How online trading works




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How online trading worksIntroduction to How Online Trading Works

New York Stock Exchange See more investing pictures .

Legend has it that Joseph Kennedy sold all the stock he owned the day before Black Thursday, the start of the catastrophic 1929 stock market crash. Many investors suffered enormous losses in the crash, which became one of the hallmarks of the Great Depression.

What made Kennedy sell? According to the story, he got a stock tip from a shoeshine boy. In the 1920s, the stock market was the realm of the rich and powerful. Kennedy thought that if a shoeshine boy could own stock, something must have gone terribly wrong.

Now, plenty of common people own stock. Online trading has given anyone who has a computer, enough money to open an account and a reasonably good financial history the ability to invest in the market. You don't have to have a personal broker or a disposable fortune to do it, and most analysts agree that average people trading stock is no longer a sign of impending doom.

В­The market has become more accessible, but that doesn't mean you should take online trading lightly. In this article, we'll look at the different types of online trading accounts, as well as how to choose an online brokerage, make trades and protect yourself from fraud.

Review of Stocks Markets

Review of Stocks Markets

Before we look at the world of online trading, let's take a quick look at the basics of the stock market. If you've already read How Stocks and the Stock Market Work. you can go on to the next section .

A share of stock is basically a tiny piece of a corporation. Shareholders -- people who buy stock -- are investing in the future of a company for as long as they own their shares. The price of a share varies according to economic conditions, the performance of the company and investors' attitudes. The first time a company offers its stock for public sale is called an initial public offering (IPO), also known as going public.

When a business makes a profit, it can share that money with its stockholders by issuing a dividend . A business can also save its profit or re-invest it by making improvements to the business or hiring new people. Stocks that issue frequent dividends are income stocks . Stocks in companies that re-invest their profits are growth stocks .

Brokers buy and sell stocks through an exchange, charging a commission to do so. A broker is simply a person who is licensed to trade stocks through the exchange. A broker can be on the trading floor or can make trades by phone or electronically.

An exchange is like a warehouse in which people buy and sell stocks. A person or computer must match each buy order to a sell order, and vice versa. Some exchanges work like auctions on an actual trading floor, and others match buyers to sellers electronically. Some examples of major stock exchanges are:

Worldwide Stock Exchanges has a list of major exchanges. Over-the-counter (OTC) stocks are not listed on a major exchange, and you can look up information on them at the OTC Bulletin Board or PinkSheets .

When you buy and sell stocks online, you're using an online broker that largely takes the place of a human broker. You still use real money, but instead of talking to someone about investments, you decide which stocks to buy and sell, and you request your trades yourself. Some online brokerages offer advice from live brokers and broker-assisted trades as part of their service.

If you need a broker to help you with your trades, you'll need to choose a firm that offers that service. We'll look at other qualities to look for in an online brokerage next.

How Online Trading Works

Lots and Day Trading

A block of 100 shares of stock is called a round lot . Any other number of shares is an odd lot . Before the development of electronic exchanges, many brokers charged a fee for trading in odd lots.

You may remember stories of people becoming millionaires as day traders during the early days of online trading and the tech stock bubble. Some people still use online brokerages to make their living as day traders. But capital gains taxes, commissions and fees for trades can significantly reduce a day trader's profit. In fact, most new day traders lose money for several months before they give up or learn to gauge the market well enough to make a profit.

Making Trades

Once you've opened and funded your account, you can buy and sell stocks. But before you do that, you want to get a real-time stock quote to confirm the current price of the stock. Your brokerage may provide real-time quotes as part of your service. Many free financial news sites offer delayed quotes . which are at least twenty minutes behind the market. If the market is moving quickly, a delayed quote can be substantially different from the real trading price.

Once you've gotten your quote and decided you want to make a trade, you can choose to place a market order or a limit order . A market order executes at the current market price of the stock. A limit order, however, executes at or better than a price you specify. If the price doesn't reach the limit you set, your trade will not go through.

Some brokerages offer additional options, often used to prevent high losses when a stock price is falling. These include:

Stop order - A form of market order, this executes after the price falls through a point that you set. The order executes at market price, not at the stop point.

Stop limit order - These are like stop orders, but they execute at a price you set rather than market price. In rapidly moving markets, the broker may not be able to execute your order at your set price, meaning that the stock you own may continue to fall in value.

Trailing stop order - Like a stop order, a trailing stop executes when the price falls through a point you set. However, its selling price is moving instead of fixed. You set a parameter in points or as a percentage, and the sale executes when the price falls by that amount. If the price increases, though, the parameter moves upward with it. So, if a stock is trading at $20 per share, and you set a trailing stop order with a three-point parameter, your initial selling price would be $17 per share. But if the price then increases to $25 per share, your new selling price would be $22 per share.

You must also select whether your order stays active until the end of the day, until a specific date or until you cancel it. Some brokerages allow you to place all or none or fill or kill orders, which prevent a partial rather than complete exchange of the stocks you want to trade.

Contrary to many people's perceptions, making trades online is not instantaneous, even if you're placing a market order. It can take time to find a buyer or seller and to electronically process the trade. Also, even though you can access your account and place buy and sell orders twenty-four hours a day, your trades execute only when the markets are open. An exception is if your firm allows after-hours trading . which is riskier due to the reduced number of trades taking place.

How Online Trading Works

The advent of online trading has changed the world of trading forever; it has been a great leveler. Now trading in primary markets and secondary markets is simpler and faster and what’s more you have access to accurate and up to date information. Small and individual investors are no more at the mercy of intermediaries and brokers which means greater transparency and lower transaction costs.

Understanding Online Trading and How it works ?

Most of the investment in stock markets nowadays for retail investors happens online. Online trading as the name suggests is buying and selling of financial instruments online.

This means that you hold these instruments in an electronic form instead of holding them in physical form. Does that sound confusing?

Illustration

Just compare it with your savings account; when you see your savings statement you see the net balance in your account but you do not have that cash physically. Similarly if you buy 40 shares of Infosys and 15 shares of Reliance Communications and then you sell 10 shares of Infosys and buy 5 more shares of Reliance Communications over a month; at the end of the month your statement will show a net balance of 30 shares of Infosys and 20 shares of Reliance Communications without you having either bought or sold these shares physically.

Components of a Trading account

An online trading account is made up of three components, these are the

savings account,

demat account and

actual trading account or the e-broking account.

Savings Account: The savings account is linked to the trading account. So when you want to buy online the money from your savings account is used to make the purchase and in case you sell online then the proceeds from the transaction are directly credited to your savings account.

Demat Account: The demat account is the account which reflects the balance of the various instruments you hold electronically. In case you have physical shares you can send them to the respective company registrar and get them dematerialized (converted to electronic form). Theses dematerialized shares will also reflect in your account even if you have not bought them online.

Trading Account: The third component is the actual trading account which provides you a platform for trading. It is an agreement that you have with a portal of your choice so that you can use their platform for trading in the primary and the secondary market.

The type of account that you get will vary according to the portal you choose; some like 5paisa do not have a savings account of their own, so they allow you to link your savings account from HDFC, ICICI, CITI Bank etc while ICICI and AXIS Bank offer you all three accounts under one umbrella.

Opening a Trading Account

For opening a trading account the first thing that you will have to do is choose a portal that you want to register yourself with. Here the choice is huge which can be a vice and a virtue as well. The large choice helps you in getting good rates and a user friendly portal but at the same time trying to find a safe and reliable choice can be a daunting task. Most private and public sector banks offer this service and some NBFCs (Non Banking Finance Company) also do it. You need to do your homework well before you make your choice. The service providers listed below are known to be amongst the best in the market and are market leaders in terms of volume of the total business:

Most popular names

ICICI Direct from ICICI Bank)

Indiabulls

Kotak Securities from the Kotak Mahindra Group

Sharekhan

HDFC Securities from HDFC Bank).

5 Paisa from India Infoline

You would be required to comply with a set of guidelines for account opening. These are more or less similar irrespective of the financial institution and are laid down by SEBI (Securities Exchange Board of India) which is the governing body for stock markets, depositories and depository participants.

Documents required for account opening include:

PAN Card

Identity Proof

Proof of Residence

Photograph

Apart from this you will also require an internet connection and some basic knowledge about markets before you start trading. Most sites offer tips and tutorials online so these can help you in familiarizing yourself to the world of trading. All the sites also have helpline numbers listed and the address for your nearest branch as well; you could choose to visit the branch or ask for a representative to visit you to complete the account opening formalities. Alternatively you could fill in the form online and a representative will visit you to collect the required documents.

How Much Do I Pay?

Again this factor will vary with the service provide you choose. There is a onetime cost which is the account opening cost and there is recurring cost which is based on the volume of your transaction. As of this article print date. here are some illustrative costs

Account opening

ICICI charges a onetime fee of Rs. 750 for their three in one account

Indiabulls charges Rs. 1200 which includes charges for a demat account, a trading account and charges for software

5paisa charges Rs. 500 for account opening.

Brokerage may vary as per the product and the bank; charges vary depending on the type of trade as far as ICICI is concerned,

5paisa charges .05% and .20% additional in case the trade results in delivery.

Sharekhan charges .1% for intra day and .5% for inter day transactions.

The rates offered by Indiabulls and 5 paisa are quite competitive.

What all Can I Buy Online?

Below mentioned is a list of what all you can buy through your online trading account. Please remember each bank will not offer all products so you must check exactly what all you can do with your account before you open one. Reliance money offers the largest range of products that you can purchase online.

Stocks

Initial Public Offers (again stocks, etc)

Mutual Funds

Government of India Bonds

Postal Savings Schemes

General Insurance

Life Insurance

Derivatives Trading

Commodity Trading

Why Should I Trade Online?

Online trading offers you the following benefits:

Lower transaction cost

Access to real time information

Transactions are faster

Transparency in deals

No paper work involved

Advice from experts and help available

Can access you account anytime and anywhere.

The need to be cautious while operating an online account cannot be overemphasized; that is why it is important to choose a reputed portal and be extra careful with your user id and passwords.