Trading: Definition, Working, Types and Advantages

Basics about trading – how it works, its advantages, types and their comparison.
Trading: Definition, Working, Types and Advantages
3 mins
13 july 2023

What is trading?

Trading is the buying and selling of securities, such as stocks, bonds, currencies, commodities, and derivatives, with the goal of making a profit. Traders can include individuals, institutional investors, and financial institutions.

Trading differs from traditional investing mainly in its short-term focus, contrasting with the long-term perspective of traditional investing.

In the stock market, trading is common as people buy and sell shares of listed companies. Share prices fluctuate constantly, giving traders the opportunity to choose the right moment to make a profit.

What is the meaning of trading?

In simple terms, trading refers to the buying and selling of stocks, bonds, commodities, currencies, or other financial securities for a short period to earn profits. The main difference between trading and traditional investing is the former’s short-term approach compared to the long-term horizon of the latter.

Trading is mostly prevalent in the stock market as numerous people buy and sell shares of listed entities. The price of these shares changes every second and a trader can pick a favourable direction to make a gain.

What assets and markets can you trade?

You can trade a wide variety of financial assets and markets which include:

  1. Shares: Trading in individual company stocks, allowing you to buy and sell ownership stakes in specific businesses.
  2. Indices: These are indicators that represent a basket of stocks or assets, allowing you to predict the overall performance of a group of companies or markets.
  3. Forex: The foreign exchange market, where you can trade currency pairs, taking a chance on the relative strength or weakness of one currency against another.
  4. ETFs (Exchange-traded funds): These are investment funds that hold a collection of assets like stocks, bonds, or commodities. Trading ETFs allows you to gain exposure to a diversified portfolio.
  5. Bonds: You can trade bonds, which are debt securities issued by governments, municipalities, or corporations, providing fixed income in the form of periodic interest payments.
  6. Commodities: Trading in raw materials and primary agricultural products, including precious metals, energy resources, and agricultural goods.
  7. IPOs (Initial public offerings): Participating in the initial issuance of shares by a company when it goes public, potentially gaining from the stock's early price movements.

While there are various instruments to trade, it's essential to recognise that trading carries inherent risks. The primary goal is to make a profit on the basis of market's movements. However, it's crucial to exercise risk management to avoid unexpected losses, as trading can be volatile and unpredictable.

Types of trading

Listed below are the major types of trading strategies prevalent in the market.

  1. Day trading
    It is a type of trading where traders buy & sell stocks within a single day, from 9:15 am to 3:30 pm. In day trading, the trader purchases the stock, holds it for a few minutes or hours and concludes the transaction before the market closes.
  2. Swing trading
    In swing trading, a trader usually purchases a stock and holds it for several days or a week to capitalise on the short-term stock patterns & trends. These traders must have adequate knowledge of stock trends and patterns to execute their trades successfully.
  3. Scalping or micro trading
    Scalp trading is a type of trading in which traders buy and sell stocks in large quantities repeatedly several times within a day. This may result in profits even with minute changes in the stock price. However, there is also a high probability of losses.
  4. Momentum trading
    Momentum trading is a strategy where a certain stock price moves either upwards and downwards for a certain period, i.e., it gains momentum. When the peak is reached, a downtrend follows; therefore, traders take a selling position at the peak of a stock’s momentum.

How does trading work?

Stock trading in India is the buying and selling of shares of a listed entity in one of the leading stock exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE).

The capital market in India consists of two major segments: primary market and secondary market. On the primary market, private companies (who became public )can issue securities directly to the public to raise funds through a public offering. These are of two types: Initial Public Offering (IPO) and Follow-on Public Offering (FPO).

Once the IPO is completed, all shares of a company are listed in the secondary market, where investors can freely buy and sell stocks and other securities. In India, people are required to open a Demat and trading account with a stockbroker to hold and trade shares.

Whenever there is a purchase request with the broker, it gets passed on to the respective stock exchange. Here, the exchange matches a buy order with an equivalent quantity of a sell order of the same stock. Following this, a transaction takes place where cash and securities are exchanged.

What is online trading in India?

Online trading is the process where people can buy and sell shares electronically. To do this, one must have a Demat account to hold stocks and other securities in the digital format and a trading account with a SEBI-registered broker to place buy and sell orders.

Furthermore, one must link his/ her bank account to receive and send amount for purchasing/ selling securities.

What are the advantages of trading?

Trading stocks and other securities offer several benefits that make it an attractive option for investors:

  1. Profit potential: Trading provides the opportunity to achieve significant profits within a relatively short time frame. When executed with the right strategy at the right time, traders can capitalise on market movements to generate substantial returns on their investments.
  2. Flexibility: Trading is inherently flexible. Traders have the freedom to buy and sell securities as and when it seems appropriate. This flexibility allows investors to adapt to changing market conditions and capitalise on opportunities.
  3. Access to a growing economy: Active participation in trading, especially in sizeable trades, provides traders with direct exposure to the economic growth of the country. When a market index increases in value, it signifies the economic expansion of the nation. Therefore, professional traders can benefit from the growing economy by strategically investing in assets influenced by this growth.
  4. Take advantage of economic growth: Trading allows investors to leverage economic growth. A growing economy often translates to increased corporate earnings due to job creation, higher income levels, and increased consumer spending. Investors can capitalise on this by investing in businesses poised for growth in response to economic expansion.
  5. Easy buying and selling: The process of buying and selling shares in the stock market is straightforward and accessible to all investors. It begins with opening a Demat account, which can be done through a broker, financial planner, or online mode. Setting up an account is a quick process, taking about 15 minutes, and allows investors to initiate their investment journey. Once the account is established, investors can conveniently place buy and sell orders to engage in trading activities.
  6. Flexibility for small investments: Even new investors can start with a relatively small amount by purchasing stocks of small-cap or mid-cap companies in smaller units. This accessibility is ideal for those who want to test the waters of trading with limited capital.
  7. Liquidity: Stocks are considered highly liquid assets. They can be readily converted into cash at any time, offering a level of liquidity that is often superior to other financial assets. Investors can easily sell their stocks when needed, making it a convenient choice for those who require quick access to their investment funds.

Online trading vs. Offline trading

Here is a comparison between online trading and offline trading in India:

  • Convenience: In the online mode, one can trade from almost every part of the world. While in an offline mode, a trader will have to visit a broker's office in person or call your broker for trading.
  • Ease of trading: In online trading, one can make decisions freely without any intervention from any external source. However, with offline trading, all transactional activities are carried out by the broker.
  • Quality advice: Online trading provides access to detailed reports with charts, patterns and trend recommendations.

Conclusion

The practice of trading in India is growing at an exponential pace as evidenced by the growth of Demat and trading accounts with various stockbrokers. Hopefully, this article has served the purpose well for those who are looking forward to starting trading on the stock market.

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Frequently asked questions

What is trading and how does it work?

Trading refers to the buying and selling of financial assets in markets with the aim of making a profit. It involves analysing market trends and identifying opportunities to enter the market, thereby making a profit.

What is the concept of trading?

The concept of trading is to capitalise on the differences in prices of financial assets in the market. Traders use various strategies to identify these price differences and make a profit by buying/ selling assets. Trading can be done in various markets and involves a range of financial assets such as stocks, bonds, currencies, and commodities.

Which trade is profitable?

There is no definitive answer to the question of which trade is the most profitable, as this can vary depending on a range of factors including market conditions, the investor's investment style, and their risk tolerance. As a general rule, assets that are more volatile tend to offer greater profit potential, but also come with higher risks.