- Date : 29/01/2021
- Read: 17 mins
The stock market has been witnessing substantial participation from retail investors. With many of them being first-timers, it is important to follow some tips that will enable them to invest and trade effectively.
The average interest rates offered on fixed and recurring deposits have been falling over the past few years. As of August 2020, the weighted average term deposit rates fell to 5.86%. In such a scenario, Indians have been increasingly warming up to financial assets such as stocks and mutual funds.
There is abundant information on the internet about stock markets, with many websites, blogs, and videos educating viewers in English as well as regional languages. The advent of discount brokerages, access to affordable and fast internet, and ease of opening accounts have encouraged many Indians to enter the stock market for the first time. This is validated by the fact that 4.9 million demat accounts were opened in FY 2020, which is an impressive 22.5% increase from the 4 million demat accounts opened in FY 2019.
There are primarily two types of investors who are investing directly in the stock markets for the first time: those who have never invested in any financial instrument (stock or mutual fund), and those who have been investing in mutual funds for a few years and now wish to directly invest in stocks. If you belong to either category and are just beginning your stock market investment journey, here are some useful tips to help you along:
Tips to help you across both investing and trading
One can either trade in stocks or invest and hold them for a long time. Here are some important points to consider for either of these activities:
1. Choose the right broker
Before beginning your investment or trading journey, it is imperative to choose the right broker. Nowadays, there are several discount brokerages that can help you save significantly on commissions. However, a full-service broker might be able to offer you services that a discount brokerage may not. So, you should choose a broker depending on your requirements.
2. Be clear whether you are planning to invest or trade
There is a running joke among seasoned market participants that if a trade goes wrong, it turns out to be a long-term investment. You should be clear about your objectives when buying shares – whether it is for long-term investment or trading. This will ensure that you are able to take suitable decisions while investing or trading.
3. Keep your investing and trading portfolios separate
It is recommended to have two separate accounts for trading and investing. Doing this will make it easier to track your returns and also have greater clarity.
4. Don’t invest more than what you are comfortable losing
Stock markets are volatile. Your temperament is likely to be tested when you find your portfolio in the red during certain phases of your investment journey. This may force you to withdraw your funds. There could also be instances when you need to withdraw funds for emergencies. If you do this when markets aren’t performing well, you could lose out on the potential of compounding.
So, the amount you wish to invest should be equivalent to a figure you don’t mind losing. For example, if you feel Rs 2000 per month is such an amount, you could begin your investing journey by investing Rs 2000 per month in fundamentally strong stocks. This way, you won’t have to feel gutted when the markets aren’t doing well.
5. Don’t invest on the basis of tips
Once you begin your investing journey, you are likely to receive stock tips from several sources. You could receive stock picking tips from social media platforms, messaging groups, friends, family members, your broker, etc. Before investing in any such stock, thoroughly scrutinise its fundamentals and future prospects. If they are up to the mark, you can invest. Otherwise, include them in your watchlist. Discard stocks with poor fundamentals.
Leading investors such as Warren Buffett and George Soros have spoken about the importance of holding a concentrated portfolio. However, this approach works well if one has done substantial research and also has deep conviction about the selected stocks. Otherwise, it is best to spread your risks and diversify by investing in stocks of various fundamentally strong companies.
7. Make use of technology
Although younger investors are well versed with most websites, applications and similar platforms which augment the process of investing, older investors who are starting off might want to explore websites such as ValuePickr and Stock Screener before starting on their investment journey. ValuePickr is a vibrant community for investors to share unbiased and credible information about stocks and their investment styles, while Screener is a useful tool that enables investors to evaluate various aspects of a stock.
8. Track a few shares before investing substantially
Most broking platforms offer a watchlist that can be used to track stocks. However, it is recommended that you take tiny positions in stocks that look interesting to you. This way, you would be able to track them regularly and take larger positions when valuations turn attractive.
9. Learn from your mistakes
Stock markets are a place where mistakes cost you money. You are likely to make mistakes during the first few years of your investment journey. However, it is important to realise your mistakes and learn from them. For instance, if you have taken large positions in stocks due to certain hot tips and have lost your money, it would be foolhardy to repeat this again.
10. Preserving capital is more important than capital appreciation
Warren Buffett famously said: “Rule no. 1 is to never lose money; rule no. 2 is to never forget rule no. 1”. This means that over a period of time, the principal amount that you have invested shouldn’t suffer substantial loss in value. Therefore, it is important to pick stocks whose prices don’t fall drastically whenever the market turns bearish. Such stocks should also have the ability to start performing and offer decent returns once the market turns bullish.
11. Don’t get attached to a stock
Sometimes, one gets emotionally attached to a stock. This could be hazardous as one may not want to sell shares of such a stock, even if it is underperforming or offering negative returns.
12. Keep a certain percentage of your capital in the form of cash
Since 2008, there have been 10 instances when the Sensex fell by more than 5% in a single day. However, the rally post such falls have been meteoric. It is prudent for both investors and traders to wait for such market crashes and swoop in to purchase fundamentally strong stocks that might be available at mouth-watering valuations. However, one may find oneself to be fully invested and without cash. So, 5% to 10% of your investing or trading capital should always be in cash. This will enable you to make the most of market crashes in the future.
13. Seek inspiration but don’t follow blindly
Retail participants often keep tracking investment decisions taken by successful investors and traders. They may even try to mimic their investing and trading styles. However, this may prove detrimental to retail participants who may not be privy to information that is accessible to successful investors and traders. So, while you can always seek inspiration from investors who have made it big, you should also strive to develop your own investing style.
14. Give it time before becoming a full-time investor or trader
Early successes in the stock market might tempt you to leave a steady job and pursue trading or investing full-time. Unfortunately, if things go south, you would not only suffer losses in your portfolio but also be without a stable source of income. Instead, you could set a goal of being a full-time investor or trader and work towards it. During this phase, you could also fulfil your responsibilities towards your dependents and create a corpus. These actions would provide a sufficient cushion during those months when your earnings as a trader or investor might be lean.
Tips specific to investing (you would want to buy and hold these stocks for a long time)
15. Be clear about your investing goals
Your investing goals can be short-term, mid-term or for the long-term. You might be looking to secure 25%-40% gains in a couple of years or your objective might be to earn dividend income. It is imperative for you to be clear about your reason for investing. This will ensure that you reduce the chances of taking improper decisions while investing.
16. Understand the business
Make an effort to understand as much as possible about the business of the company you are investing in. You could look at parameters such as the list of products/services being sold by the company, market share attained by each of its offerings, profit margins, future growth potential of the entire sector (and therefore, of the business), past and future growth rates, etc.
17. Look at businesses in your own line of work
You are likely to have extensive understanding about businesses in your line of work. So, it wouldn’t be a bad idea to evaluate listed companies in the industry you belong to. For example, if you are a part of the paints industry, you can explore listed companies in this sector and start investing in the ones that are fundamentally strong.
18. Learn how to analyse financial statements
Even if you don’t have a background in commerce or finance, you can learn how to analyse the financials of a business in just a few weeks. There are several books, websites, and videos that provide all the necessary information. Some important ones include profit-and-loss statement, balance sheet, and cash-flow statement.
19. Practice scuttlebutt
The ‘Scuttlebutt Method’ was introduced to the investment community by legendary stock-picker Philip Fisher in his landmark book Common Stocks and Uncommon Profits. As per this method, an investor must try to find out as much as possible about the business whose stock they wish to invest in. The investor should speak with vendors, distributors, and customers, and even interact with the management to get a holistic picture of the business. This requires time, effort, and commitment. However, the rewards would be well worth it.
20. Read about the management
If you are investing in Indian companies, it is critical to know about the management quality. Analyse whether management has consistently walked the talk over a span of time. If you find multiple instances of the management behaving inappropriately, it is best to avoid such firms.
21. Look out for red flags
Are management salaries and perks way above industry standards? Is the promoter shareholding consistently dropping? Is the cashflow volatile? Is the debt-to-equity ratio continuously increasing without any visibility on how debt is being put to use? Is the return on capital employed decreasing consistently? By scrutinising the annual reports, you would be able to get answers to all these questions. If there are too many red flags, it is best to exit and scout for better investment opportunities.
22. Be aware of your circle of competence
Back in 1996, in a letter to shareholders, Warren Buffet laid down the concept of ‘circle of competence’. This is a mental model that has been used successfully by several investors. According to this concept, it is important for an investor to be clear about what they know and what they don’t. For example, if you understand the IT sector really well, it would make sense for you to focus on fundamentally strong companies belonging to that sector. A simple method to figure out whether you understand a company’s business is to describe the same in 3-4 lines. This is easier said than done.
23. Keep learning
When it comes to investing, learning never stops. Most successful investors read extensively. These could be annual reports or financials or books on investing. You could even attend online or offline workshops, or courses offered by credible educators.
24. Be a part of a serious investing community (Like ValuePickr)
One of the best ways to improve your investing skills is to engage with experienced and successful investors. On a platform like ValuePickr, you will find discussion threads about several stocks. You can not only use these discussions to take better investment decisions but also enhance your own knowledge.
25. Keep evaluating your investments
Evaluate your investment portfolio at regular intervals to scrutinise its performance. This could be done once a year or every 18 months. Here is a brief checklist:
Is your portfolio heavily dependent on certain stocks or on certain sectors? If yes, you could further diversify it.
Are you up to date with information about each stock in your portfolio?
Are the returns generated by your investments beating the benchmark index?
Did you perform adequate research to pick every stock?
You can add more points to this checklist.
26. Reinvest dividends
Are you earning dividends from your stock holdings? Promptly redirect them into increasing your holdings. By reinvesting dividends regularly, you can augment your stock portfolio substantially over the long term.
Finally, a look at tips specific to trading in equities:
27. Create a trading strategy
Evaluate multiple trading strategies and choose the ones that could work for you. Some of these trading strategies could be end-of-day, swing, scalping, trend-based etc. Over time, as you hone your skills, you are sure to find a strategy that works well for you.
28. Don’t leverage and trade
Planning to trade in the markets using borrowed funds? This may not be a good idea. If the market tanks, you will find yourself servicing high-interest loans for a long time.
29. Start small and increase your trading capital steadily
Begin your trading journey with a few thousand rupees. Even if you make a loss, it won’t be much. Once you are consistently booking profits, increase your trading capital. Remember that the experience of trading with a few lakhs is completely different from trading with a few thousand rupees.
30. Don’t invest your retirement corpus
Taking up trading during the sunset of your career or after you have retired? Early success may tempt you to use your retirement corpus for trading. Never do that. For those who are beginning to trade in their 30s or 40s, it is recommended that you create a trading corpus after saving up for a few months. And then use that corpus exclusively for trading.
31. Fix and follow stop loss religiously
When you begin to trade in the markets, you will realise that managing your losses is significantly more important than earning gains on your profitable trades. Substantial losses in just 20%-25% of your holdings can erase your overall gains. Therefore, you must be ruthless with adhering to your stop losses.
Here’s an example of implementing an effective stop loss strategy: You have purchased a few shares of a stock priced at Rs 300 assuming that you might want to sell them off when they reach Rs 320. However, you have also kept a stop loss of 5%. Which means if your losses in this particular transaction hit 5%, you will immediately exit your positions.
You will realise the importance of this especially if markets end up falling for several days in a row. Certain stocks may experience losses of more than 30% and you wouldn’t want to be holding onto them.
32. Recovering losses requires a higher percentage gain than the percentage loss
Imagine you purchased a few shares of a stock priced at Rs 300. If it falls to Rs 240, this means you have made losses worth 20%. However, the journey from Rs 240 to Rs 300 would require you to gain 25%. This highlights the importance of adhering to stop losses mentioned earlier.
33. Don’t get greedy (sell once your target is reached)
In the 1987 movie Wall Street, Gordon Gekko famously quipped “Greed is good”. However, traders who are beginning their trading journey in the markets should religiously stick to selling the shares of those stocks that have achieved their price targets. It is better to have profits in hand rather than feeling good about notional profits.
34. Control your emotions
While trading in the markets, you could feel exuberant on days when your portfolio is performing well, and down in the dumps on days when your portfolio is bleeding. In either case, you should not take decisions that are clouded by extreme emotions.
35. Avoid trading in instruments you don’t understand
Don’t understand futures and options? Are you tempted to get into it because you came across a video on YouTube where a young trader is gloating about the profits he made by trading futures? Well, if you get into it without understanding the nuances of how futures work, you are likely to lose a substantial part of your capital. Trade in instruments that you understand. Once you have a fairly deep understanding of other instruments, you can dabble in them.
36. Trend is your friend
Avoid taking positions against the market while trading. Following the trend is prudent for a trader. For instance, if banking stocks are doing well, it makes sense for you to go with the flow and take positions in banking stocks.
37. Be open to short-selling
One can make money even when the markets are falling. This can be done by short-selling or shorting stocks whose prices are falling. Short-selling is the process of selling stocks (without owning them) and buying them back later during the day. For example, assume that a single share of a stock is priced at Rs 300 at 10 am. You believe that it may fall to Rs 295 or even lower within the day. Therefore, you place an order to ‘short’ 50 shares of this stock priced at Rs 300. Note that this happens without you owning the stock as you are only borrowing it. Once the price hits Rs 295 or lower, you will ‘short cover’ your position (buy back the shares), thereby earning a profit of Rs 5 per share or more.
However, shorting has to be done on an intraday basis, which means you will have to square off your positions within the same day. So, if the price of the stock goes above Rs 300, you would end up suffering losses.
38. Learn about indicators
If you wish to improve your chances of executing successful trades, you could consider learning about indicators. These are nothing but calculations plotted on price charts. Indicators enable traders to pick up signals and trends while trading. You can learn about moving average, exponential moving average, moving average convergence divergence (MACD), Bollinger bands, Fibonacci retracements, average directional index, standard deviation and relative strength index (RSI).
39. Avoid trading in illiquid stocks
Due to their propensity to give fantastic returns in a short span of time, illiquid stocks tend to be favoured. They could experience consecutive upper circuits and offer exponential returns within days or weeks. However, such stocks are likely to be controlled by market operators and just like they recorded consecutive upper circuits, they may also end up falling due to consecutive lower circuits and wipe out your investment.
40. Never catch a falling knife
There would be stocks which may fall significantly within a few days. You might be holding them or you might feel like entering them when their prices look attractive. For instance, Yes Bank started falling from 370-odd levels in August 2018 and was priced a little less than Rs 12 in July 2020. Anyone who thought about averaging their holdings in Yes Bank would have ended up quite unhappy.
You could copy these 40 tips into a document and print them out for easy reference. Before venturing into investing or trading (or both), ensure that your loved ones and you are covered by health insurance. You must also create an emergency corpus for times of need. This way your foundations will be strong – on which you can build your tower of wealth.