Here are a few key aspects of the stock market that new investors should be well acquainted with.
The basics of the stock market
The stock market to a great extent replicated real life. That is to say, if you treat it nicely, it treats you back nicely in return. But if you play around with it, it will naturally mess around with you. The stock market is not a place to make some quick money or to gamble for an overnight fortune. Instead, it is a place where you can create wealth for yourself over a long period. At the same time, you do not need great knowledge to make reasonable returns in the stock market. More important than the knowledge of individual stocks, financial trends and technical charts are your investing principles and discipline. Make sure that you enter the stock market only when you are prepared for a long term commitment, and are willing to take risks and bear losses from your side.
The power of averaging
Believe in averages, and get ready to celebrate exceptions. Have faith in the bell curve. 80 percent of all of us are average; and all of us are average outside our fields. The stock market is no exception. The stock market can give you a decent return over and above the deposit rate of returns that are offered by banks. However, as a part-time investor, you will be unable to catch the market when markets are low, and sell them when prices are high. Though exceptional returns do occur in the stock market for beginners and amateurs, they are rare events and happen largely due to lucky stock picks. Thus, it only makes sense to not wait for a miracle, but to always expect average returns on your investments. Make room for some exceptions, which could either be complete losses or high returns. When your expectations are average, you will be able to handle surprises better.
The importance of long term investing
This single factor can help you create massive wealth in the long run. Just like they say, investors never lose money in the stock market, only traders lose. The stock market is not a 100-meter race, rather it is a marathon. What you need to be doing is holding the stocks, and running for a long time to create real wealth. Thus, the underlying principle here is to buy stocks, Demat them, and then forget them. Sleepover your stocks; since fluctuations on a daily, weekly, or monthly basis mean nothing since this often happens for any or no reason.
Another long term principle is to be strict in terms of never pulling out your portfolio in panic, because of a sudden crash in the stock market. The stock market can always rebound over short term crises, so the key is to go long for a longer bank balance.
The cycle of time
Stock markets always go through repeated cycles of up and down, and no trend is permanent. Thus, taking an impulsive action to the fluctuation in price without considering the cycle of the stock market can have negative impacts on your portfolio forever. Therefore, when the stock market reacts to an economic downturn, do not react along with the stock market. If you can manage to stay for long enough in the stock market, and not get involved but stay a mere observer, all cycles and trends will ultimately give you an average return.
The inheritance of risk
Risks are integral to any and every stock market. There are no risk-free stocks. And while profits are not guaranteed, losses are! Everything in the stock market has a varying degree of risk, which you just cannot escape. What you could do at the max is to minimize the risk.
To reduce risk, try and invest money in small chunks over different periods so that you can get a better average price. And to further reduce risks, stay only with blue-chip companies and companies that make up the index, such as Sensex or Nifty; since these are all tried and tested companies. Alternatively, you can also start with investment only in mutual funds, and then proceed towards stocks later on.
The art of stock picking
The art of stock picking takes time to master, and even the best of experts can often go wrong. To know what stocks to pick, first know which stocks to not pick. Do not pick stocks based on tips by friends and family, SMS tips, tips on the discussion forum of popular websites, etc. While some of these random tips might work, most casual ones would not. Stay within the boundaries of industries that you can understand, and then develop basic knowledge about the following:
- Cash flows of the company
- The Earnings per share
- The Price to Earnings Ratio
- The industry PE ratio
Though there are other parameters, technical charts, and ratios that you need to analyze, the above parameters are very important and will give you enough information about whether or not the stock price is worth it. And once you buy the stock, Murphy’s law will operate, and all stocks will go up, while yours will go down. Make sure that you ignore this temporary movement.
Know when to exit
Exiting from stock is one of the most difficult things to figure out. Human greed tends to take over. When a stock has given you a return greater than what you expected, your mind will tell you to go on in the hope that the stock will double and triple, and thus you end up not selling the stock. However, make that hard call. Let go of greed, and exit well in time, before it gets too late.
Winning in the stock market requires time, patience, analytical work, and of course, lots of discipline. You are bound to fail initially through trial and error, but learning would soon come to you and give you enough knowledge to help you manage the market better.
Till then, happy investing!