Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it.” – Peter Lynch.
Money makes the world go round. Everyday billions of people around the world flock to the stock markets in the hope of turning a quick fortune and becoming rich overnight. However most of these people do not do their homework properly.
If you are looking to achieve success in the stock market it is important that you get your basics right.
|How I made over 100K trading the markets?|
What is the stock market?
A stock market is where shares of publicly listed companies are traded. People buy shares if they believe that the price will go up and sell shares if they think the price will go down. It is peoples opinion that makes the stock market.
In the stock market when one person buys, the other sells and they both think that they are right.
Why do stock prices go up and down ?
Stocks are priced based on demand and supply. If demand exceeds supply, the prices will go up and if supply outweighs demand then prices will go down. The below graphic will make it clear.
Markets operate on the principle of price discovery. The demand and supply for a given stock at any point in time, determines the price for the stock at that point in time. Demand and supply keep on varying as a result of news and change in opinions. Positive news such as share buyback or appointment of a competent manager can create high demand for a stock, on the other hand reports of insolvency and financial irregularities can cause investors to dump the stock thereby creating heavy supply.
Need for investing in the Stock Market
One thing we all can agree on is that we like to see our money grow
Money cannot grow by itself. In order for money to grow, we need to invest it somewhere. There are various investment options available such as
#1 Saving Accounts and Fixed Deposits
This is the safest investment option available. Here there is no risk of loosing money, but the returns may not be enough to cover the effects of inflation.
#2 Real Estate
This kind of investment is much more complex and involves a lot of legal work and a large cash commitment. The returns can be in the form of rent or value appreciation.
#3 Precious Metals
This is another popular investment option. Gold in India is more than an investment option, it also has sentimental value attached to it. Investment in gold and silver has yielded CAGR returns of 8-9% historically.
Equities trump all investment options mentioned here, they deliver 15% returns CAGR which more than cover the cost of inflation. You can start equity investments with small amounts and no large cash outlay is needed. Investing in blue-chip companies can yield up to 20% CAGR returns which is way more than what precious metals have to offer.
It is important to note that long term returns on equity investments are tax free.
How can you play the markets?
Now that you have a fair understanding of the stock markets, let us look at some of the ways you can be a part of the markets.
#1 Direct Investment
Anybody who has a deemat account can purchase shares of his choosing on the exchange. The orders can be placed electronically using the traders platform or through phone. To place an order over the phone, you need to call your broker, who will verify your credentials and place the order for you.
You can purchase as little as one share or thousands depending upon your need and ability. You need to do a lot of research before selecting a stock for direct investment if you are to be a successful investor.
#2 Mutual Funds
Mutual funds are a great way to play the market for those people who lack the skill and the resources to play the market on their own. Mutual funds are managed by professionals who have a greater understanding of the markets and often deliver greater returns than what ordinary individuals can achieve on their own.
Thanks to the recent out-performance of equities as an asset class, mutual funds have seen record inflows.
#3 Equity Derivatives
Since it’s introduction, the derivatives markets has grown by leaps and bounds and now the derivative market clocks volumes higher than that of cash market. Derivatives help you make money by betting on the future price action of a stock or commodity.
Amongst the three options mentioned above, investment in derivatives is fraught with great risk, but offers the greatest reward. In derivatives it is not uncommon to double or triple your money within a single trade.
Future & Options are examples of derivative trades. We will be exploring these more in the coming articles.
Types of Market Participants
People who buy/sell shares in the market are referred to as market participants. Market participants can be broadly classified as traders and investors.
Traders are people who buy/sell equities with the sole aim of making a profit in the least amount of time. Their actions are mostly driven by news, charts or price differences across market. Their outlook can span anywhere from a few minutes to a few months.
These typically make hundreds of trades a day and aim to make small profits per trade. A typical trade for a scalper would buy a 1000 shares of stock A for 10$ and hope to sell for 11$.
In order to make money through scalping you need to have a broker who charges extremely low brokerage.
B. Day Traders
These type of traders typically make 5-6 trades per day. They close all their trades before the market closes so as to avoid any event risk that may happen overnight. This requires good knowledge of the markets and fast decision making skills. It is not advised for beginners.
C. Swing Traders
A swing trader holds his trades for longer as compared to a scalper and a day trader. A typical swing trade could last from a few days to a few weeks. The greater time frame allows the trade to evolve and make a large profit if the trade works out.
Arbitragers make money by exploiting the price differences of a stock that is traded across multiple exchanges. An arbitrager will simultaneously buy at the lower price and sell at the higher price, making a profit when the price converges.
Investors are not typically concerned with the daily price movement of their stocks. A typical investment may span years. A longer holding period allows the investment to grow and yield a handsome profit in the end, cancelling out any shocks that may arise as a result of short term volatility.
Depending upon the research one is willing to do, investors can be classified as.
A. Active Investors
These type of investors track their investments closely and monitor the news surrounding their investments to spot any change in trends. They don’t typically buy one day and sell the another, but closely watch the price movement and sell their investment if they notice a significant change in tend.
B. Passive Investors
These types of investors do not aim for the biggest gains, but are satisfied by reasonable gains, in return for a less hectic lifestyle. These investors typically invest in large reputed companies and wait a few years for their investment to turn profitable. Most of these play the market through mutual funds.
Stock Market Terminology
Some of the market jargon can be confusing if you are a newbie. Here is a list of terms commonly used in the markets.
Stock market where prices rise more than they fall.
Stock market where prices fall more than they rise.
Refers to the bias of the trader. Trader looking to buy is said to be long.
Refers to the bias of the trader. Trader looking to sell is said to be short.
Gap Up & Gap Down
When the price of a stock opens significantly higher/lower than the previous days closing price.
A market that moves in a particular direction with some strength is said to be trending.
52 Week High / Low
The highest price for a stock in a year (52 weeks) is referred to as 52 week high, similarly, lowest price for a stock in a year (52 weeks) is referred to as 52 week low.
52 week highs are bullish for the stock as they signify demand, whereas, 52 week lows are bearish for the stock as they indicate supply pressures.
Investing in stock markets is just one of the paths you can take to build a secure future for yourself and your loved ones. It sure is risky and you could loose all your capital, but what data shows is the exact opposite. If you invest in the right stocks and stay invested over longer periods, not only will you get inflation beating returns but also a corpus large enough to achieve all your dreams.
Long term investments will give you compounding benefits which will further bolster your returns and what more long term investments are either tax free (depending on the tax jurisdiction you are subject to) or taxed at a rate lower than for other sources of income.
That’s it from me folks, do let me know what you thought in the comments section below. Let me know if you would like to read about anything in particular.
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