First Step To Investing | A Beginner's Guide

Learn To Invest, a Beginner's Guide

Wouldn't you love to be a business owner? Imagine if you could sit back, watch your company grow, and collect the dividend checks as the money rolls in!

This situation might sound like a dream, but it's closer to reality than you might think. As you've probably guessed, we're talking about owning stocks. This fabulous category of financial instruments is, without a doubt, one of the greatest tools ever invented for building wealth. 

When you start on your road to financial freedom, you need to have a solid understanding of stocks and how they trade on the stock market.

WHAT IS SHARE MARKET?

A share market is where shares are either issued or traded in.

A stock market is similar to a share market. The key difference is that a stock market helps you trade financial instruments like bonds, mutual funds, derivatives as well as shares of companies. A share market only allows trading of shares. 

The key factor is the stock exchange – the basic platform that provides the facilities used to trade company stocks and other securities. A stock may be bought or sold only if it is listed on an exchange. Thus, it is the meeting place of the stock buyers and sellers. India's premier stock exchanges are the Bombay Stock Exchange and the National Stock Exchange.

There are two kind of markets: Primary & Secondary Market

Primary Market:

This where a company gets registered to issue a certain amount of shares and raise money. This is also called getting listed in a stock exchange. A company enters primary markets to raise capital. If the company is selling shares for the first time, it is called an Initial Public Offering (IPO). The company thus becomes public.

Secondary Market:

Once new securities have been sold in the primary market, these shares are traded in the secondary market. This is to offer a chance for investors to exit an investment and sell the shares. Secondary market transactions are referred to trades where one investor buys shares from another investor at the prevailing market price or at whatever price the two parties agree upon. Normally, investors conduct such transactions using an intermediary such as a broker, who facilitates the process.

WHAT DOES THE SEBI DO?

Stock markets are risky. Hence, they need to be regulated to protect investors. The Security and Exchange Board of India (SEBI) is mandated to oversee the secondary and primary markets in India since 1988 when the Government of India established it as the regulatory body of stock markets. Within a short period of time, SEBI became an autonomous body through the SEBI Act of 1992. SEBI has the responsibility of both development and regulation of the market. It regularly comes out with comprehensive regulatory measures aimed at ensuring that end investors benefit from safe and transparent dealings in securities.

Its basic objectives are:
  • Protecting the interests of investors in stocks
  • Promoting the development of the stock market 
  • Regulating the stock market
Now that we are done with the basics, let’s move on to some terms and concepts you would frequently hear with respect to the stock markets.

WHAT ARE BULL AND BEAR MARKETS?

Markets are often described as ‘bull’ or ‘bear’ markets. These names have been derived from the manner in which the animals attack their opponents. A bull thrusts its horns up into the air, and a bear swipes its paws down. These actions are metaphors for the movement of a market: if stock prices trend upwards, it is considered a bull market; if the trend is downwards, it is considered a bear market.

The supply and demand for securities largely determine whether the market is in the bull or bear phase. Forces like investor psychology, government involvement in the economy and changes in economic activity also drive the market up or down. These combine to make investors bid higher or lower prices for stocks.


WHAT IS MARGIN TRADING?

Many traders trade on the Stock Market using borrowed funds or securities. This is called margin trading. It is almost like buying securities on credit. Margin trading can lead to greater returns, but can also be very risky. While it lets you actively seize market opportunities, it also subjects you to a number of unique risks such as interest payments charged for the borrowed money.

WHAT IS MAHURAT TRADING?

Every year, the stock market is open for a few hours on the first day of Diwali. A special trading session conducted for an hour on the auspicious occasion of Diwali. Usually this takes place in evening. Mahurat trading has been going on for over 100 years on the Bombay Stock Exchange. It marks the beginning of a new financial year called 'Samvat'.

WHAT IS STOCK VOLATILITY?

Stock prices constantly fluctuate. This is because the demand for the stock changes. As more stocks change hands, greater is the change in its share price. This is called stock volatility. Even the amount of volatility in the market changes on a daily basis.

To measure this volatility, the National Stock Exchange introduced the VIX India index, also called the fear gauge. VIX is often used as an indicator of stock price trends. This is because, VIX rises when there is more fear and uncertainty in the market. This means, investors perceive an increase in risk. This usually follows a fall in the market.

What are Small-cap stocks

‘Cap’ is the short form of ‘Capitalization’. As the name suggests, these are stocks with the smallest values in the market. They often represent small-size companies. Generally companies that have a market capitalization in the range of up to Rs. 250 crore are small cap stocks.

These stocks are the best option for an investor who wishes to generate significant gains in the long run; as long he does not require current dividends and can withstand price volatility. This is because small companies have the potential to grow rapidly in the future. So, an investor may profit by buying the stock when it is cheaply available in the company’s initial stage. However, many of these companies are relatively new. So, it is difficult to predict how they will perform in the market.

Being small enterprises, growth spurts dramatically affect their values and revenues, sending prices soaring. On the other hand, the stocks of these companies tend to be volatile and may decline dramatically.

What are Mid-cap stocks

Mid-cap stocks are typically stocks of medium-sized companies. Generally, companies that have a market capitalization in the range of Rs. 250 crore and Rs. 4,000 crore are mid-cap stocks.

These are stocks of well-known companies, recognized as seasoned players in the market. They offer you the twin advantages of acquiring stocks with good growth potential as well as the stability of a larger company.

Mid-cap stocks also include baby blue chips – companies that show steady growth backed by a good track record. They are like blue-chip stocks (which are large-cap stocks), but lack their size. These stocks tend to grow well over the long term.

What are Large-cap stocks

Stocks of the largest companies in the market such as Tata, Reliance, ICICI are classified as large-cap stocks. They are often blue-chip firms.

Being established enterprises, they have at their disposal large reserves of cash to exploit new business opportunities. However, the sheer size of large-cap stocks does not let them grow as rapidly as smaller capitalized companies and the smaller stocks tend to outperform them over time.

Investors, however, gain the advantages of reaping relatively higher dividends compared to small- and mid-cap stocks, while also ensuring the long-term preservation of their capital.

What are Blue-chip stocks

These are stocks of well-established companies with stable earnings. These companies have lower liabilities like debt. This helps the companies pay regular dividends.

Blue-chip stocks are thus considered safe and stable. They are named after blue-colored chips in the game of poker, as the chips are considered the most valuable.

What are Defensive stocks

Defensive stocks are issued by companies relatively unmoved by economic conditions. Best examples are stocks of companies in the food, beverages, drugs and insurance sectors.

Such stocks are typically preferred when economic conditions are poor.

WHAT ARE STOCK QUOTES?

You must have often seen a ticker on a business news channel on the TV or on the huge billboard outside the Bombay Stock Exchange, constantly showing a bunch of letters and numbers in green or red lettering. These are stock quotes. The bunch of letters you see is a stock symbol, while the numbers that follow signify the stock price.

What are stock symbols?

A stock symbol is a unique code given to all companies listed on the exchange. Once you know the stock code or symbol of the company, you can easily obtain information about the company. This is important for investors who wish to conduct a financial analysis before purchasing a company’s shares. For example, TCS stands for Tata Consultancy Services, while INFY stands for Infosys.

Often, it is not possible to write the full name of a company. It would take up a lot of space on the ticker board or stock table. In such a case, the stock symbol comes handy and it is just 3-4 letters. For this reason, stock symbols are also referred to as ticker symbols. So, when you are searching for a stock, typing the stock symbol will directly lead you to the company’s page, which will give you all possible details.

HOW TO READ STOCK QUOTES?

The stock table – available in financial papers and online – contains the information of all stocks. It can be a little confusing to understand. It has the following elements:

Company name and symbol: 

The stock table needs space to fit in details of as many shares as possible. There is thus a space crunch. For this reason, company symbols, and not names, are used. On the internet, though, company’s names too are given. This helps you identify the stock.

Stock price: 

This is the price an investor or trader pays to buy a single share of the company. This fluctuates constantly during market hours, and remains constant when markets are closed for trading. It reflects the value the market has allotted to the company.

High/low:

During market hours, share prices keep changing as more trades are conducted. This is because buying makes the stock more valuable, while selling makes it less valuable. This in turn affects the share price. To give an investor a basis for comparison, the stock quote mentions the highest and lowest prices the stock hit in that day. If the share price is constantly rising, the ‘high’ would keep climbing. In the same way, the ‘low’ would keep falling in a down market. Once the market closes, the difference between the highest and the lowest prices gives an idea about the volatility in the stock’s price.

Close:

Stock prices stop fluctuating once the market is shut for trading. The ‘close’ or the ‘closing price’ thus reflects the last price at which the stock traded. During the market hours, it represents the previous day’s closing price, again giving investor a benchmark to compare against. Since the newspaper is delivered in the morning, it reflects the price at which the stock closed the previous day.

Net change:

The closing price also helps calculate how much the stock’s price has changed. This change is written in both percentage as well as absolute value format. It is calculated by subtracting today’s price from the previous closing price, and then dividing with the closing price to get the percentage change. A positive change indicates the stock price has increased from the previous day. When the net change is positive, the stock is written in green color, while red color is used to denote share price has fallen. 

Volume: 

If a company has a stipulated number of shares floated on the exchange, not all of them may be traded in a single day. It depends on demand for the stock. This is understood in the ‘volume’ section of the stock quote, which shows how many stocks changed hands. A higher trading volume is usually followed by a significant change in the stock price.

52-week high/low: 

This shows the highest and lowest stock price in one year or 52-weeks. This too helps the investor understand the stock’s trading range over a broader period of time. PE Ratio: Some stock tables and quotes also mention.

PE ratio:

This is the amount an investor pays for each rupee the company earns. It is calculated by dividing the stock price with the company’s earnings per share. This is important because stock price is a market-assigned value. It largely depends on market sentiment about the stock, and hence may not be in synchronization with the share’s internal value. The PE ratio, thus, helps give perspective about the share’s value in comparison to the company’s financial performance. A high PE ratio means the stock is costly, while a low PE ratio means the stock is cheaply available.

What are stock market indices?

You may often hear people speaking that the ‘market’ fell one day, or that the ‘market’ jumped. However, if you read the stock table, you will realize that not all stocks rose or fell. There were some which moved in the opposite direction. Then, what does the ‘market’ mean? 

It means an index. 

From among the stocks listed on the exchange, some similar stocks are selected and grouped together to form an index. This classification may be on the basis of the industry the companies belong to, the size of the company, market capitalization or some other basis. For example, the BSE Sensex is an index consisting of 30 stocks. Similarly, the BSE 500 is an index consisting of 500 stocks.

The values of the grouped stocks are used to calculate the value of the index. Any change in the price of the stocks leads to a change in the index value. An index is thus indicative of the changes in the market. 

Some of the important indices in India are: 

Benchmark indices – BSE Sensex and NSE Nifty 
Sectoral indices like BSE Bankex and CNX IT 

 Market capitalization-based indices like the BSE Smallcap and BSE Midcap Broad-market indices like BSE 100 and BSE 500.

HOW ARE STOCK INDICES FORMED?

An index consists of similar stocks. This could be on the basis of industry, company size, market capitalization or another parameter. Once the stocks are selected, the index value is calculated. This could be a simple average of the prices of the components. In India, the free-float market capitalization is commonly used instead of prices to calculate the value of an index.

The two most common kinds of indices are – Price-weighted and market capitalization-weighted index.

What is stock weightage? 

Every stock has a different price. So, a 1% change in one stock may not equal a similar change in another stock’s price. So, the index value cannot be a simple total of the prices of all the stocks. Here is where the concept of stock weightage comes into play. Each stock in an index has a particular weightage depending on its price or market capitalization. This is the amount of impact a change in the stock’s price has on index value.

Market-cap weightage 

Market capitalization is the total market value of a company’s stock. This is calculated by multiplying the share price of a stock with the total number of stocks floated by the company. It thus takes into consideration both the size and the price of the stock. In an index using market-cap weightage, stocks are given weightage on the basis of their market capitalization in comparison with the total market-capitalization of the index. For example, if stock A has a market capitalization of Rs. 10,000 while the index it is part of has a total m-cap of Rs. 1,00,000, then its weightage will be 10%. Similarly, another stock with a market-cap of Rs. 50,000, will have a weightage of 50%. 

The point to remember is that market capitalization changes every day as the stock price fluctuates. For this reason, a stock’s weightage too changes every day. However, it is usually a marginal change. Also, the market capitalization-weightage method gives more importance to companies with higher m-caps. 

In India, most indices use free-float market capitalization. In this method, instead of using the total shares listed by a company to calculate market capitalization, only the amount of shares publicly available for trading are used. As a result, free-float market capitalization is a smaller figure than market capitalization.

Price weightage 

In this method, an index value is calculated on the basis of the company’s stock price, and not market capitalization. Stocks with higher prices have greater weightages in the index than stocks with lower prices. The Dow Jones Industrial Average in the US and the Nikkei 225 in Japan are examples of price-weighted indices. There are also other kinds of weightages like equal-value weightage or fundamental weightage. However, they are rarely used by public indices.

WHAT IS TECHNICAL ANALYSIS?

In technical analysis, the analyst simply studies the trend in the share prices. The underlying assumption is that market prices are a function of the supply and demand for the stock, which, in turn, reflects the value of the company. This method also believes that historical price trends are an indication of the future performance.

Thus, instead of assessing the health of the company by relying on its financial statements, it relies upon market trends to predict how a security will perform. Analysts try to cash in on the momentum that builds up over time in the market or a stock.

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First Step To Investing | A Beginner's Guide First Step To Investing | A Beginner's Guide Reviewed by Admin on July 19, 2019 Rating: 5

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