In order to properly answer the question how does the the stock market work, first I have to explain what is the stock market. The stock market is a place where stocks are traded. And as for every market, there must be buyers and sellers. Buyers represent demand and sellers represent supply.
The price of any stock is determined by relationship between supply and demand, by market participants willing to buy or sell at a certain price. If demand exceeds supply, price should rise. If supply exceeds demand, price should fall. This economic principle applies to every market.
From this results that for a deeper understanding of what makes the price of a stock change, it is necessary to know what influences supply and demand. There is a lot of factors that determine price movement and their effect is relative because only buyers and sellers know why they bought or sold any given stock. Between these factors belongs news about company, industry or the whole economy. If good news comes out on a company, the price and demand for the stock mostly go up. When bad news occurs, the price and demand mostly go down. Next factor is information about company's performance like sales growth, earnings, production and so on, next element is the market psychology, what is topic itself, and generally there is countless amount of other factors that influence opinions of market participants.
Nowadays these stock trades are very organized and performed electronically by computers in stock exchanges like New York Stock Exchange (NYSE). Stock trading is very popular and everybody with little capital and phone or computer with internet connection can be part of the stock market.
Example of One from My Last Option Trades - Call Option on ESI
In this post I want to show you example of one from my last actual option trades with call option on stock ITT Educational Services(ESI) with exact option name ESI GP. I don't want go into more depth, but only to show you how can option trade look like. In the picture below you can see chart of ESI(as underlying stock of this option) with enter and exit of the trade and other circumstances.
With use of technical analysis I saw chart pattern on the chart of ESI called channel breakout. Very important factor was also that volume was much higher in comparison with other days. So I decided to buy call option ESI GP with strike price $80, expiring July 19, 2008 for $2.70 per share, what is $270 for 1 option contract. Price went up and after few days it created line of resistance and did not go up so I decided exit from the trade and take my profit. I sold this option for $3.80 what is 40% profit. This is one example how can option trade look like.
With use of technical analysis I saw chart pattern on the chart of ESI called channel breakout. Very important factor was also that volume was much higher in comparison with other days. So I decided to buy call option ESI GP with strike price $80, expiring July 19, 2008 for $2.70 per share, what is $270 for 1 option contract. Price went up and after few days it created line of resistance and did not go up so I decided exit from the trade and take my profit. I sold this option for $3.80 what is 40% profit. This is one example how can option trade look like.
Technical Analysis of Stocks - part 2
Technical analysis is based on principle that history repeats itself. Behind this principle is human psychology. Charts reflect psychology of the market. Chart patterns have been studied and categorized over one hundred years. Some of these patterns have worked well in the past, so it is assumed that they will continue to work well in the future. These are based on study of human psychology, which tends not to change.
Next very important premise of technical analysis is that everything what can influence the price like fundamental, psychological, political, or other factor is actually reflected in the price of that market. And how is the price created? From technical point of view price movements reflect relation between supply and demand. If demand exceeds supply, price should rise. If supply exceeds demand, price should fall. This is basic economic principle. Behind demand are buyers and behind supply are sellers. Behavior of buyers and sellers is what drives the market. These willing buyers and sellers come to an agreement of price but are in disagreement as to value.
From all this results that analyzing price and it's history is indirect analyzing of fundamental and other factors that influence market behavior. Although this argument is quite controversial, most of technicians would agree. The question of this post is - what is all this analyzing for? The purpose of studying price charts and supporting technical indicators is to show trader which way is the market most likely to go. This last sentence is very important and notice that technical analysis is not for predicting future actions as a sure thing. Technical analysis uses term probability. When graphical picture of change of price in chart is in some pattern there is some probability that price will go in certain direction. This claim is based on research and analyzing price movements in the past.
Oftentimes happens that some traders who are new to technical analysis are little disappointed when some of their trades doesn't go well even though according to the chart analysis it should. Well, it's not magic. And it doesn't have to be. Technical analysis helps many traders and institutional investors to make very profitable trades, so it doesn't have to prove it's value.
One of the main objectives of chart analysis is to determine the trend of prices. The key concept and discovery in technical analysis is that prices move in trends. A trend represents a consistent change in prices in some direction. The most of trading techniques are based on determining trends and trading in the direction of those trends.
One of the most interesting facts about technical analysis is it's adaptability. First is the adaptability to different time dimensions. Chart analysis is used in day trading and also in longer term investing. Next is the adaptability to various trading mediums. Charts are analyzed in trading with stocks, commodities, foreign currencies, and so on. This is because the same principles are so widely applicable. This is a big advantage against fundamental analysis where traders are more specialized.
The bottom line is that the same data like open, high, low, and closing price are available to all traders, but how they analyze, interpret, and act on the information available is one from factors that differentiate one trader from others.
Next very important premise of technical analysis is that everything what can influence the price like fundamental, psychological, political, or other factor is actually reflected in the price of that market. And how is the price created? From technical point of view price movements reflect relation between supply and demand. If demand exceeds supply, price should rise. If supply exceeds demand, price should fall. This is basic economic principle. Behind demand are buyers and behind supply are sellers. Behavior of buyers and sellers is what drives the market. These willing buyers and sellers come to an agreement of price but are in disagreement as to value.
From all this results that analyzing price and it's history is indirect analyzing of fundamental and other factors that influence market behavior. Although this argument is quite controversial, most of technicians would agree. The question of this post is - what is all this analyzing for? The purpose of studying price charts and supporting technical indicators is to show trader which way is the market most likely to go. This last sentence is very important and notice that technical analysis is not for predicting future actions as a sure thing. Technical analysis uses term probability. When graphical picture of change of price in chart is in some pattern there is some probability that price will go in certain direction. This claim is based on research and analyzing price movements in the past.
Oftentimes happens that some traders who are new to technical analysis are little disappointed when some of their trades doesn't go well even though according to the chart analysis it should. Well, it's not magic. And it doesn't have to be. Technical analysis helps many traders and institutional investors to make very profitable trades, so it doesn't have to prove it's value.
One of the main objectives of chart analysis is to determine the trend of prices. The key concept and discovery in technical analysis is that prices move in trends. A trend represents a consistent change in prices in some direction. The most of trading techniques are based on determining trends and trading in the direction of those trends.
One of the most interesting facts about technical analysis is it's adaptability. First is the adaptability to different time dimensions. Chart analysis is used in day trading and also in longer term investing. Next is the adaptability to various trading mediums. Charts are analyzed in trading with stocks, commodities, foreign currencies, and so on. This is because the same principles are so widely applicable. This is a big advantage against fundamental analysis where traders are more specialized.
The bottom line is that the same data like open, high, low, and closing price are available to all traders, but how they analyze, interpret, and act on the information available is one from factors that differentiate one trader from others.
Technical Analysis of Stocks
For some of you who don't know what is technical analysis and how it works, I will try to explain it to you what it is about. Technical analysis is trading and investing tool that involves the study of past share prices or indices and is helpful in showing you when to enter and exit the trade. For technical analysis are needed charts. One example of chart you can see in the picture below. It's chart of Apple.
The dedicated technician analyses the charts and indicators to forecast future share price and index movements. There are traders whose trade decisions are based strictly on price and volume movement and there are traders who also use other tools like fundamental analysis to support their decisions and I belong to this second group. But technical analysis is essential for my trading.
In future posts I will go into more depth and I will write about charts, indicators, chart patterns, etc.
The dedicated technician analyses the charts and indicators to forecast future share price and index movements. There are traders whose trade decisions are based strictly on price and volume movement and there are traders who also use other tools like fundamental analysis to support their decisions and I belong to this second group. But technical analysis is essential for my trading.
In future posts I will go into more depth and I will write about charts, indicators, chart patterns, etc.
Paper trading - ground school for traders
What is paper trading? It's trading without real money - trading only on the paper. And without money means without real risk of losing real money. As pilots are learning to fly first on the simulator so should do traders (to simulate trade). On simulators pilots don't risk loss of their life or destroying plane (and traders losing money). But they are improving their skills. I hope that this analogy can help you better understand reasons and benefits of paper trading.
I think and recommend that before putting real money into real trades beginners should first test their skills on the paper. With paper trading you can test your strategy without risking losing money. The factor that you are not using real money can have big impact on trading psychology - you are not under preasure of losing money and you can make more rational decisions without being influenced by emotions. By the time your trading skills are getting better and you gain confidence in your trading actions. When your skills will be on desired level you can then start real trading with real money.
As a good example of trading or investing simulator in my opinion I would like to recommend Investopedia Simulator that I personally use. It offers a lot of features, real data and a lot of informations mainly about stocks.
As I said before with paper trading you can trade without risk of losing money and still you can gain skills and experience. That's the main point of paper trading as I see it.
I think and recommend that before putting real money into real trades beginners should first test their skills on the paper. With paper trading you can test your strategy without risking losing money. The factor that you are not using real money can have big impact on trading psychology - you are not under preasure of losing money and you can make more rational decisions without being influenced by emotions. By the time your trading skills are getting better and you gain confidence in your trading actions. When your skills will be on desired level you can then start real trading with real money.
As a good example of trading or investing simulator in my opinion I would like to recommend Investopedia Simulator that I personally use. It offers a lot of features, real data and a lot of informations mainly about stocks.
As I said before with paper trading you can trade without risk of losing money and still you can gain skills and experience. That's the main point of paper trading as I see it.
Benefits of Stock Options
Stock options are wonderful financial instrument and tool. Maybe you heard famous saying that options are risky. Sure it's true when you know nothing about them. I think that not enough knowledge is the only serious reason why not to trade options, because benefits of options trading can easily outweight any obstacles. This is list of some benefits.
- Leverage. One from the most important words in wealth creation. The basic definition of leverage is the ability to do more with less effort. How this applies to stock options? We can control more assets with less money. One option contract controls 100 shares. With fraction of cost we would pay for equivalent number of shares, we control and profit from change of price of all underlying shares.
- Big profits even in short time. Because options are very sensitive to the underlying stock's price movements and costs for buying options is low in comparison with shares, percentage returns can be very big.
- Profit even from declining stocks. Based on what strategy we will use we can profit in every situation. We can use puts when stock goes down or calls when stock goes up. We can even profit when stock goes sideways.
- Reducing or eliminating risk. Options can protect us from some unwanted scenarios when for example price movement of stock doesn't go in direction we would want. Also risk from point of amount of money we put to options trade is much less then with comparison with shares.
A word about risk
Trading and investing and no matter in what - be it stocks, real estate, oil or stock options has associated risk. In every aspect of life there is a risk. When you go to shop you have some probability that you will have a car accident. When you approach someone you don't know you risk that you can be rejected. Risk is part of life. We must face it. Life does not offer a money-back guarantee - and stocks or options are no different.
What we can do about risk is that we can lower it by gaining knowledge, experiences and researching and analysing what we put money in. But there still will be some risk. It's not possible to be always right. Trading is not about being 100% right. It's about being profitable in the long run. Losing is part of winning. The point is that profits from winning trades should outweight loses from losing trades.
What we can do about risk is that we can lower it by gaining knowledge, experiences and researching and analysing what we put money in. But there still will be some risk. It's not possible to be always right. Trading is not about being 100% right. It's about being profitable in the long run. Losing is part of winning. The point is that profits from winning trades should outweight loses from losing trades.
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