Every person dreams of boosting his/her monthly remuneration with some extra income. Many think the share market is an easy source of either alternative or supplementary income—a means to achieve overnight fortune. Others perceive it as a social evil that must be avoided. The concept of the share market as a place to gamble, where your hard-earned money is destined to be lost, is prevalent among middle-class, average Indians. Both views are mistaken.
Shares represent part ownership of a company. The principal owner of a company sells portions of ownership to buyers through an Initial Public Offering (IPO), often with a premium over its face value. The face value of a share is the pre-determined price attached to it at the time of the company’s registration. When you buy a share of a company, you become part owner of that company, though the lion’s share remains with the original owner.
The share market is divided into two segments: the cash or capital market, where shares of a company are bought and sold and is most familiar to the public, and the derivative market, where futures and options are traded. In this article, I will focus solely on the cash market.
The share market is like any other market where products are bought and sold. The primary difference is that the items traded in the share market are intangible. Previously, one could own a piece of paper called a share certificate, which proclaimed ownership of a specific number of shares in a particular company.
A unique feature of the share market is that you can first sell a product without owning it and then buy it! This practice is known as short selling. In the cash market, a share that is sold short must be bought back within the same trading day.
Times have changed, and so has the process of keeping records of shareholders. In today’s digitized world, all information is stored electronically. Shareholders no longer possess physical certificates because all shares are digitized or de-materialized and stored in their de-mat accounts with a depository. In India, there are two depositories: National Securities Depository Ltd (NSDL) and Central Depository Services Ltd (CDSL).
Nowadays, you can access your digitally stored shares with the press of a button on a phone, laptop, or desktop. However, to do so, you must have a de-mat account with a depository. You also need a trading account with a broker, which acts as a platform to trade or invest in equities, derivatives, and commodities, and serves as a mediator between the client and the depository. The broker is your depository participant. The place where these activities occur is called a stock exchange. The Securities and Exchange Board of India (SEBI) is the regulatory body that oversees and regulates these activities. In India, we have two stock exchanges: the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).
Gambling or Legitimate Business?
The dictionary defines gambling as “playing games of chance for money” or “taking risky action in the hope of a desired result.” Thus, gambling is associated with speculation. You can speculate in any field if you wish to, so why blame the share market alone? Ultimately, it is your decision whether or not to engage in speculation.
Speculation becomes an issue when money is staked on something you do not understand in the hope of making a spectacular profit. A person seriously involved in the share market, choosing it as a career, would never do that. They would take risks, yes, but calculated risks where risk and reward are pre-defined.
Investing in equities or shares is no different from other investments. In any investment, the profit gained is directly proportional to the risk involved—high risk, high gain; low risk, low gain. The gain or reward is high in the share market, but so is the risk.
But why is the share market so risky? The market is influenced by many factors that make it quite vulnerable and sensitive, such as:
- Global economic conditions.
- Global political situations.
- National political conditions.
- National economic conditions.
- Industry-specific conditions.
- Company-specific conditions.
- The expertise and transparency of the company’s board of directors.
However, the most significant factor that makes forays into the share market risky is the wrong decisions made due to improper knowledge of the market.
It is obvious that your first priority should be risk management to make your association with the share market profitable. The ability to manage risk comes with proper knowledge of the subject, allowing one to analyze a particular share before acquiring it.
How to Analyze a Share
Analyzing a share involves two broad approaches depending on the type of trade executed. There are two types of traders in the stock market: short-term traders, who hold shares for a short duration, typically less than a year, and long-term investors, who keep their shares for more than a year for a handsome gain. There are also very short-term traders who terminate their trades within the same day, with or without a profit. They are called day-traders.
To be an investor, you need lots of patience and a mindset capable of withstanding the anxiety and agony of watching your investment go through a roller-coaster ride. Long-term investors need to analyze their stocks fundamentally, while short-term traders require technical analysis to evaluate the price action of a stock.
Fundamental analysis can be broken down into two types:
- Quantitative Analysis
- Qualitative Analysis
Quantitative analysis deals with the company’s profit and loss account, balance sheet, and assets and liabilities. Qualitative analysis, on the other hand, looks at the background of the company’s management, their business ethics, and the details of their corporate governance.
Technical analysis doesn’t care about fundamentals. It focuses solely on the price action of a stock, which is the movement of the stock’s price. Technical analysts rely on chart patterns of price movement to identify the support and resistance levels of a particular share. A trader need not know the fundamentals of a stock since the goal is to achieve a quick gain of 4 to 5 percent. Gains may be higher, but the strategy is to exit the trade with a desired profit as quickly as possible.
How to Manage Risk
Fear and greed are the two emotions that guide the market—greed for money and fear of losing it. The highest priority in the share market is to protect the capital invested from the influence of these two factors. Risk management involves keeping these primal human emotions in check.
For long-term investments, risk management starts with fundamental research of the stock. Once a fundamentally sound stock is chosen and invested in with a long time horizon in mind, one can sit back relatively relaxed, ignoring the usual market fluctuations. In fact, a long-term investor can invest more during a market downturn if spare money is available, lowering the average cost of the shares held. However, nothing is permanent in the share market. Even a fundamentally good stock may decline due to sudden and unforeseen factors. If the price of the share drops 50 percent from its all-time high, consider it a warning signal. The company may have an issue that has weakened it fundamentally, indicating it’s time to sell and cut your losses. In share market parlance, this practice is called applying a stop-loss. Most investors cannot endure the agony of watching their investments decline that much and exit much earlier. Often, the stock, after losing, say, 30 percent of its value, rebounds and returns to its previous level, offering more than a 40 percent gain if you are brave and fortunate enough to buy at the lowest point.
For short-term trades (also known as swing trades, lasting a few days, weeks, or months) and day trades, the stop-loss is shorter too. Traders choose an appropriate stop-loss level according to their risk tolerance. Stop-loss not only cuts losses in a trade but also protects gains in a winning trade. All you have to do is adjust the stop-loss upwards as the price of the share rises, a practice known as trailing stop-loss. There are many techniques to apply stop-loss properly; a detailed discussion would make this article undesirably long. Those interested in learning more can easily access information online.
When to Buy and When to Sell
This is the most fundamental and tricky question in the share market. Common sense usually tells you to buy low and sell high, but “low” and “high” are relative terms in the share market. What seems high to you may be someone else’s entry point to that stock. However, there are parameters to judge the fair value of a stock that helps us determine when to buy or sell. A simple rule is to buy at a support level and sell at a resistance level. Technical analysis is all about identifying these levels. A separate article would be needed to delve into this subject in detail.
Conclusion
As I conclude, a few important points must be reiterated.
First, identify yourself as either a trader or an investor. This distinction makes a huge difference in how you operate in the share market.
Do not buy shares with borrowed money. Although the share market is not a gambling joint, substantial risks are involved. Your priority should be to protect your capital to stay in the market for the long term, which ensures profitability.
Do not sell in panic and do not buy in euphoria. Instead, do the opposite. When everyone is selling in panic, you should consider buying high-quality stocks at a cheaper value. During buying euphoria, when a stock is widely discussed and most sought after, sell and take your profit. The share may continue to rise after you exit, but don’t fret—that’s part of the game.
This article discusses only the basic points, aimed at readers who are completely unfamiliar with the workings of the share market. I hope this brief overview encourages them to view the share market from a different perspective and sparks enough interest to give it a try. One last word of caution: before involving yourself in the share market, please acquire knowledge from every available source. That will be your greatest asset besides your money. Wishing you a profitable journey through the share market—happy trading!
