How Trading works
Before we get into options we need to know some STOCK basics. We call stocks securities and options are securities as well. They are a derivative security. Their price is derived from the price action of the underlying security.
Stocks can go up, down, or stay the same. Stock is ownership in a company and that ownership is measured in stock.
You BUY stock because you believe the company is growing strong and the price will increase over time. And you want to participate in that upward move. You can have unlimited upside potential, but you can only make money, if the price goes up.
When you buy a stock, you are long the stock. The stock be-longs to you. When, you buy a stock you pay a debit, and, later, when you sell it you receive a credit provided the price went up. So, you Buy to get in and Sell to get out. When you BUY, you are long the stock. The stock be-longs to you. When buying , you want the stock to go up, and you make money, when it does.
However, you can SELL a stock as an opening trade, if you believe it may go down. If you believe a company is on a bad track you can take a short position in the company. You sell to get into the trade and you buy to get out. You sell high now, to buy low later.
When, you sell to open, your broker gives you credit for opening the trade. You buy it back later for a debit. Just the opposite of being long. But this time you are short the shares. You borrowed the shares from the broker and give them back, when you close the trade. The broker doesn’t care which way the price goes. They have made an agreement with you to get the stock back, when you close the position. That is why you sell high and buy it back lower and you get to keep the difference.
Buying and selling can be expensive and just as the stock you BUY can go down, the stock you SELL can go up.
The trading process
Every trade has three phases – The open, the activity and the close
At the open you either BUY or SELL
During the activity, the price moves up or down or stays the same.
The close is where you do the opposite of what you did when you opened.
The open and close are events, whereas the activity involves a period of time, during which something happens. Stock prices move around and you don’t know how long your stock is going to be tied up. It is an open-ended proposition. And stocks can be expensive. Stocks can have huge runs as we have seen over the past decade. Look here for ideas about building a trade.
So, to recap. Stocks represent an ownership interest in a company, You can buy a stock and be long the stock, if you believe the company has good prospects for increasing in value, or you can sell a stock and be short the stock, if you believe the company may be heading into trouble. The trading process involves the open phase, the activity phase, and the close. Stocks can be held for an indefinite period and it can be expensive to hold, during the activity phase.
Please check back next time as I begin to talk about Options, what they are and how they can take you way beyond trading stock.
In the meantime, if you have found this brief description useful and/or have any questions, please leave a comment below and I will get back to you as soon as I can.
Here is a link to one of the most comprehensive discussions of options trading.