Before getting into buying/selling stock, lets answer very basic question - what a stock or share really means?
Let’s consider you started a retail store with an area of around 1000sqft and it is doing well for 6 months. By seeing an opportunity and potential of the business, you decided to expand the store by increasing area and the product range. Since you have already invested all your money and business has not generated enough cash to fund the whole expansion at this early stage, you will have to seek fund from external source. Options available are 1) Debt or Loan 2) Partnership, for whatever reason if you don’t choose option 1 (say, due to already existing loan) only other option left to you is partnership. Say, your friend is interested in joining you and ready to contribute the money you require for 40% of the share in your business. You accepted the offer and expanded the store with the fund you raised from your friend.
Now, store is doing well, better than expected. After 4 to 5 years of good business, you expanded the business to 9 more locations using the profit generated by business and taking some loan. New stores also started performing well and hence you decided to open 10 more stores in other cities. Since you need large amount, you and your friend started searching for investors who can fund your expansion, let’s say you couldn’t find any. Since you couldn’t find any investor for expansion, you decided to go public, which means to sell your business to public and list your company in stock market.
Now that you are selling your business to public, you need to divide the company into small partnerships which is affordable to public. Say, you divided your company into 1 crores partnerships of Rs.10/each. Each of this partnership in other words is called as share.
Let us consider, by following all the procedure of going public (it is also called as IPO – Initial public offering) you issued 60 lakh shares to public and retained 40 lakh shares with yourself and your friend. With this you would have raised 4 crores of money for expansion. Your ownership after IPO will be 36% (36 Lakh shares) and your friend ownership is 24% (24 Lakh shares).
You will find variety of instruments available in stock market. Here we will explain basics of all the available instruments.
Equity is the basic form the financial instrument. This is same as stock or a share.
Equity/Stock = Part of company. Buying a stock is equivalent to buying a part of company.
Derivatives is basically contract. As the name suggests it is derived instrument derived out of stocks. Derivatives are hedging instrument available to protect your investment.
Derivatives can be divided into 2:
Future = Hedging instrument for equity.
Options = Hedging instrument for future.
What is hedging?
Hedging = Safe guarding your investments against market movement.
Example: Consider that you own 1000 stocks of Infosys and you are worried about the movement of stock price due to quarterly results that is due to be announced the next day and you want to safeguard your investment against the market movement. In this case you will have to sell Infosys future in derivative market which is equivalent to your holding. By selling the derivative, you are nullifying your position in Infosys without actually selling the stock.
On the result day if Infosys stock price goes down, the money you lost in downward movement of stock will be gained by future. If stock price goes up, the money gained out of stock movement will be lost in future.
Commodities as the name suggests it is a basic goods. In financial market commodities are not directly bought and sold as it happens in city markets. It will be traded in the form of derivatives (i.e., commodity futures).
Commodity futures are bought and sold to hedge the position in underlying commodity similar to stock futures.
For beginners, I would advise to stick to equities alone until you fully understand derivatives
There are 2 ways of analysing stocks to make buy or sell decisions:
1) Technical analysis
2) Fundamental analysis