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 a quick hands-on introduction to the stock markets. In our endeavour to introduce the stock markets to you, we have carefully selected concepts 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, you need to understand why we have so many different learning modules and how these modules are interrelated. Here are some of the modules that we will cover in Varsity to give you a head up.
- 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 fundamental analysis, technical analysis, derivatives, trading strategies, risk management, financial modelling, 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.
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 risk management, discipline, market timing, access to information, etc. as the key to success 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 the 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, you would be a stock seller.
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. A few methods are 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
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 look 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 are 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 a 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 recommends 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 action based on an outside view.
So after developing a POV, what does one generally do? Does the 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 options market.
- Within the options 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 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 the stock from a 1-year prospective, I’m better off making a delivery trade. However, if I’m out rightly bullish on the stock from a short term perspective (say 1 week), 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), it would be prudent to choose an option 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 the 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. In the later modules, we will discuss the different trading instruments you can choose to compliment your perspective. As we progress along, we will ramp up the flow to help you start calibrating your trades with effective risk management techniques.