Theory of Stock Market and Options

1.Basics of Investing and Trading

Types of Assets: e.g. Stocks (Shares or Equity), Fixed Income Securities (Bonds, Treasury Bills), Commodities, Cash, Real Estate etc.

Financial Instrument: a tradable asset, or negotiable item, such as a security, commodity, derivative, or index, or any item that underlies a derivative.

2.Stock Market and different Industrial Sectors and Earnings Reports

Collection of markets and exchanges where regular activities of buying, selling, and issuance of shares of publicly-held companies take place. Such financial activities are conducted through institutionalized formal exchanges or over-the-counter (OTC).

According to the Global Industry Classification Standard (GICS), there are 11 sectors identified which can be further delineated to 24 industry groups, 68 industries, and 157 sub-industries. There are:

  • Energy

  • Materials

  • Industrials

  • Consumer Discretionary

  • Consumer Staples

  • Health Care

  • Financials

  • Information Technology

  • Telecommunication Services

  • Utilities 

  • Real Estate

Public listed companies need to release quarterly and annual earnings reports (financial statements) early to mid-January, April, July, and October as regulated by Securities and Exchange Commission (SEC).

3.Stock Market Indices, Index Funds, ETFs

Market Indices are portfolios of investment holdings which represents a segment of the financial market. Index values are calculated from prices of underlying holdings and based on weighting from either market-cap, revenue, float, or fundamental.

Index Funds are a type of mutual fund with a portfolio constructed to match or track the components of a financial market index.

Exchange Traded Funds (ETF) are exchange traded security involving collection of securities (e.g. stocks or bonds) that often tracks an underlying index, although can invest in any number of industry sectors or use various strategies. They are similar to mutual funds; but are listed on exchanges and trade throughout the day just like ordinary stock.

4.Fundamental, Technical, Behavioural Analysis

Fundamental Analysis involves measuring a security's intrinsic value by examining related economic and financial factors. For public companies, this includes assessing the organization's business, management and evaluating financial statements for information on income, assets, debt, shareholder equity, to estimate value of the stock.

Technical Analysis involves analysing statistical trends gathered from trading activity and identifying opportunities by discerning price and volume trends and patterns seen on charts and "candlesticks". Technical Analysers believe that past trading activity and price changes of a security can be valuable indicators of the security's future price movements.

Behavioural Analysis (market sentiment) involves the study of psychological influences and biases affect the financial behaviours of investors and financial practitioners. Influences and biases can be the source for explanation of all types of market anomalies and specifically market anomalies in the stock market, such as severe rises or falls in stock price.

Stocks can also be influenced by news such as economic growth, GDP, central bank interest rates, inflation, unemployment rate, political situation, trade negotiations between countries, product breakthrough, mergers and acquisitions etc.


5.Diversification, Portfolio Management and Risk

A diversified portfolio is used as a risk management strategy. It is prudent to select investments that span different financial instruments, sectors / industries, and other categories. To achieve a diversified portfolio, look for asset classes that have low or negative correlations so that if one moves down the other tends to counteract it.

Systematic or market risk, associated with every company, including inflation rates, exchange rates, political instability, war, and interest rates, cannot be eliminated or reduced by diversification. Unsystematic risk such as business risk and financial risk can be reduced by diversification. Thus the aim is to invest in various assets so they will not all be affected the same way by market events.

6.Introduction to Commodities Market

Tradable commodities fall into the following four categories:

  • Metals

  • Energy

  • Livestock 

  • Agricultural

Basic economic principles of supply and demand typically drive the commodities markets. Commodities are traded in special commodity markets.

7.Introduction to Derivatives

Financial security with a value that is reliant upon or derived from, an underlying asset or group of assets – a benchmark. The derivative itself is a contract between two or more parties, and the derivative derives its price from fluctuations in the underlying asset. The most common underlying assets for derivatives are stocks, bonds, commodities, currencies, interest rates, and market indexes. Common types of derivatives include Futures and Options.

8.Introduction to Futures

Futures are derivative financial contracts that obligate the parties to transact an asset at a predetermined future date and price. Here, the buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date. The buyer of a futures contract is taking on the obligation to buy and receive the underlying asset when the futures contract expires.  The seller of the futures contract is taking on the obligation to provide and deliver the underlying asset at the expiration date. Underlying assets include physical commodities or other financial instruments.

9.Introduction to Options

Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset. Unlike futures, the holder is not required to buy or sell the asset if they choose not to. Call options allow the holder to buy the asset at a stated price within a specific timeframe while Put options allow the holder to sell the asset at a stated price within a specific timeframe. Each option contract will have a specific expiration date by which the holder must exercise their option. The stated price on an option is known as the strike price.

10.Trading Psychology and Emotions

Trading psychology refers to the emotions and mental state that help to dictate success or failure in trading securities. Trading psychology represents various aspects of an individual’s character and behaviours that influence their trading actions. Trading psychology can be as important as other attributes such as knowledge, experience and skill in determining trading success. Discipline and risk-taking are two of the most critical aspects of trading psychology, since a trader’s implementation of these aspects is critical to the success of his or her trading plan. While fear and greed are the two most commonly known emotions associated with trading psychology, other emotions that drive trading behaviour are hope and regret.


Adapted from Investopedia