How does Online Trading Work?

5paisa Research Team Date: 31 Oct, 2023 03:42 PM IST

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Content

Introduction
What is Online Trading?
How Can You Do Online Trading?
What is Cash and Margin Account?
The EndNote

Introduction

Long back in 1929, ace investor Joseph Kennedy sold all his stock holdings just one day before the devastating 'Black Thursday,' which marked the beginning of the Great Stock Market Crash of 1929. Many investors lost their capital assets in the event.

But why did Kennedy sell all of his holdings suddenly? It was apparently because he received a stock recommendation from a shoeshine man. In those days, stock trading was reserved for the whos who of the society. But, Kennedy thought that if a shoeshine boy (a retail investor) could give stock recommendations, there must be something seriously wrong with stock valuations.

Fast forward to 2022, and retail investors far outnumber institutional investors. They influence stock prices, trading volumes, and the overall market depth. A large credit for this goes to online trading. Online stock trading has opened a world of unparalleled convenience and excellent profit-making opportunities. This article explains how online trading works and ways to trade efficiently.

What is Online Trading?

Online trading or online stock trading refers to investing in publicly listed companies through stock exchanges like the National Stock Exchange (NSE), Bombay Stock Exchange (BSE), etc. For trading online, investors need a special account. Besides trading stocks, you can also trade or invest in commodities, mutual funds, exchange-traded funds, currencies, and bonds through an online trading account.

The primary purpose of an online trading account is stock trading. But, what is a stock? A stock or share is a percentage of a company's ownership. When a company goes public, they release some shares for the public. When a company lists for the first time, they launch an IPO or Initial Public Offering. And, when seeking funds again, they launch an FPO or Follow-on Public Offer. Before the listing, 100% of the company's shares belong to the rightful owners. However, after listing, whoever buys the shares through a stock exchange becomes part-owner of the company. You can hold the company's shares for as long as you want.

When the company whose shares you hold makes a profit, it may share a part of the profit with the shareholders. Stocks that provide regular dividend income are known as income stocks. Conversely, a company may reinvest the profit to grow its business. Companies investing their profit for growth are known as growth stocks.

An online stock trading account lets you invest as a positional or intraday trader. Positional investors buy stocks and hold them until their investment objectives get fulfilled. In contrast, intraday traders buy and sell stocks on the same day. Alternatively, some intraday traders sell in the morning and buy before the market closes.

How Can You Do Online Trading?

You need two special accounts for online trading - A demat account and a trading account.

Demat account is used to store shares electronically. Demat accounts are managed and maintained by depository institutions like the National Securities Depository Limited or https://www.5paisa.com/finschool/what-is-nsdl/https://www.5paisa.com/finschool/what-is-nsdl/ and the Central Depository Services Limited or CDSL. Stockbrokers like 5paisa facilitate free and convenient Demat account opening.

The other account you need to engage in online trading is a trading account. The trading account acts as the interface between you and your Demat account. When you put money for share purchases, it goes into the trading account. Similarly, when you withdraw money, you withdraw it from the trading account.

To open an online stock trading account, you need to approach a stockbroker. While some brokers charge account opening fees, brokers like 5paisa offer free Demat and trading account opening facilities. Before opening your account, the broker will ask for documents like PAN card, Aadhar card, and photograph. After the account opening process is over, you can pour money into the account and start buying and selling stocks.

What is Cash and Margin Account?

A cash account is much like a bank account. If you have a cash account, you can buy stocks equivalent to the amount in your cash account. In contrast, a margin account allows you to buy more shares than your clear account balance permits. Lenders keep your shares as collateral to offer you an amount higher than your account balance. For example, if your clear account balance is INR 10,000 and you have INR 5,000 worth of shares in your Demat account, the lender may offer you up to INR 50,000 for trading. However, you may need to pay some interest to avail the margin facility.

The EndNote

Now that you know how online trading works and the procedure to open an account, put your knowledge to use with 5paisa's free Demat and trading account. You can trade in three types of stocks in the market - large-cap, mid-cap, and small-cap. Large-cap stocks belong to companies with huge market capitalisation and a stable business model. Mid-cap stocks belong to companies with decent growth potential. And small-cap stocks belong to companies with a viable business plan and a strong willingness to grow. Besides the three categories, there is another stock category - penny stocks. Penny stocks are ultra-low-priced stocks that might become multi-baggers or stay as laggards.

Hence, before trying your hands with online trading, it is prudent to research and read to make informed decisions.

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