4. Advantages & Disadvantages of Stock Trading

Curated By
Vivek Gadodia
System trader and algo specialist

Skill Takeaways

  • The good, bad and ugly aspects of stock trading
  • Trader can hone their skills and achieve great success
  • How to face the risks of the trade by staying informed?
  • Do's and Dont's of trading

Like there are two sides to a coin, stock trading also has its upsides and flipsides. This profession welcomes everyone, starting from novices, who are willing to learn and grow, to veterans who already have put in years of work either in stock trading or any other profession. With the advent of online trading, you can grow your business without any marketing efforts or doing due diligence on buyers’ or sellers’ creditworthiness.

Stock trading focuses more on your ability to place trades in an agile and wise manner rather than on communication skills or the capacity to navigate a corporate world. Assurance of timely payment and the rarity of default makes this profession even more attractive.

While the benefits are too many, there are some low points too. You have to be constantly willing to learn more by doing research and have the trait to take and bear risks. You will have to compete with the know-how, resources and intuition of professional and seasoned experts.

The biggest pitfall of stock trading is the misconceptions, and topping the list is the myth that it is easy to become a successful trader. Perhaps this very misunderstanding has led to catastrophic failures that have forced traders to quit the profession at early stages. It is, therefore, critical to have a clear knowledge of the advantages and disadvantages of stock trading before taking a plunge.

Advantages

Good returns: A disciplined trader with analytical skills has the potential to earn exceedingly good returns, and that too in a short time. This makes the profession lucrative, especially if you are able to manage the risk efficiently. Stock trading becomes even more attractive with low interest rates and a high inflation regime.

Interviews with some of the Market Wizards, as they are called in trading, featured in Jack Schwager’s series of books titled “Market Wizards”, reveal that the amounts of money made in trading by professional traders and trading firms are as high as one can imagine.

High liquidity: Stock markets provide liquidity which is unparalleled when compared to other asset classes, such as real estate. In other words, getting out of the market is easy and without much impact cost. Thus, investing/trading in stocks is a good option to put surplus funds to use, and it is more profitable than keeping the money lying in savings accounts.

Regulatory surveillance: Gone are the days when brokers used to routinely default on payments, thanks to the regulatory reforms that have taken place in recent years. The strict and alert surveillance system of the Securities and Exchange Board of India (SEBI) has thwarted the possibility of any major scams or malfunctioning in the system. Margin and net worth requirements minimise the risk of defaults at the brokers’ end. The recent rules that have reduced overall intraday margins in the Futures and Options segment, although they may look as hurting traders in the short term, are good long-term measures to reduce overall risk and the possibility of financial instability in the system by way of trader bankruptcies or trader firm/broker defaults.

High transparency: Online trading, as compared to the ring-based trading system, has introduced transparency in trading and pricing. In this system, you can place ‘buy’ and ‘sell’ orders directly (without the intervention of your brokers’ representatives), decide price limits, put a stop loss (and keep changing it), know the status of the order and stay informed about its execution immediately. Online trading has also reduced costs for both traders and investors.

Easy access to back-end accounts: Online trading also ensures that you have access to your back-end accounts all the time, thus enabling you to know your stock and cash position. Further, the online system ensures you also have ready access to all your previous investment statements.

No conflict of interest: Watertight compartmentalisation of proprietary trades (i.e. trading for self in own account) and client transactions also protect innocent clients from any wrongdoings by the brokers. SEBI has clearly laid out procedures to effectively prevent any conflict of interest between customer trading and proprietary trading activities.

Disadvantages

Highly volatile: Stock markets are volatile and highly dynamic. We live in a technologically-driven world that is constantly shrinking. An event in any corner of the world may impact the price of the stock you are holding. Also, stock prices go up and down multiple times within a single trading day. Volatility touches its peak on some days with important events like the Budget, elections and announcements such as GDP numbers and results by leading companies.

Highly risky: Volatility and the unpredictability of the market make it highly risky, especially for small-time traders who don’t have access to high-quality research. If enough precautions are not taken at the appropriate moment, stock trading can wipe out your entire capital in no time.

Malpractices: Despite the fact that the regulator has intensified vigilance, some still take advantage of loopholes in the system. As a result, some traders are at an advantage as they are privy to information such as purchases by parties close to management, expected company results, auction data released by the stock exchanges, etc.

High volume, low margin: Despite the fact that stock trading can be started with low capital and no educational qualification, stock trading is a high volume-low margin profession, due to which the odds are usually stacked against the trader.

Taxation: The taxation framework for trading in India can sometimes not be clear, leaving the assessee at the mercy of income tax officers. The law is not clear yet whether the results of frequent short-term buying and selling should be treated as capital gain/loss or as business income. This often leads to harassment of traders at the time of assessment.

Impulsive decisions: The ease of opening accounts with brokers and the need for a small initial investment many times tempt newcomers to act on impulse. Fuelled by a lack of knowledge and unable to differentiate between rumours and facts, they end up making huge losses. Though the profession itself is not a wrongdoer, in this case, such situations arise mainly due to a lack of investor awareness programmes.

Points to remember:

  • Stock trading allows you to be as good as you want to be
  • You are your own benchmark and competition
  • Losses happen mainly because of the mistakes traders make
  • Weak enforcement of rules or system manipulation by some unscrupulous people are some of the negatives, like in other professions
  • Newcomers can avoid losses through in-depth research, study and analysis
  • And lastly, there are no shortcuts to success
All Modules