If you want to make trade decisions that yield better results, understanding the stock market is important. A deep understanding of a company’s financial statements and reports are required if you want to know which stocks to choose. Learning how to find out the value of a stock is also a crucial skill for traders in the stock market. All of these together will help you make better decisions and prevent you from investing in stocks that will give poor returns.
An introduction to stock markets:
The stock market is a system of trade where shares of companies that are publicly-traded are issued, and can be bought and sold. Contrary to a layman’s belief, trading in stocks is different from gambling. Suppose you bet Rs 100. If you win, you win X amount, and if you lose, you lose the entire Rs 100. On the other hand, if you invest in stocks, you win Rs X or lose Rs Y. You will rarely lose the entire amount that you invested. The stock market can also be viewed as a group of traders who pit their expertise against each other.
To begin trading in stocks, you need to create two accounts- a trading account and a DEMAT account. A DEMAT account is where your shares will be stored in a digital format. Your trading account will be used to buy and sell shares. Your savings account is linked to these to facilitate the smooth transfer of money.
Kinds of Share Markets
Primary Market- The market where the new stocks and bonds of a company are sold to the public for the first time is the primary market. Now, the company is said to be listed in the stock exchange. It is in the primary market that the company registers to raise money for itself by issuing some shares.
Secondary Market- After the company has registered itself; its shares are traded in another market, the second market. Investors can exit the investment they have made and sell their shares here. Investors buy shares from one another in market transactions which are called trades. Some investors rely on the assistance of brokers during this procedure.
The stock market primarily deals in four things.
4. Mutual Fund
Bonds– Companies need finances to undertake projects. Money borrowed is paid back with the profit made on the project. Bond is one of the ways of gathering funds. The fund borrowed from a bank is called a loan. A bond is when a company borrows from a group of investors. You can invest money by lending it to others through a bond. It is similar to a bank loan, where the time period, loan amount and interest rate is specified right from the beginning.
Shares– Companies issue their shares in exchange of money. If you own a share of a company, it basically means you own a portion of the company. Shares of companies are traded in the share market. A share is a certificate of ownership. As a stock holder, both the company’s profit and loss affect you. When the company whose stocks you owe makes profits, the value of its shares increases, and so do your profits.
Mutual Funds– If you wish to invest in bonds or shares indirectly, mutual funds come into the picture. What a mutual fund does is collects money from a group of investors, and then invests that amount in financial instruments. A professional fund manager takes care of this. A mutual fund scheme gives out units, which hold a certain value. You become a unit holder when you invest. When the company the mutual fund scheme has invested in makes money, you get money, since you are a unit-holder.
Derivatives– The value of all financial instruments fluctuates. It is very difficult to fix a price. This is when derivatives come into the picture. Derivatives help you fix a price now, that you can trade in in the future. In a derivative, you agree to either buy or sell a share at a specific fixed price.
Understanding the Stock Market
We know that the stock market may seem like a strange, unfamiliar place that confuses people. Some people compare investing in stocks to acts of gambling, both of which have high chances of failure according to them. These fears mostly stem from the experiences of family members and friends, and while they are understandable, they are not the whole truth. People who think in such a fashion do not have a thorough understanding of the stock market, and their fears are guided by poor knowledge.
On the other end of the spectrum are people who see the stock market as the solution to all their problems. They feel like they should invest in stocks long term, but are not sure how to go about it. These people often depend on professionals to influence their decisions, and hence are perennially uncertain of how things work.
It is the second group of individuals who are more at risk than the first. While the first group will invariably miss out on the benefits of the stock market trade, the second will most likely make wrong moves, and end up losing a lot of money. Or, they might expect good returns, and be disappointed repeatedly only by mediocre returns.
To prevent this, you just need to put in some effort to learn the basics of the stock market. If you learn a few techniques, you can also evaluate the balance sheets of various companies, make calculations and figure out which stocks you should invest in. To make an investment, you need to figure out the true value of the stocks, and then understand whether the current prices are going lower than this, and make timely investments.
The Adversarial nature of the stock market
The stock market is basically a collection of billions of investors who have opposing views. When one investor sells a particular stock, someone else is ready to buy it. So, what one trader finds worthy of letting go, another considers worthy of acquiring. Both the investors cannot be right. One of these investors will make a profit, while the other suffers a loss. So, it is extremely important to become familiar with and gather knowledge about any investment you are considering.
Why do Stock Prices Go Up and Down?
To know how to understand share market, you need to understand why the stock prices go up and down. Stock prices are influenced by multiple factors that determine whether they will go up or down. Factors like media, opinions of famous investors, political upheaval, natural calamities, risk factors, and supply and demand. The complex interaction of these factors, along with all relevant information about the stocks, is responsible for the creation of a specific kind of sentiment, and a resultant number of sellers and buyers. If the number of sellers is more than the buyers, the prices tend to fall. When the opposite happens, prices generally rise.
Why is it so difficult to predict the Stock Market?
Let’s imagine a scenario where there has been an increase in the stock prices for years. Investors know that a correction is round the corner which will upset the stock prices. What is unknown is the ‘what’ and the ‘when’- what will trigger it, and when will it happen. In that scenario, what can we do? Some will sit back with cash in hand, waiting for a suitable time to enter the trade. Some will be willing to take the risk and jump in. Now, the questions are- if you are waiting, how will you identify the right time to begin the trade? And how will you know when to exit it? In a world where the stock market was predictable, understanding the stock market would have been easier.
Before you invest, there are three things you should take into consideration.
Stock Valuation– Market activity determines the actual price of a stock. When you are wondering whether you should buy or sell, you should compare the fair value of a stock to its current price. Suppose the current price of a stock is Rs 30 per share, but you know that its fair value is Rs 40. That share might be a good buy. But, suppose the reverse is the case. Then the stock is considered to be overvalued, and it is best if you steer clear of it. How do you find out the fair value of a stock? There are multiple ways to calculate this. Combine the value of the company’s assets without the depreciation and liabilities on its balance sheet. This is one way to calculate the fair value. But, since different methods yield slightly different results, it is a bit difficult to figure out whether the price you have calculated is its fair value.
Triggering Event– So many factors can lead to a trend reversal which will upset the current price charts. Political upheaval, social causes, natural calamities, and all the other causes mentioned above can affect the prices. So, you should follow current events closely, as they may give you premonitions of upcoming trend reversals.
The Human Decision making Process– The third factor is the most difficult to predict. Since humans have logical and emotional sides, the interaction between the two can sometimes influence our decisions. No matter how logical we are during the procession of information, at times our decisions are swayed by emotions. The same thing happens in the stock market too, when individuals are making their investment decisions.
In the stock market, two of the most important decisions you are required to make are buying and selling. When is the best time to buy? When others are pessimistic about certain stocks. When you see other traders being optimistic, that is your time to sell. Always remember this when buying- your prospect of making a higher profit is greater when you buy a stock after its price has dropped. But, do not follow this rule of thumb blindly. If you see the stocks of a company, X, have dropped by 30-40%, you should first ask why? Why did such a decline happen? Did the prices of other stocks in that industry drop too? Was the price drop similar to company X? If you see that other companies in the same sector are performing better, this price drop might be specific to this company. You should formulate your own buying and selling routine, and stick to it.