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What to know before you invest in stocks

Track a sector that you are interested in to start with. If you work in the pharma industry, start by tracking pharma stocks as you are likely to understand the industry’s financials much better than others (Photo: iStock)Premium
Track a sector that you are interested in to start with. If you work in the pharma industry, start by tracking pharma stocks as you are likely to understand the industry’s financials much better than others (Photo: iStock)

  • Take trading decisions based on market cycles and fundamentals
  • Diversify and monitor your long-term stock selection and take corrective action if fundamentals change

While equity investing is best done through mutual funds for investors not well-versed with its complexities, the thrill of stock picking can be enticing. But investing directly into the stock market is not for everyone and it should certainly not be done with the intention of making a quick buck. The asset class demands diligence and a long-term view. According to Harsh Jain, co-founder and COO, Groww, an online investment platform, for equity to work out as an asset class, playing the long-term game is important rather than treating it as a get-rich-quick scheme.

So if you are planning to start investing in direct stocks, here are a few factors you need to consider.

Choose what you know

The principle of “invest in what you know" was popularized several decades ago by renowned mutual fund manager Peter Lynch. “Track a sector that you are interested in to start with. For instance, if you work in the pharmaceuticals industry, start by tracking pharma stocks as you are likely to understand the industry’s financials much better than others," said Nithin Kamath, co-founder and CEO, Zerodha, a stock broking and trading platform.

Of course, this runs the risk of having a concentrated portfolio, which is why we reccomend investing via mutual funds. Therefore, it’s important to learn the lessons early on and apply them as you diversify. For lay investors, equity investments are best done via diversified mutual funds, but you can take small exposure to stocks by adding a company or sector of your preference.

Take the IPO route

Another way for a new investor to test equity market waters is by investing in an initial public offering (IPO). It allows them to participate early in the growth of companies. Moreover, information is easily available and there is greater transparency about the price at which the IPOs are offered. An IPO means that there is greater scrutiny by market participants about the prospects of the company and its pricing. Tracking the available information will give prospective investors a good idea of which is a good IPO to invest in. This was demonstrated by the IPO of Indian Railways Tourism and Catering Corp Ltd., which was subscribed 112 times. But according to Kamath, as far as IPOs are concerned, the Indian market has a long way to go. “IPOs are a good way for new investors to enter the market. But India hasn’t had too many good IPOs. Perhaps when brands that retail investors can relate to put out IPOs, it will really take off," he said.

Do your due diligence

While a bull run in the stock market may seem like a joy ride with all stocks doing well, a downturn can be equally painful. There is no getting away from going through the process of stock selection to mitigate this. So be mindful of market cycles and have the patience to weather these. The Economy-Industry-Company (EIC) analysis is a good filter to apply to analyse stocks. It looks at the impact of macro and micro economic factors on businesses, the structure, competitive environment, regulatory aspects of an industry, and then the specifics of a company including its financial performance, product and markets, management, competition and other relevant factors to identify quality companies to invest in.

“Think in terms of buying a business. Ignore looking at only 52-week highs and lows only. Invest in good businesses," said Jain.

Follow the trend

If you don’t think you can keep up with what fundamental analysis entails, there is an alternative. “If the fundamentals are not of interest to you, forget all the news and rely on technical analysis. It can help you scan the whole market and automatically pick stocks that have momentum and are cyclically on the right side," said Kamath.

Technical analysis track historical stock prices and trading volumes to identify patterns and trends and use this information to make buy and sell decisions. It is suitable for making short-term investment calls to benefit from expected price movements and not for long-term asset allocation decisions. Kamath added that technical analysis strategy works well for retail investors who are starting off as most indicators wouldn’t allow them to go against the trend, thereby avoiding the biggest mistake one can make in the stock market.

Remember, this is a specialized area of expertise and not a DIY method. You will require a good analyst to give you advice. Assign only a small portion of your tactical portfolio to this method of investing.

Find the right platform

There are various retail stock trading platforms, most of which allow you to open a demat account for free. However, there are other charges involved like brokerage and intraday fees. You can also use an online aggregator like to calculate and compare the brokerage you will have to pay on your trading, and choose the platform that gives you the best deal and user experience. While most platforms and brokerages offer stock picks and tips, assess the quality of advice you receive if this is going to be an important aspect of your engagement with the broker.

As the saying goes, “you win some, you lose some". When it comes to trading in direct stocks, you should definitely be prepared for both. “You will lose money. Not even the world’s best investors always makes money. The idea is to make more than you lose. Initially, this might be hard but as you go forward, you’ll get better," said Jain.

“Often, people start with investing in a single stock rather than taking a portfolio approach—if this doesn’t do well, people sell and never come back to stocks. But equity returns need to be balanced with risk," said Vasanth Kamath, co-founder and CEO, Smallcase Technologies, a company that offers ready-made portfolios of stocks or ETFs to users.

The right approach is to diversify and monitor your long-term stock selection so that you can take corrective action if the fundamentals change. For the tactical, short-term investments, set price targets and exit when they are breached. There are costs and taxes associated with trading; so factor those in while making your trading decisions.

Sunita Abraham contributed to this

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