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Equity trading refers to the buying and selling of company shares on the stock market, often referred to as equities or stocks. Stocks can be publicly or privately traded, issued by companies to raise money to fund operations. Publicly traded stocks are bought and sold on a stock exchange. When an individual or a larger fund purchases these shares, the buyer holds part ownership in a company: they have equity in that said company. As a company grows, the value of the shares increases alongside this growth.
If an investor has total faith in the vision of a company and those tasked with carrying out that vision, they tend to invest in the company long-term; they believe that over time the value of their investment will increase. Individuals can hold equity in a company for as long as they wish. Long-term investors tend to overlook short-term market price fluctuations (the value of the stock rising and falling throughout a business day). This price movement will generally not dissuade their long-term bias. Nevertheless, it is these short-term price fluctuations that allow short-term investors to trade: scalpers and day traders.
The stock markets draw a lot of short-term interest from investors. Short-term investors attempt to profit by buying and selling stocks throughout the trading day, often employing technical analysis tools (fundamental analysis tends to be used for a longer-term assessment). It is important to acknowledge that this constant trading of stocks increases liquidity (willing buyers/sellers) in the stock market.
An equity market, or a stock market, represents a domain that’s designed for the issuance (and investment) of shares of companies. Well-known equity markets are the New York Stock Exchange (NYSE) and the UK’s Financial Times Stock Exchange 100 Index (FTSE 100).
When investing in a company, there are two popular options of investment: bonds and shares. Equity makes up the shares category of the company and bonds represent fixed-income obligations. With equities, there is no obligation from the company, while with bonds the investor is a creditor and in return receives interest on the principal loaned to the company over a specific time period (the principal is typically returned after the bond matures). It is common to see fixed interest rates when bonds are bought, and whatever the company owns and creates serves as collateral. The holders of the bonds are usually banks, who loan sizable amounts to companies over a long-term deal, though individual investors also participate heavily.
Equity of a company can be bought and sold through the stock market; the perceptive profitability of the company sways the price of the stock. A purchase of a bond means you are loaning money to a company for regular interest payments, whereas a stock purchase is buying part ownership in a company. Bonds are separated into secured and unsecured bonds. The simple difference between them is that secured bonds have an asset as collateral, while unsecured bonds do not have that option. As they are a riskier option for the investor, a higher interest rate is usually placed on unsecured bonds.
Stocks, on the other hand, are simpler. They represent a share of the company, a percentage that has a certain value given the overall net worth of the company. Purchasing stock means you now own that percentage of the company. While the value of a stock will fluctuate, the stock itself remains the same percentage. Given the high-risk nature of stocks, with the possibility of a collapse in terms of values, traders may seek a safer form of investment: bonds. If the company doesn’t go bankrupt, bond payments are likely to continue. This strategy is used by those who try to manage the risk involved with their portfolios. If the company is declared insolvent and the assets are sold off, the debt holders are paid first, and the common stockholders tend to take the biggest share of the loss.
A form of short-term equity trading is known as day trading (a short-term trading style), which involves buying and selling stocks and shares in an attempt to profit from small price changes. This investment strategy is used throughout the financial markets: commodities, FX trading and equities, for example. This strategy can be effective when the market is volatile, as intraday price changes signify an opportunity for a day trader. Though do bear in mind that volatility is a proxy for risk; therefore, risk management is recommended.
Within a single day, the share price of a specific stock may fluctuate significantly. Hence, a day trader’s objective is to largely spot these fluctuations and attempt to profit. Day traders can profit from both long (buying) and from a stock losing value over a day (through shorting). The equity market is a good home for this form of trading as there are constant price fluctuations of stocks and shares in a liquid trading environment.
There are various strategies employed by day traders, which have become an accessible position for many; the digitisation of the stock market has allowed what was once a closed-off circuit for a select few to be available to the masses. While this is a big part of the activity on the stock market, it remains a risky proposition for many. Those without proper knowledge can find themselves out of their depth, potentially leading to a total loss of investment (account ruin).
Options Trading (Derivatives)
Options trading represents a contract between two parties, in which the contract holder has the right but not the obligation to buy or sell the underlying asset at a specified price and date in the future.
Call options give the holder the right (but not the obligation) to buy shares at the strike price (the set price in the contract) until the contract expires. For this, the call holder must pay a premium to the writer (the seller).
A put option is the mirror opposite of a call option. A put provides the right (but not the obligation) to sell the underlying stock at a set price in the future up until the contract expires.
If an investor purchases a 30-day call option (and thus pays a premium to a writer) for 100 shares of a stock at $100 and at expiration, the stock sits at $120, the investor has profited from this price rise. That investor now owns 100 shares at $120, bought for $100. However, cutting into profits is the option bought on the stock – the premium paid. Whereas the investor would have made a profit of $2000 from the trade if purchased directly, the premium brings it down to $1500, assuming the premium paid was 500 USD. However, if the same stock purchased at $100 finished at $80 after 30 days, the investor can opt out of the contract (the right but not the obligation) and only lose the premium paid rather than a $2000 loss.
Contract for Differences (CFDs)
A Contract for Difference (CFD) is a financial contract that pays the difference between the opening and closing price of a position. Essentially, this contract allows the investor to trade on varied financial markets without owning the underlying assets.
If you think a stock will gain in value, you can buy a CFD of that stock (going long) whereas if you think it will go down, you can sell a CFD (going short). If the investor is correct in their prediction when they close the trade, they make a profit. However, if the stock acts against their prediction, they lose their investment allocated to that specific trade (usually contained through a protective stop-loss order).
These contracts are traded on margin. Therefore, the initial investment is lower than the full stock price: initial margin. This allows for higher leverage. While potential profit is high when using leverage, the risk of loss is equally magnified.
Social trading allows synchronisation between trades, meaning the ability to replicate a certain trade or behaviours of a trader. This form of equity trading simplifies a highly complicated market for beginners and provides them access to professional trading behaviours (and potential returns). The investor can follow (mirror) these trades, investing as the more senior trader has done, or can analyse the behaviour over time of professional traders.
Social trading facilities can be found through FP Markets. It is easy to set up an account which provides the customer with MetaTrader 4 (MT4) and MetaTrader 5 (MT5) trading platforms, both of which offer user-friendly interfaces on a VPS with low latency. Within the social trading portal, there is a detailed rating page, where the most successful traders are presented, including their full trading history. If the desire is to replicate that person’s trading behaviour, the user can simply click follow (though the subscriber is free to alter risk metrics to suit their personal preferences).
Exchange Traded Funds (ETFs)
ETFs can be active or passive investment funds that trade on the global market like a stock. There are various ETFs available. They can be structured to follow larger funds such as the S&P 500, or single commodities, bonds, and currency.
ETFs allow for diversification as a single ETF can hold multiple underlying assets. These can be isolated to one sector or a mixture as well as based on a single index, as noted above.
More information on ETFs can be found here.
The equity market allows a trader to build their savings through time, help protect their money from inflation and maximise income. Due to inflation, people cannot sit on their earnings - as over time they will diminish - therefore, investment is often necessary. The equity market is one of the oldest and most popular forms of investment for various reasons.
The capacity of the market to generate gains for investors is the most attractive element. The liquidity of the market is another selling point as the daily trade volume is high - therefore, investors can buy and sell with relative ease.
Dividends are another source of income for a long-term investor. This payment comes alongside a voting share in the company - the right to vote and offer input on how the company should be run. Finally, the transparency of the regulated market offers protection for investors as all public information related to stocks is available.
From the standpoint of a company, the equity market is a place to generate funds for company growth. When the company is at a stable point of production it can list itself on the exchange as an IPO - this is an initial public offering. This entails selling a portion of the company to raise capital. The shares for that company have a starting price - if demand is high, the price of the share goes up and so does the value of the company. However, if demand for that stock is low on release, the price of the share may drop, and the company will lose value. A successful company can issue more shares to be put into the market while giving out dividends of the profits to shareholders - though they do not need to.
As with all forms of investment, there are risks involved for equity traders. The main risk is the loss of part or all the capital invested in selected shares. The cause of these losses can be varied.
Larger geo-economic problems can affect stock prices negatively. These can be the rise of commodity prices, currency inflation, negative media headlines and new legislation. Liquidity issues could see certain stocks becoming difficult to sell due to low demand. Mismanagement of a company by employees and investors can cause businesses to suffer and even collapse. Unfortunately, there are no risk-free stocks or businesses. However, there are certain forms of risk management to help mitigate these risks.
One particular risk-management technique is setting a protective stop-loss order, a price which, if reached, will automatically see the position in that stock liquidated (closed), limiting your loss. Risk can also be mitigated through hedging - for example, holding options instead of only shares. Another form of softening your risk as an investor is diversification (unsystematic risk is diversifiable): widening your investments into various companies, sectors and geographic locations. This means that if a specific investment incurs a loss, it should not affect most of your portfolio. Larger equity funds and ETFs can be useful for this form of investment. While it is still possible for you to have losses, spreading your wealth lowers that chance.
Through the FP Markets portal, you can begin your equity trading journey. Setting up an account is straightforward, simply fill in your details here. You can then trade stock and share CFDs on two powerful platforms from the same trading account (Iress and MetaTrader 5) using your desktop or mobile. The stocks available come from a range of worldwide markets including London, Hong Kong, Amsterdam and New York (NYSE & Nasdaq).
Through the FP Markets website, trading course videos, webinars and podcasts surrounding the equity market are provided alongside a wealth of market information. We pride ourselves on giving our clients the best possible resources to make astute investment decisions. Therefore, we attempt to provide the most up-to-date and in-depth technical and fundamental analysis of the current state of the financial markets. We also equip you with the knowledge you need to be successful through our trading guides, where you can learn about various financial markets and investment techniques.
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