Sunday, January 10, 2010

New to investing in shares? Here are some dos and don'ts:

It often happens that the first-time investors take to investing in shares motivated by the fascination toward the stock market, and in most of
the cases they ignore the rationale behind a rise or fall of a company’s share. It is not always the case that whoever enters the stock market, leaves with a neat profit. Rather, it is much easy to enter the market, and equally tough to stay invested and make profits consistently. Listed below are certain dos and don’ts for those who are new to the volatilities of the stock market.


If your objective is make a quick buck in a short span of time – then you need luck more than anything else to be successful. Be ready to suffer the losses as well because in the short term share prices can move sharply in either direction without any apparent reason. Best is to avoid equity investing if you don’t have a clear idea about that company. Approach with a proper plan before you start buying into shares. Check the company’s financials and its business before you put in your money in it.


Educate yourself about how the market works before jumping on the bandwagon. Seek professional advice and follow a gradual approach. Increase your exposure as you gain experience. Avoid burning your fingers to learn the tricks of the trade. And never ever invest by relying on tips given by your broker, a trader friend or office colleague. The best of experts can’t predict the stock price movements with certainty and very often those who suggest may have their own personal agenda.


Because, if markets turn adverse, frontline stocks are always liquid and you can sell your investments anytime and at least limit your losses. In contrast, small- and mid-caps stocks are subject to circuit filters, which means you cannot liquidate your investments in a falling market and thus your money gets locked. Besides, most of the A-group stocks belong to reputed business houses. If you stay invested for longer terms, there’s a very slim chance of losing money in these counters unless the market sentiments turn too bearish as it happened in 2008. Other advantages with A-group stocks are that, they are widely tracked by brokers and the financial media. This minimises the chances of nasty surprises, which can change the market outlook about the company overnight. In contrast penny stocks may even destroy your initial investment and may vanish without a trace. In such a scenario, if a first time investor burns his finger in the initial attempt there is a chance that he may resist investing in stock markets, which is not desirable.


Don’t be over-ambitious in your first attempt. This means following a conservative approach to portfolio building by using your surplus savings even if it amounts to a few thousands rupees every month. Best is to use only that part of your savings, which you are less likely to use in next one year under any circumstance. Never borrow money to play in the stock market, and neither should you get tempted to use the margin funding provided by many brokerages to first time clients. In the short run stock market may move in either directions for no apparent reason and as such an ambitious investment in equities may upset your financial plans.


Don’t be reckless while investing. Invest in limited number of well-known stocks with limited exposure in each stock. Never try to juice-up your returns by playing in the futures & options segment. F&Os are double-edged swords –just as they magnify your returns in good times, they also multiply your losses if your call goes wrong. It’s best to stick to the cash market, where at least you will own a share even if its price has fallen in the short-run. If the company is good there is a high probability that you may ultimately recoup your investments and even make money in the medium to longer term.


While gains may start accruing immediately after investing in a stock, investors generally, and firsttime investors in particular, are advised against booking profits on their investments in the short term. This is because little gains booked on your investments may not significantly contribute to your monthly income. But a long-term investment would provide not only a healthy capital appreciation but may also give you a regular and growing dividend income. Moreover, a long term investment in equities can prove to be a good source of wealth in later life.


First-time investors typically invest in stocks enticed by the noise and din created by a rising bull market. But you are better off entering the market when others are selling and the market or a particular stock is falling and not in flavour. Buying when everybody is buying raises your acquisition cost and minimizes the chances of an upside. There is no rocket science here, it’s a simple rule of life –higher an object goes, greater is the probability of its falling and vice versa. Remember in the stock market, nothing is guaranteed; you can just hope to improve your odds by buying low and selling high.


Don’t invest in a stock by just looking at its current market price, a stock with a lower market price compared to another stock in the sector doesn’t necessarily former is cheaper. A stock’s market price is a function of its number of floating shares, its net worth (book value), earning per share and its price to earnings multiple. It may happen that a stock with a market price of Rs 4,000 per share may be cheaper than a stock with market price of Rs 100 per share because the former may have few outstanding shares and very high earning per share say Rs 400 per share, which translates into a P/E multiple of 10. In contrast, the latter may have a very large number of floating shares and an EPS of say 5, which translates into a P/E multiple of 20. So, in the above example, the latter is twice as expensive as the former.


While investing in IPOs, select IPO of a company with a good track record and low valuation. Read enough about the company’s business and growth prospects before taking the plunge. While investing in an IPO for the first time, don’t subscribe to it with a short-term intention of making listing gains. This is because, not all companies end up producing gains for the investor immediately after the listing. Making a beginning in the stock market maybe a lot easier, but building a fortune takes time. One should be careful and must not overleverage. Well-known investor Warren Buffett said: “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

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