People starting off in the stock market generally ask whether they should be long term investors or short term traders. The answer is to let it evolve, but there is a caveat here. Whatever you eventually end up doing, there is a lot to learn about trading if you want to be successful in the stock markets.
There are limited entry barriers to trading
As long as you can bring a small capital as margin money and are willing to take risk, there is nothing to stop you from becoming a trader. You need to be legally eligible to enter into a contract before you can become a full-fledged trader. If these basic conditions are met, then you are good to trade with your money. Today it is possible to open a trading account and operate it with the click of a button.
Remember your profits and losses will be proportionate to your investment. For example, if you trade with a capital of Rs1 lakhs and earn 3% monthly and reinvest these returns, you are looking at the corpus growing to Rs35 lakhs at the end of 10 years. If you earn 1% more then you are sitting on Rs1.11cr at the end of the tenth year. In trading, it is possible to create wealth with small capital outlays.
You can tweak your trading capacity based on capital
How much risk should you take in the market? That would depend on your capital allocated for trading. For example, if you bring in Rs1 lakh as margins then you can take intraday trading positions up to Rs.5-6 lakhs, which is good enough. Your capacity to trade depends on your own risk appetite and also the capital that you bring in.
Trading is the best way to get educated about markets
It is said that the market is a great teacher but extracts a huge price from the learner. Hence you need to carefully learn how to trade and that will form the basis if you want to invest for the long-term. Trading teaches you finer aspects of operating in the capital markets like reading signals in the market, interpreting the order book in the market, managing risk, understanding ROI etc. It is trading that provides insights into stock market mechanics.
Trading teaches you to manage risk better
As a trader, you need to manage with finite capital. Firstly, trading compels you to set limits on the capital you are willing to lose. Secondly, trading impels you to appreciate the importance of stop losses; which can be invaluable for investors. Lastly, trading underlines the importance of booking profits at regular intervals because profit is what is booked. This lesson is important as it facilitates progress through your investment journey.
Learn finer points of Return on Investment (ROI)
Investment looks at stock markets in a very discrete fashion. You are either creating wealth in the long run or you are not. Trading combines two important aspects; rate of return on trading and churning velocity. Let us understand this better. You can either earn 4% in a trade on your capital in a month or earn 2% by churning twice in a month. This is a trade off as it entails cost but understanding this trade-off is extremely useful when you get down to long term investing.
Trading works in all kinds of markets
Investing as an approach is a long-only approach while trading is multi-dimensional. For example, you can buy stocks and also short stocks without delivery. You can take hedged position in the market with the help of short futures or put options. In the case of volatile or range bound markets, you can use strategies like straddles and strangles to play the stock price movement. You don’t predict the stock price but just predict the direction of volatility. Trading can be a lot more flexible as compared to investing.
Finally, trading can be an additional source of income
If you look at the spurt in demat accounts in India, people from all walks of life are looking at trading as a source of secondary income. Trading allows you to create and build wealth in a flexible and practical manner. Trading, therefore, allows you to generate wealth without impacting your work life. You can trade 24 hours a day and now you can also trade globally.
Trading can be the perfect stepping stone as you look to leverage the capital markets more effectively to create wealth. The lessons learnt as a trader are not only enduring but also inculcate a discipline that stands you in good stead as an investor.