Assuming you are done reading and understanding the entire 12 chapters in our very first module – Introduction to stock markets, you are now warmed up to dig deeper!
The objective of the first module is to give you quick hands on introduction to the stock markets. In our endeavor to introduce the stock markets to you, we have carefully selected concepts that you need to know, especially if you are absolutely new to markets. If you have many unanswered questions at this stage, it is a good sign. You will find your answers as we proceed to other modules.
At this stage, it is extremely important for you to understand why we have so many different learning modules, and how these modules are interrelated. To give you a head up, here are some of the modules that we will cover in Varsity.
- Introduction to Stock Markets
- Technical analysis
- Fundamental Analysis
- Futures Trading
- Option Theory
- Option Strategies
- Quantitative Concepts
- Commodity Markets
- Risk Management & Trading Philosophy
- Trading Strategies & Systems
- Financial Modeling for Investment practice
13.1 – So many modules – how are they interrelated?
The idea of ‘Varsity at Zerodha’ is to put up a repository of high quality market related educational content. The content, will cover various aspects of fundamental analysis, technical analysis, derivatives, trading strategies, risk management, financial modeling etc. Each main topic is categorized as a module. If you are new to the markets, you could be wondering how each of these topics fit within the grand scheme of things.
To help you get a perspective, allow me to post a simple question to you.
In order to be successful in the markets, what according to you is the single most important factor? Success in markets is easily defined – if you make money consistently you are successful, and if you don’t you are not!
So if you were to answer this question for me, chances are you will think about factors such as risk management, discipline, market timing, access to information etc as the key to be successful in markets.
While one cannot deny the importance of these factors what is even more compelling and primary is developing a point of view (POV).
A point of view is an art of developing a sense of direction on a stock or the markets in general. If you think the stock is going up, your POV is bullish hence you would be a buyer of the stock. Likewise if you think a stock is going down your POV is bearish therefore you would be a seller of the stock.
Having said that, how do you actually develop a point of view? How do you figure out if the stock is going up or down?
To develop a point of view, one needs to develop a systematic approach to analyze the markets. There are a few methods using which you can figure out/ analyze what to buy or sell. They are:
- Fundamental Analysis (FA)
- Technical Analysis (TA)
- Quantitative Analysis (QA)
- Outside views
Just to give you a preview, here is a typical illustration of a trader’s thought process while developing a POV (whether to buy or sell stocks) based on a particular method of analysis –
FA based POV – The quarterly numbers looks impressive. The company has reported a 25% top line and 15% bottom-line growth. The company’s guidance also looks positive. With all the fundamentals factors aligned, the stock looks bullish hence the stock is a buy.
TA based POV – The MACD indicator has turned bullish along with a bullish engulfing candlestick pattern, with that study the stock’s short term sentiment looks positive therefore the stocks is a buy.
QA based POV – With the recent up move, the stock’s price to earnings (PE) touched the 3rd standard deviation. There is only 1% chance for the PE to breach the 3rd standard deviation. Hence it is prudent to expect a reversion to mean; therefore the stock is a sell.
Outside view – The analyst on TV is recommending a buy on the stock therefore the stock is a buy.
The POV you take should always be based on your own analysis rather than an outsider’s view, as more often than not one ends up regretting taking an action based on an outside view.
So after developing a POV what does one generally do? Does he straight away go and trade the point of view? Here is where the complexity of markets starts to kick in.
If the POV is bullish, you can choose to do one of the following:
- Buy the stock in the spot market
- Buy the stock in the derivatives markets.
- Within derivatives you can choose to buy the futures
- Or choose to trade via the option market
- Within the option market there are call options and put options.
- You can also do a combination of call and put options to create a synthetic bullish trade
So what you choose to do after developing a POV is a totally a different ball game. Choosing the right instrument to trade which complements your POV is highly critical to profitable trading.
For example, if I’m extremely bullish on a stock from 1 year perspective then I’m better off doing a delivery trade. However if I’m out rightly bullish on the stock from a short term perspective (say 1 week) then I’d rather choose a futures instrument to trade.
If I’m bullish with constraints attached (example – I’m expecting the markets to bounce because of a great budget announcement, but I don’t want to risk much) then it would be prudent to choose an options instrument.
So the message here is – the market participant should develop a point of view and complement the POV with the right trading instrument. A well researched POV combined with the right instrument to trade is a perfect recipe for market success.
Also by now, hopefully you have got a sense of how all the different modules in “Varsity” play an important role in assimilating the market.
So keeping this in background, go ahead and explore the content on Varsity at Zerodha.
The next two modules will explore concepts that will help us develop POV based on Technical and Fundamental Analysis.
After reading through these two modules you will get a sense of developing a point of view on markets. The later modules we will discuss the different trading instruments that you can choose to complement your point of view. As we progress along, we will ramp up the flow to help you start calibrating your trades with effective risk management techniques.