fall so rapidly and although if it falls then also you can hold it for long term and could get a good amount of return.
To know more about long term investing and various types of investing strategies you can check this article.
Disclaimer – Investing and trading in stock market is subject to market risk. We have to learn all the risk factors before making investment decisions. This article is only for basic knowledge about stock market investing for educational purposes only and not any type of recommendation. In case you need any professional advice please consult your financial advisor.
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