Investors trade in stocks to make a profit on their investments. The stock market lets buyers and sellers negotiate prices and make trades. People make money every day because the price of goods and services fluctuates constantly. Those who buy and sell securities in one day are known as day traders or intraday traders because they don’t hold any of the underlying assets they’re trading. Others are short-term and long-term investors, as they keep their money in the stock market for varying periods. Understanding the fundamentals of the financial instruments traded is essential, regardless of your choice.
Among the many types of financial instruments that are traded on the stock exchange are shares/stocks, derivatives, bonds, and mutual funds.
1. Share/Stock
Share/stock is a unit of ownership of a company. There are multiple types of shares, namely equity shares, preference shares, deferred shares, redeemable shares, bonus shares, right shares, and employee stock option plan shares. When someone buys the shares of a company, they become a shareholder. Normally it is equity shares that are invested. The income received from this ownership is called the dividend, which companies may pay monthly, quarterly, or bi-annually.
There are two ways people earn from the trade of shares. One is through the form of dividends. In case there is any residual profit, many companies decide to distribute it among shareholders periodically. Often, these profits are not distributed, and instead are re-utilized in growing the company. In that case, the shareholders anticipate the growth of the price of stocks and earn by trading them in the future at better prices.
2. Derivatives
Derivatives are the type of securities whose value is dependent on or derived from an asset. These securities are contracts between two or more parties, the value of which is based on an agreed-upon underlying financial asset, index, or security. There are two ways people earn from the trade of derivatives. The first one is by mitigating the probable risk in the future, which is known as hedging. The second one is by assuming the risk in the future and capitalizing on it, known as speculation.
Some of the most commonly used derivatives are Forwards, Futures, Options, and Swaps. Futures are contracts that obligate the parties to transact an asset at a predetermined future date and price. A forward contract is a private and customizable agreement that settles at the end of the agreement and is traded over the counter. A futures contract has standardized terms and is traded on a recognized stock exchange, where prices are settled daily until the end of the contract. Similarly, an option is a right, but not an obligation to buy or sell a financial asset on a specific date at a pre-agreed price, whereas a swap is an agreement between two parties to exchange financial instruments.
3. Bonds
A Bond is an instrument of security that allows companies to raise funds and fulfill their capital requirements without giving up ownership of the company.
Investment in bonds is one of the safest ways to get involved in the stock market because they guarantee a predetermined interest rate. The interest rate can fluctuate, but it will never fall below what is stated when the bond is issued on the stock exchange. It’s possible, however, that bonds won’t show the kinds of profits seen in stock trading and derivatives.
4. Mutual Funds
A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The risk is much lower than when individuals trade stocks on their own because here a qualified set of professionals who have knowledge and access to research invest on your behalf. Since this is their occupation, they study and monitors the market closely, carefully choosing the investments; buying and selling stocks in such a way to give you the maximum returns. There are various mutual funds that you can choose from to invest in, as per your preference of investment instruments and risk appetite. When it comes to stock market investing, mutual funds are a go-to choice for many Indians.
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