Process and Types of Online Trading in India

Now that you have gone through the process of choosing the right stock broker for yourself, it is time to understand how to go about the process of trading. While many traders have their own unique process, there are some concepts that can help all traders to start developing their style of trading.

Basic Idea of Trading

Trading is a broad category that includes short term strategies to earn returns from the buying and selling of assets. Some of these strategies include:

1. Buy low, sell high: This involves buying up assets when they're cheap and selling them when their value climbs. You can perform such buying and selling actions within a matter of minutes or seconds.
2. Short selling: Borrowing and selling assets they expect to decline, repurchasing them later at a lower price for profit.
3. Leveraging options and derivatives: Utilising contracts to amplify potential gains (and losses) without owning the underlying asset.

However, in order to understand how to perform these strategies, we must first go over certain key concepts in the following sections.

Types of Trading Based on Time Period

• Intraday trading 

Intraday traders buy and sell securities within the same day, aiming to profit from short-term price movements. These fast-paced trades square off right before market close, leaving no ownership, just potential gains or losses from price swings.

• Swing Trading

Swing Trading is done by entering a position and then holding it for a few weeks. It is done based on a momentum lasting a few days or weeks.

• Scalp Trading

This involves placing multiple trades in a matter of minutes or even seconds in order accumulate small returns over multiple trades throughout the day.

Types of Trading Based on Methodology

1) Price Action-based Trading

Price action trading is a technical analysis methodology that focuses solely on the historical and ongoing price movements of an asset, eschewing the use of lagging indicators or fundamental analysis. This data-driven approach treats the price chart as a dynamic canvas, where past and present interactions tell the story of supply and demand.

Price-based trading helps in identifying:

1. Trends: Traders learn to discern uptrends, downtrends, and consolidation phases through price patterns like higher highs/lows, lower highs/lows, and sideways channels.
2. Support and Resistance: Key price levels where previous buying and selling activity concentrated become zones of potential reversal or continuation.
3. Momentum and Breakouts: Price behavior like impulsive candles and clean breakouts offer signals of potential trend continuation or trend change.
4. Order Flow Analysis: Understanding the footprint of institutional and retail buying/selling pressure adds further context to price movements.

Advantages of price-based trading include:

1. Direct market-focused analysis
2. Potential for quick entries and exits
3. Development of technical analysis intuition.

Disadvantages of price-based trading include: 

• Requires intensive chart time and pattern recognition skills
• Prone to subjective interpretation
• Lacks fundamental context.
• Open Interest-based Trading

While traditional options analysis considers factors like implied volatility and delta, open interest (OI) adds an intriguing layer of information, ie.. the collective sentiment of market participants. This metric, reflecting the total number of open option contracts, provides insights into positioning, hidden bets, and potential market moves.

For example, if you look at a particular option with a really high OI running into lakhs, that means a lot of people have placed their bets on that particular strike price by entering call or put contracts. Each contract has both buyers and sellers and you can choose to go with either the buyers or the sellers of the contracts.

You can learn the following things from the changes in the open interest of options in the option chain:

1. Rising OI: Suggests growing conviction in a specific direction, be it bullish (increasing calls) or bearish (rising puts). It can fuel momentum and signal potential trend continuation.
2. Falling OI: Indicates closing of positions, implying reduced interest or profit-taking. A sharp decline can raise questions about the sustainability of the current trend.
3. Skewed OI: When the call or put OI significantly outpaces the other, it hints at the dominant sentiment. High call OI may signal bullish anticipation, while heavy put OI might reveal fear or downside hedging.
4. Comparison across strikes: Analysing OI distribution across different strike prices within an option chain can reveal potential target levels and areas of support/resistance.

You can apply OI in your trading strategy by:

1. Confirming directional bias: High OI aligned with your existing analysis adds confidence to your trade.
2. Guiding entry and exit timing: Sudden spikes or drops in OI can offer clues about short-term entry/exit points for momentum trades.
3. Identifying potential support/resistance: OI clusters at specific strikes may create temporary price barriers, influencing near-term price movements.

Limitations of OI-based trading:

1. OI alone is not sufficient: Consider OI alongside other technical and fundamental factors for a complete picture.
2. OI can be manipulated: Large players influencing OI to their advantage requires cautious interpretation.
3. Limited real-time data: OI updates lag trade activity, necessitating a focus on longer-term trends.

Combining Price and OI to Understand Trends in the Derivatives Market

The following trend are said to have formed based on the interaction between price and open interest:

Name of the phenomenon	Price	Open Interest
Long Buildup	Rising	Rising
Short Buildup	Falling	Rising
Short Covering	Rising	Falling
Long Unwinding	Falling	Falling

While long buildup and short buildup signifies a buildup in the long and short positions, short covering refers to traders buying up underlying assets to offset any short selling they had done earlier. As a result, the price increases due to the temporary buying pressure. 

On the other hand, the long unwinding refers to long positions being exited by traders, as a result of which both the price of the derivatives and the number of open positions start falling. 

Once you have an idea about such trading phenomenon, you will be better able to analyse the trends in the derivatives market. Based on that, you can make further assessments of the stock market, especially based on stock derivatives, i.e. derivatives which have stocks as their underlying asset.

On Angel One, you can easily check which are the assets going through long and short buildup, long unwinding and short covering. Simply visit the Home page, open ‘Market Today’ and then click on Derivatives Market. Thereafter scroll down to ‘Buildups’.

Types of Trading Indicators

Trading indicators are mathematical formulas that help us interpret price, volume, and other data points, aiming to illuminate trends, momentum, volatility, and hidden opportunities. 

You can apply trading indicators, especially on charts, in order to better understand what is the general trend in the price of an asset and thereby predict which way the price is likely to move in the near future.

Here's a concise overview of common types of indicators:

1. Trend Indicators e.g. Simple Moving Average (SMA), Exponential Moving Average (EMA), Weighted Moving Average (WMA), Bollinger Bands, Parabolic SAR, Ichimoku Cloud, etc.
2. Momentum Indicators e.g. Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), Stochastic Oscillator, Commodity Channel Index (CCI) etc.
3. Volatility Indicators e.g. Average True Range (ATR), Bollinger Bands, Volatility Index (VIX), etc.
4. Volume Indicators e.g. On-Balance Volume (OBV), Chaikin Money Flow (CMF), Accumulation/Distribution Line, etc.
5. Option Greeks e.g. Delta, Gamma, Theta, Vega, Rho, etc.

Remember, indicators are tools that cannot suffice on their own. To use them successfully, combine multiple indicators, consider fundamental factors, and prioritise risk management to navigate markets effectively.

Types of Advanced Orders

Once you know which way the price is likely to move, you can employ various types of orders in order to navigate that particular situation. These orders have their unique characteristics that help you handle unique situations:

1. Market Order: Prioritise instant execution over price precision. Buy or sell a security at the best available current price, sacrificing control over the exact purchase/sale price but ensuring immediate action.
2. Limit Order: Prioritise desired price over swift execution. Set a specific price ceiling (for purchases) or floor (for sales) you're willing to accept. Guarantees the desired price but may wait for market conditions to match, potentially delaying execution.
3. Stop-Loss Order: Automate loss mitigation. Set a trigger price that, when reached, automatically executes an opposite-side order (sell if bought, buy if sold) to limit potential losses on a position.
4. Trailing Stop-Loss Order: Dynamically protect profits. Set a stop price that adjusts proportionally to the market price, locking in gains as the trend continues your way but leaving open room for further potential profit.
5. Good-Till-Cancelled Order: Capture future possibilities. Specify a target price and timeframe for execution. If the market hits your price within the set period, the order triggers automatically, capturing opportunities that might not be immediate.
6. Time-of-Day Order: Execute at the right moment. Instruct your broker to buy or sell at a specific time of day, regardless of the current market price. Useful for capturing predictable market movements or adhering to personal trading timeframes.
7. Fill-or-Kill Order: Seize fleeting opportunities. Demand immediate execution of your entire order at the specified price. If the full quantity cannot be filled instantly, the entire order is cancelled, ensuring you only capture your desired price or walk away entirely.
8. Bracket Order: This type of order combines three orders i.e. a buy order at the first price, a sell order at a higher target price and a sell order at a lower stop loss price.

Example of a Trading Process

All trades must begin with an expectation with respect to the movement of the price of an asset. Let us assume that you are looking at the Nifty 50 Chart on January 25, 2024. 

You apply the following indicators on the Nifty 50 chart:

• MACD and Signal Line - MACD (blue) crossing the Signal line (orange) from above is usually assumed to be a sign of bearish sentiment. In this image above, the MACD line seems to be moving below the Signal line as well.
• Supertrend - Supertrend is a line that appears over the prices. If the supertrend is above the prices, then it signifies bearish nature, as in this case.

Since both the indicators are showing bearish nature, we may choose to bet that the Nifty 50 has a higher chance of staying low or moving further down in the coming days.

Now that a bearish Nifty is our view point, we can then decide how we are going to trade it. We can choose a naked put option, i.e. only buy a put option with the entire capital, at a strike price that we believe the Nifty 50 will stay under. We can also diversify that put option by having multiple put options, each bought with a portion of the total capital, at various strike prices that the Nifty may stay under.

Of course, there are various other positions that we can take, with various combinations of put and call options.

We can also choose to place these put options in the form of a bracket order, whereby we specify:

The limit price for the initial entry into the long position.
The target price at which we sell the put option and exit or square off the position, in case the price of the option increases.
The stop loss price at which we sell the put option and exit or square off the position, in case the price of the option decreases.

The System of Cash Settlement

Cash settlement, unlike physical delivery, avoids exchanging the underlying asset in F&O contracts. Instead, profits or losses are directly credited or debited to trader accounts based on the difference between strike price and final settlement price at expiry. This simplifies logistics, enhances efficiency, and allows F&O contracts on non-deliverable assets like indices. However, it eliminates potential physical ownership and can limit profit or loss potential compared to physical settlement.

Final Words

Trading can be a thrilling pursuit, offering the chance to capitalise on market movements and build wealth. However, it's crucial to remember that it's also a high-risk endeavour, demanding constant learning, discipline, and risk management. Whether you're a seasoned pro or a curious newcomer, approaching trading with knowledge and caution is key to navigating this dynamic and potentially rewarding arena.

Now that you have learnt about the basics of the trading process, we can move on to the concepts related to price discovery, i.e. how to find the right prices to trade or invest at. Check out the next chapter to know more!