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With the changing demography of India, the younger working population has realized the importance of investment as a source to generate extra income and is looking for avenues to generate higher returns instead of parking their money in low-interest bearing instruments like fixed deposits or recurring deposits.

Most people looking for higher returns today have taken the indirect route of mutual funds, and most people are still wary of directly investing in the stock market, be it as an investor or as a trader.

The main reason people shy away from investing in stock market is because they feel stock market is an endeavour that requires immense expertise in financial domain.

Although it does require some amount of financial awareness and knowledge, it is not as complex as people make it out to be. It seems complex because of an overload of information and opinions regarding stock market. So, don’t worry; it is natural to feel a bit lost when you start any journey, and the stock market is no different.

With this blog, I will try to clear the clutter by giving you a complete overview of how the stock market works.

The Demand and Supply rule

Stock market functions on similar lines on which any other market operates i.e. the concept of Demand and Supply. Let me explain with a simple example from our day to day life. The price of onion increases when there is a shortage of supplies of onion due to factors like bad harvest, or transportation strikes. On the other hand, a surplus of supplies brings down the prices. Similarly, rise and fall of stock prices is governed by the same phenomenon of demand and supply.

Demand and Supply Rule

But how is this supply or demand created? Every private company that wishes to go public and get listed has to go through a process called Initial Public Offering or an IPO. An IPO is a method by which a company issues its shares for the first time to the public via Primary Market. Before getting listed on the stock exchange, newly issued shares are first offered to both institutional as well as retail investors in the primary market. Major portion of the issue is reserved for the “big players” or institutional investors while a small portion of the issue is offered to retail investors.

The IPO process continues for a period of 3-7 days where both type of investors can bid their purchase order based on the price band of the shares. If the demand for the shares is high, the stock goes oversubscribed or else it goes undersubscribed. Also, the number of shares to be issued is decided by the investment banks based on the capital required to be raised by the company. These newly issued shares create the supply.

After the IPO process, the company decides a date on which it will list the stock on the stock exchange (NSE or BSE). Based on the popularity of the shares during IPO, it can open at a higher or lower price on the stock exchange on the listing date. A higher price opening can result in Listing Gains for the investors. When the stock gets listed, it enters the Secondary Market where actual trading takes place.

Now, investors can trade these shares with other investors on an Intra-day time frame (i.e. buying and selling the stock on the same day) or on a Delivery time frame (i.e. holding the shares for one or more days) based on their preferred style of trading. The two type of trading positions that can be taken by an investor are Long Position (Buy low – Sell high) or Short Position (Sell high – Buy low). Short selling or Shorting is generally done with derivatives instruments.

The change in price of stocks in the secondary market is driven by demand and supply. As we know, the number of shares outstanding in the market is limited to the shares issued during the IPO.

How does the demand of stocks increase or decrease?

Whenever there is some positive news about a company, or when investors have a positive outlook for its future prospects, the demand for the share increases resulting in an increase in the share price. A negative news or negative investor outlook, the opposite happens and brings down the price.

How does the supply of stocks increase of decrease?

The number of shares outstanding in the market can be increased in case company decides to go for an FPO, stock split or issuance of stock dividend.

  • FPO: An FPO stands for Follow on Public Offer where a company issues additional shares to the public over and above what it had issued during an IPO. Generally, this process is conducted via private placement.
  • STOCK-SPLIT: A stock-split generally happens when a company decides to make its shares more affordable to the public. A 3-for-1 stock-split, for example, means that for every 1 share that an investor holds, there will now be 3. If a person has 100 shares at the price of Rs.30 each, then after a 3-for-1 stock split, he will have 300 shares at the price of Rs 10 each. Therefore, the total market value of a person’s holding remains unchanged. However, now there are more shares available in the market and the shares are more affordable for the public to invest.
  • BONUS SHARES: Bonus shares are additional shares given to the current shareholders of a company without any additional cost, based upon the number of shares that a shareholder owns. These are company’s accumulated earnings which are not given out in the form of dividends, but are converted into free shares. If a shareholder holds 100 shares at Rs 50 each, and companies issues 1:1 Bonus shares, he will get 100 more shares for free. So now, shareholder holds 200 shares at Rs 50 each, and the value of his shareholding has doubled, and also increased the number of shares available in the market.

Who can create an impact on the price of shares?

Though the price change is driven by supply and demand, this movement is majorly impacted by the institutional investors like mutual funds, banks, hedge funds etc. as they have huge amount of funds, it is easier for them to dictate the direction in which the price will move. So, to prevent price manipulation and protect the retail investors, the stock exchange has imposed a price band bordered by an upper circuit and a lower circuit. Whenever the stock price hits an upper circuit or lower circuit, trading is suspended for the remainder of the session. This helps to prevent the sudden spike in the price that can be created by the institutional investors with huge capital which can be detrimental to the retail investors.

Not only stock price, even the Nifty Index itself has an upper and lower circuit, which if hit, results in suspension of trading for 45 minutes. While individual stocks routinely hit upper and lower circuits now and then, the Nifty index itself rarely does so.

However, earlier this year, Nifty hit the lower circuits, on 13th March 2020 and 23rd March 2020, which led to 45 minutes halt in trading. The last time Nifty had hit the circuit limit was in May 2009 when it had hit the upper circuit just after 2009 Lok Sabha results.

So with this article, I have tried to demystify the working of the stock market in the simplest terms possible from a beginner’s perspective. Hope it has helped you in understanding the basics about the stock market.

Please mention in the comments below if you would like me to write on any specific topics related to stock market, and I will write a post on it in the days to come.

Until next time, keep learning and keep growing.

The Stock Market has always been a contentious topic. People are usually divided between two schools of thought – some think of the markets as gambling while some are attracted to it as legitimate business with huge earning potential.

If you are reading this article, then you most probably belong to the latter group. But in case you subscribe to the idea that the stock markets is just one big casino, then I will try to convince you otherwise in this article. Let’s go.

Even among those who believe that stock markets make you money, there exists different schools of thought – most commonly known as a “trader” or “investor”.

The basic difference between a stock market trader and a stock market investor is that a trader usually tries to look for short-term opportunities to make money based on the price movement of the stock, while an investor researches the core fundamentals of the company thoroughly before making any investment with a long-term time horizon.

The general public with little capital fall under the category of Retail Investors and big financial institutions like banks, asset management companies, mutual funds etc. with huge capital are called Institutional Investors.

SKILLS NEEDED IN STOCK MARKETS:

In order to beat the market or at least be competitive in it, you need to possess the skills required to perform stock market analysis. These skills are:

Technical Analysis

 It is a process based on the price movement and volume of a stock. There are various candlestick patterns (like flags, triangles, head and shoulders etc.) and indicators (like moving averages, RSI, VWAP, MACD, etc.) that are used in conjunction with the stock price to get an entry and target price for a trade. Though it sounds complex, it is an easily learnable skill.

I have written a detailed articled article on how to learn technical analysis which you can read here.

Fundamental Analysis

This method of analysis is used to arrive at the long-term potential of a company rather than making intraday trades. The holding period here is much longer than in trading and involves forecasting the long-term earning potential of the company. This is a more detailed way of analysis which requires good understanding of financial statements of a company and how to connect it with macro-economic factors, if any. Using this information, valuation professionals built financial models which help arrive at the value of the company which investors can then use to make a BUY/HOLD/SELL decision.

I have written a detailed articled article on how to learn fundamental analysis which you can read here.

TYPES OF MARKET INSTRUMENTS:

Now, let us look at some instruments that can be traded in the stock market based on the analysis.

Equity

Equity is a share of a company that a person can own. If a company has 1000 shares in the market and you buy 10 shares, then you are 1% equity or share holder of that company i.e. you own 1% of that company. Once you have purchased an equity share, you can own the shares as long as you wish or till the company exists. The return on investment in equity shares can come in 2 ways – a) through dividend payments or; b) through capital appreciation.

Dividend is a portion of profits shared by the company with its shareholders, whereas on capital appreciation is the increase in price of the shares over time.

Derivatives

These are instruments that derive its value from the underlying assets. For example: An equity derivative derives its value from the underlying respective equity shares. Similarly, a commodities derivative will derive its value from the various tradable commodities like gold, silver, crude oil, etc.

Following are the types of derivatives –

1. Futures – It is an agreement where the buyer/seller has the obligation to buy/sell the underlying asset on a pre-determined date at a pre-determined price. A lot size defines the quantity of shares in 1 futures contract. The advantage of trading in futures is the leverage and liquidity that it offers.

For example: Reliance Industries Ltd (RIL) has a lot size of 505, which means if you trade in futures of RIL, you will have to trade in multiples of 505. 1 lot = 505 shares, 2 lots = 1010 shares, and so on.

If you buy 505 equity shares of RIL from the market at CMP of Rs. 2225/share, you will have to invest approx. INR 11.20 lacs. On the other hand, 1 lot of RIL costs approx INR 2.90 lacs.

Though the use of leverage makes futures an attractive investment tool, it also makes it riskier than an equity share. So, in case of RIL, a Re.1 increase in stock price will result in a profit of Rs. 505 and a Re.1 decrease will result in a loss of Rs.505. You also have to pay some upfront money as a margin amount to buy a futures contract and if your position in the market bears losses, you will receive a margin call from your broker to add additional funds into your account in order to maintain the required margin. Failing to do so will lead to automatic squaring–off of your trade by your broker to prevent further losses.

Futures contracts are generally available for a three-month period – near-month, mid-month and far-month; Eg: for RIL futures contract in October 2020, near-month contract: OCT 2020, mid-month contract: NOV 2020 and far-month contract: DEC 2020 as shown in the image below.

Futures contracts also have an expiration date which in India is the last working Thursday of that month on which either you can square-off your position ie. close out your current position; or rollover your position ie. close your current position and take same position in next month’s futures.

2. Options – It is an agreement similar to futures where the buyer/seller agrees to buy/sell the underlying asset on a pre-determined date at a pre-determined price. The difference is that the buyer does not have any obligation to buy but the seller does have the obligation to sell if the buyer decides to exercise the option to buy.

The option buyer has to pay a premium to the option seller before buying the options contract. A Call Option gives the option holder the right to buy while a Put Option gives the option holder the right to sell.

An added advantage of options trading apart from leverage and liquidity is that the loss for option buyers is capped to the premium amount while the profit has no limit. This is because when the options position makes losses, the option buyer has the liberty to let the option contract expire on the expiry date as he does not have an obligation to buy.

So, all he will lose is a small option premium paid to the seller. But same cannot be said for the options seller as he is under an obligation. Though the risk-to-reward appears very attractive for options buying, amateur traders are advised not to trade in options as it involves knowledge of many other complex concepts such as option Greeks.

Understanding these concepts require in depth explanations and hands-on training which are covered in detail in our stock market course.

OPENING A TRADING ACCOUNT:

The next requirement to start trading is to open a trading account with broker who suit your trading needs. There are two types of brokers in the market – a discount broker and a full-service broker.

Some of the leading discount brokers are Zerodha, Upstox, 5paisa etc. and some full-service brokers are Kotak Securities, ShareKhan, Motilal Oswal, etc. Discount brokers charge cheaper brokerage fee than full-service brokers and it is highly recommended that you start your trading journey with a discount broker.

I personally use Zerodha as for my trading as well as investing needs since their user interface and brokerage charges suit my needs perfectly. You can open your account with Zerodha by clicking here.

There are also some websites which provide trading platforms for free. Some of them are tradingview.com. Their basic free plan provides all the features for charting and technical analysis that any beginner would need. For fundamental analysis, you can refer to screener.in. This website provides various fundamental parameters and ratio-based analysis of different companies which can aid in taking a position from a fundamental point of view.

Shown below is a screenshot of Nifty chart as seen on Tradingview.com

Even after collecting all kinds of information pertaining to stock market, the biggest dilemma that a person faces is with how much capital must he invest in stock market. My advice to newbie traders/investors will be to start with an amount which is not more than 10% of your monthly income. Under no circumstances must you trade with borrowed money or with money which you cannot afford to lose. I have written a separate article covering trading tips for beginners which you can read here.

This was a small effort to answer the most commonly asked queries and doubts we get from students, and I hope this article makes it a little easier for you to start your trading journey.

This article will focus on fundamental analysis stocks and other important terms in details for beginners, including Definition, Importance, comparison with Technical analysis, stock picking guide and much more.

Fundamental Analysis

  • Fundamental analysis is performed to identify and select stocks for long-term investment. 
  • It helps in estimating the intrinsic value (present value of the company’s future cashflows calculated using a discounted cash flow method) of the stock, which is deemed vital for long-term investment. 
  • The analysis is performed by evaluating the company’s financial statements viz Balance sheet, Income statement & Cash Flow statement. These statements help in acknowledging the past and current situation of the company that assists in forecasting the prospect of the company. 
  • Fundamental Analysis answers the vital question of “WHAT TO BUY?”

Why Fundamental Analysis important for long term investment?

  • As Benjamin Graham quoted in his book Security Analysis, Astute observers of corporate balance sheets are often the first to see business deterioration. This is the most important reason why Fundamental analysis is a must do task, to see if the company can stay afloat for a long time. 

Fundamental Analysis vs Technical Analysis

  • Fundamental analysis focuses on the long-term period while technical analysis focuses on the short-term period.
  • The former is majorly inclined towards stocks while latter is widely used in all asset classes.
  • Fundamental Analysis determines the intrinsic value to evaluate if the stock is undervalued or overvalued, while technical analysis focuses on the right time to enter & exit the trade.
  • Above mentioned are a few of the important differences between these two pillars of investment philosophy. Both techniques are equally great and one of these cannot be termed best. 

How to select a stock 

  • To select a stock the best way is to use a top-down approach (structured method) wherein an investor first selects a sector that has been performing well then advances to select a stock that is performing well among its peers. 
  • This method helps in mapping the sector and the stock that has the potential of giving good returns over the long-term.

Evaluation of financial statements

  • Financial statement analysis is the process of reviewing and analysing a company’s financial statements. These statements consist of Profit & Loss statement, Balance sheet, Cash flow statement, and statement of changes in equity (revaluation account).
  • Evaluation of these statements aids us in acknowledging the efficiency, liquidity, profitability, and solvency of the company.
  • It supports the analysis by providing us the past and present performance and by forecasting the future outcome of the company.
  • There are two types of statement analysis- Horizontal analysis & Vertical analysis

Horizontal Analysis- To analyse the information of the financial statements, a base year is selected generally the first year and all elements of the base year are standardized to 1 and further growth or fall in the future years is calculated relative to the first year.  

Vertical Analysis- It expresses all the elements of the statements in the percentage form. Vertical analysis standardizes the financial statement, eliminates the effects of the size of the company, and allows for comparison across companies. Most commonly, Sales/Revenue (for income statement) and Total assets (for balance sheet) are considered as the base value and other elements are calculated relative to them. 

Calculation of financial ratios 

  • Financial ratios are calculated using various components of the financial statements and are considered very important for fundamental analysis. It helps us gain a deeper understanding of the health of the company which may not be apparent from just looking at the Balance Sheet.
  • Amongst all the ratios, the three types of ratios mentioned below hold most importance as it deals with the important aspects of stock analysis.
  • The elements used are both from the income statement and balance sheet. Below are the categories of ratios, which is calculated for finding if the stock is worth investing, or not.
  • Liquidity ratios: This ratio aids in determining the company’s ability to pay short-term obligations like short-term debt, inventory, etc. A ratio above 1 is considered reliable. Below mentioned are the important ratios that must be calculated to check the liquidity ratio of the company:
  1. Current ratio = Current assets/Current liabilities (Here, Current assets includes cash, marketable securities, accounts receivables and inventory)
  2. Quick ratio (Acid test) = (cash + marketable securities + accounts receivables)/Current liabilities
  3. Cash ratio = (Cash + Marketable securities)/ Current Liabilities
  • Solvency ratios: This ratio evaluates the company’s ability to fulfil its long-term obligations, which is an important factor for investors who wish to stay invested in the stock for a very long period. Below are the important ratios that must be calculated to know where the company stands in terms of long-term debt solvency. Generally, a ratio below 1 is considered good and reliable.
  1. Debt-to-equity = total debt/total shareholders’ equity
  2. Debt-to-capital = total debt/(total debt + total shareholders’ equity)
  3. Debt-to-assets = total debt/total assets
  4. Financial leverage = Average total assets/ Average total equity (Here, average means; the sum of the value of the beginning and end of the period divided by 2)
  5. Interest coverage = Operating Profit/ Interest payments (A lower ratio indicates that the firm will have difficulty in meeting its debt payments)
  • Profitability ratios: It measures the overall performance of the firm relative to revenues, capital, equity, and assets and its ability to generate profits. It checks if the company is efficiently employing its capital or not. A ratio of 1 or higher is considered good. Below are the mentioned ratios that must be calculated:
  1. Net profit margin = Net income/revenue
  2. Gross profit margin = Gross profit/Revenue
  3. Operating profit margin = EBIT (operating profit)/Revenue
  4. Return on Assets = Net income/Average total assets
  5. Return on equity(ROE) = Net income/ Average total equity
  • Activity or efficiency ratios: This ratio indicates how efficiently a company uses and employs its assets. Below are few important ratios that are to be calculated for analysing the company. 
  1. Receivables turnover = Annual sales/revenue
  2. Days sales outstanding = 365/receivables turnover
  3. Payables turnover = purchases/average trade payables
  4. Number of days of payables = 365/payables turnover
  5. Inventory turnover = Cost of goods sold/Average inventory
  6. (Very important ratio for companies whose main business is manufacturing)
  7. Working Capital turnover = Revenue/average working capital

DuPont Analysis

  • DuPont approach is used to analyse return on equity (ROE). It decomposes the different drives of ROE.
  • The different drivers of ROE represent financial leverage, asset turnover ratio, and profit margin.
  • DuPont analysis aids in analysing which factor is helping the company grow and which is acting against its growth only to find out the pain point to fix it.
  • DuPont analysis has two variants viz three-part approach and extended five-part approach.

Original three-part approach: This approach breaks down ROE into three parts, which helps in specifying the elements of ROE. The specified elements help us in acknowledging what drives the ROE higher or lower. A low ROE can be due to a lower profit margin or poor asset turnover or too little leverage. 

Extended five-part approach: This approach further digs into the ROE formulae. It further divides the Net profit margin formula into three different parts, which consists of the tax burden, Interest burden & EBIT Margin. This explains that there are factors other than financial leverage that affects the Return on Equity. 

  • The breakdown has been shown below in the form of flow chart:
  • The overall analysis facilitates us in determining if the stock is fundamentally strong or weak and if the business can sustain for a long period or not. This helps us in meeting the end goal of deciding if the stock is worth investing in or not.

Ending Note

  • One thing that keeps fundamental analysis uncertain is the macroeconomic factor. It deals with the aggregate demand/supply and consists of GDP projections and results, budgets, employment levels, interest rates by the central bank, etc.
  • Where Macroeconomic indicators are poor, it can have a negative impact on the valuation of stocks as market sentiment turns negative.

Companies with good fundamentals will certainly find out ways to tackle such situations and hence investment must not be pulled out in panic. It is advised to close the position of any stock only after thorough analysis, or after consulting an investment professional.

In this article, we will delve in detail into the details of Technical Analysis, and see how a newcomer in the markets can obtain mastery over it . Following are a few pointers which you must know about Technical Analysis –

  • Technical analysis is a method of forecasting the direction of prices through the study of past market data, primarily price and volume. 
  • Technical analysis only deals with the secondary market.
  • This type of analysis works extremely well for short term trading (intraday or swing trading). It works on the assumption that price patterns in the market tend to repeat themselves because market participants behave in the same way in a similar situation. 
  • The main purpose of Technical analysis is to answer the question of “WHEN TO BUY?”  

Three basic principles/assumption of technical analysis

  • History tends to repeat itself – Market participants react to price actions in a similar manner every time prices move in certain directions.  
  • Stock prices move in trends – Stock prices move in uptrend, downtrend, or horizontal (sideways) trend. 
  • Market discounts everything – All known and unknown information is reflected in the stock market through price movements.

Learning Technical Analysis

Technical Analysis consists of various types of charts viz Candlestick, bar charts, Line graphs, point & figure charts, Heiken-Ashi chart, etc. Amongst these charts, the most commonly used is the candlestick chart as it helps in identifying various candlestick patterns, which are used to generate trade signals.

Let us now dive deep into learning technical analysis –

Types of charts

  • Charts form the most important part of technical analysis and there are various types of charts available, which helps in improving the analysis.
  • Candlestick, bar charts, line charts, Heiken-Ashi chart, point & figure charts, etc. are some of the charts available to market participants. They can select the charts as per their convenience, whichever would help them form their strategy.
  • Candlestick is one of the most popular chart types among technical analysts because it not only captures the OHLC (Open-High-Low-Close) but also helps in identifying candlestick patterns, which helps in taking trades accurately.

Understanding the trend

  • The first important point to understand while applying technical analysis is to identify the trend of the stock/security. 
  • We know that prices move in a trend. We need to first identify if the prices are moving upwards (shows uptrend) or downwards (shows downtrend). 
  • Understanding a trend is important because sometimes indicators give conflicting signals and hence a clear trend aids us in avoiding the trade with such divergent signals. 

Support and Resistance lines

  • Support lines refer to that level where prices often hit but fail to break below due to strong demand. At this level, buyers are likely to buy and sellers unlikely to sell. Support lines can temporarily change the short-term trend, which provides an opportunity for trade. 
  • The resistance line refers to that level beyond which the price of the stock is unlikely to increase. Here, the supply is likely to be heavier than demand, which forces the prices lower and results in traders taking short positions, while buyers wait for breakout (prices moving beyond the resistance line) to take a buy position.
  • The more time particular support or resistance is tested (touched and bounced off); the more significance is placed on that level. 
  • A move beyond the resistance or below the support emerges as a breakout, typically providing a good trading opportunity.

Channels

  • Channels are two parallel lines consisting of series of highs which acts as channel resistance and a series of lows, which acts as channel supports. 
  • These trendlines are considered strong resistance and supports, and prices move within the channel. It aids in anticipating the direction of the prices, which could support in taking trades wisely. 
  • A channel can be upward, downward, or horizontal. It plays an important role in intraday or swing trades. Besides, it helps in envisioning the directional movement of the stock over the long-term as well. 
  • There can be a minor violation of the channel as prices sometimes break it but re-enter the channel. It is known as “throw-over”

Candlestick patterns

Like mentioned earlier, Candlestick charts are one of the most preferred chart types among analysts. Apart from displaying the trend, it also shows various candlestick patterns, which is considered effective while trading, and these patterns complement the analysis. 

Some of the most effective candlestick patterns are as follows:

Engulfing patterns: Engulfing patterns are candlestick patterns consisting of two consecutive candles. The second candle engulfs (surrounds) the first candle. There are two types of engulfing patterns viz, Bullish Engulfing and Bearish Engulfing. Bullish Engulfing forms at the bottom of the downtrend and Bearish Engulfing forms at the top of the uptrend.

DOJI candle: DOJI candles are neutral candles that show indecisiveness in the market but gain significance if appeared after an Engulfing pattern. A spinning top is another pattern, which indicates indecisiveness in the market.

Morning star: A morning star pattern is a bullish candlestick pattern. It indicates a downtrend reversal and is formed with three consecutive candles.  

Evening starAn evening star pattern is a bearish candlestick pattern. It indicates an uptrend reversal and is identified by three consecutive candlesticks.

Use Indicators for analysis

  • Indicators are tools that indicate a change in trends, it aids in making buying or selling decisions by predicting future price movements. 
  • It is calculated mathematically based on the price or volume of the stock/security. 
  • There are two types of indicators namely leading and lagging indicators. A leading indicator gives an advance indication of a change in trend whereas a lagging indicator follows the trend rather than predicting a reversal or trend change. A majority of leading indicators are called oscillators as they oscillate within a bounded region. 

Examples of Leading Indicators: RSI (Relative Strength Index), Stochastic Oscillator, Williams’ % R, etc.

Examples of Lagging Indicators: Moving Averages, MACD (Moving Average Convergence Divergence), Bollinger bands, etc.

  • There is another category of indicator, which is an amalgamation of leading and lagging named Momentum indicator. Momentum is the rate at which price changes. These indicators determine the movement of price over time and the strength of these movements irrespective of the direction of the prices.  Example: RSI, MACD, etc. 
  • Indicators are extremely helpful as that supplement the analysis and provide the right entry point for taking trades. 

You can consider the above-given points as a basic guide to begin technical analysis. The above points are written in a step-wise format and hence can be considered in the same manner for anyone who wishes to analyse any stock/security.

Fibonacci Retracements

  • To learn Fibonacci retracement we first need to know what Fibonacci series is. Fibonacci series is a series of numbers whose value is the sum of its previous two numbers. (E.g. 0,1,1,2,3,5,8,13,21,….infinity)
  • Any number divided by its previous number always gives a number close to 1.618, which is also known as “Golden ratio or phi” E.g. 21/13= 1.615, 34/21=1.619.
  • A golden ratio is a universal number as it is found in nearly everything in our surroundings. E.g. Human face, flowers, vegetables. To learn about it in-depth, you can read about it on the internet.
  • Fibonacci retracements consist of Fibonacci numbers that assist in determining the levels where prices could pause at the time of retracements or could extend when in a Bull Run. 
  • Retracements are movements that go against the trends, say a stock is in a bull run but the upward move pauses and a minor down move is witnessed, that is known as retracement. 
  • Retracement provides an opportunity for market participants to re-enter the stock just in case the trader missed the first leg of the rally.
  • How to apply retracement – To apply retracement select a bottom and top of the same leg of the rally and then apply the retracement to the up move. The retracement tool consists of 23.6%, 38.2%, 50%, 61.8%, and 100%, all these numbers are Fibonacci numbers derived by dividing the Fibonacci series numbers in a certain manner. (see image)
  • The retracement helps in identifying the price levels from where prices can certainly bounce back and can be used to identify entry points to buy or sell a security.

The above image shows that prices bounced off several times after hitting 61.8% of the retracement level.

This is a rough framework of what technical analysis comprises of. Technical analysis is an ocean if one really wishes to learn. There are various other aspects like Elliot Wave Theory, Gann Theory, Option Chain Analysis that help us to make better decisions about how to take an accurate trade.

How to learn technical analysis in detail?

These aspects require in depth explanations and hands on training as they are complex to understand, especially for beginners. These concepts are covered in our Stock Market course along with detailed study of above mentioned techniques on live market charts which will give you hands on training and confidence to take actual trades in live market.

As you begin your journey in the stock markets, we have compiled a list of 10 stock market tips for beginners. This list will comprise of some essentials and “must DOs” for beginners and will also try to make you aware of most common mistakes made by new entrants, which we want to help you avoid, and make your journey in the markets as smooth as possible –

Know your true purpose

To begin with, you must know your true purpose for entering into the stock markets. Do you want to participate as a trader or an investor? A trader is typically someone who enters and exits positions in the market in a very short timeframe – which could range from a few minutes/hours to a few days and even weeks in some cases.

Investors, however, hold on to their positions much longer than traders – Holding periods for investors typically range from a few months to a few years or sometimes even decades.

Generally, strategies followed by traders and investors are quite different, so making up your mind about being a trader vs being an investor is critical as that would clear up a lot of confusion about what strategies you should adopt going further.

Invest some time to get the basics right

Having decided to foray into stock markets, you need to invest some time to educate yourself and learn the basics so as to set a strong conceptual foundation for yourself.

The stock market might look easy as a layman, and a lot of people think to themselves – “You either buy or you sell. The price either goes up or goes down. That is all there is”, but it is not so.

If it were that easy to make money in the markets, everyone would be doing it. But the truth is that only a small percentage of people who enter the markets are actually successful / profitable.

Most people, unfortunately lose money, and it is largely due to lack of basic knowledge and not being clear about concepts.

So, invest some time to learn before you actually put in your hard-earned money in the markets. You can do this by reading up on the vast resources available for free on the internet or you could choose do a certification course from a reputed institute which would shorten your learning curve significantly.

In any case, the time and money invested in gaining knowledge would never go waste and will always give you multi-fold returns in the time to come.

Always do your own research

Never follow trading calls by stockbrokers or “experts” blindly. Always do your own research. You may win or lose, but stockbrokers only stand to gain through brokerage.

As a trader, you must know the basics of technical analysis and the key indicators and tools that professional traders use to enter and exit a trade.

And as an investor, you must learn fundamental analysis, and how to read and analyse the key ratios which would help you decide whether a stock is a good pick for the long term.

So, keep in mind, that any calls / tips / recommendations by experts must always be corroborated with your own independent research or analysis.

Never risk too much capital on a single trade

Every trade must be an execution of a strategy, and before you enter a trade, you must know your entry, target and stop-loss levels in advance.

This is especially true for intraday traders who use margin facility to trade, and an improper risk management strategy can lead to capital erosion or even account blowout.

Typically, for traders, you must not risk more than 2% of your capital on any single trade. Instructive here would be to read Van Tharp’s book “Definitive Guide to Position Sizing”. There is no better book out there on position sizing and risk management to help you achieve your trading objectives.

Avoid using leverage or margin facility

Almost all traders at some point or the other have faced a problem of capital shortage. In order to overcome this, traders are often tempted to use the leverage facility offered by stockbrokers.

To put it in very simple terms, what leverage does is it allows you to trade in values much higher than the capital you have at your disposal.

For eg. Suppose you have Rs 50000 capital and your broker allows you 5x Margin, you can take a trade for the value of Rs 250,000 ie. 5 times your capital.

Now, if the stock purchased by you goes up by 3%, your profit would be 250,000 x 3% = 7500. However, since capital employed by you was only only 50,000 your return on capital is much higher –

 (7500/50,000)   x 100  =  15%

So what margin facility does is it multiplies your gains or losses by margin factor. So 5x margin gives you 15% profit when the underlying moves by only 3%.

However, we ought to remember that margin is a double-edged sword. If the trade goes against us, and the value of the underlying reduces by 3%, we would bear a loss of 15% on our capital in a single trade!

If we have a streak of 5-6 losing trades, using 5x margin, it could potentially wipe out almost 75-80% of our capital.

Hence, I always recommend beginners and seasoned traders alike to trade with full capital and never use the margin facility.

Avoid using too many indicators

Another classic mistake by traders, especially beginners is an over reliance on trading indicators. There are more than 200 indicators available on almost all platforms provided by stockbrokers, and using too many of them will often lead to conflicting signals, and that increases your chances of entering a wrong trade of missing out on a good one.

Trading indicators are just tools to aid your trading journey and are best used as additional confirmations for entering a trade, but must never be the sole criteria based on which we decide to enter a trade.

Find your comfort zone

Are you a bull or a bear? Do you want to trade in equities or forex or commodities? In cash segment or derivatives segment? In futures contracts or in options contracts? These are all the questions you would need to have an answer to in order to find your comfort zone.

Sounds confusing right? Yes, it is. The stock market can be an extremely confusing place with so many segments, product types, and derivatives contracts. As you get more accustomed to the wide range of trading possibilities the stock market offers, it is crucial that you find the set of combinations and categories that you find most comfortable trading in.

This question can only be answered by YOU however, as your trading comfort zone would be a result of your trading style, temperament, and risk appetite.

There are no right or wrong answers here, as each person would have his own unique style, the sooner you find it and settle down in it the better.

‘NO TRADE’ is also a trade

Another common mistake that beginners make is overtrading.

Most traders, especially beginners are looking to either go long (buy) or go short (sell) in order to capture the market movement and make a profit, but the classic mistake they make is they are looking to take a trade EVERYDAY or sometimes even MULTIPLE times a day. And this where they err.

In markets, there is a third option as well, which most people miss out on – NO TRADE.

Markets are trending ie. Giving a clear upwards or downwards move only 40-50% of the time. For the remaining time, markets are sideways. ie they are range-bound with no clear upward or downward trend.

Advanced traders can and do make money in sideways markets as well, however, for a beginner or a novice, the chances of making a mistake is significantly higher in sideways or volatile markets and they should avoid trading on such days.

Trading psychology > Trading strategy

Being successful in the stock market is 30% about skill and strategy and 70% about temperament and mindset ie. Trading psychology.

It would take you only a few weeks or months to learn the theoretical aspects of stock markets and start developing strategies. However, developing the right temperament and mindset to correctly implement those strategies while conquering some of the most basic and hardcoded human emotions like greed and fear can take years.

The same can be said for most other professions, especially the high-pressure ones like that of sportspersons. Why do people with similar skill sets, talent, experience and knowledge differ so much in the levels of success they achieve? It all comes down to one key ingredient — temperament and mindset.

Stock Market is NOT for Everyone

The stock market is an uncertain place, and a career in stock markets can be highly rewarding, but it comes with it’s own set of risks and uncertainties.

The stock market is as competitive and cut-throat a place as can be, although we don’t see it or realise it since all the trading now happens in electronic form behind the comfort of our computer screens and not on the trading floor as it used to in the good old days.

Unless one is ready to put in the necessary toil and hard-work necessary to understand and be successful in the markets, it might be better off to let professionals (ie. Fund managers) do the work for you by investing through mutual funds rather than directly through stocks or derivatives.

Here I would also like to dispel some myths about the stock market and I would like to reproduce this recent conversation I had with an acquaintance (let’s call the person S), and it went something like this —

S : I don’t invest in stock market as I like to earn my money the hard way. I don’t like easy money.

Me: Money earned through stock market is not “easy” by any means. It is hard work. Each day when you enter the market, you don’t know if you will earn or lose money. There is risk every day. Sure, there is the chance of earning great returns, but it comes with the risk of great losses as well. There are no casual leaves, sick leaves or paid leaves in the stock market. You earn only on the days you “work”. Seeing a successful trader make large profits, it might seem like “easy” money to you, but remember that only 5% of traders are successful in the market; 95% lose money.

What you don’t see are the years of learning, failing, losses, stress and hard work that have gone into putting oneself in the top 5%. Saying stock market is easy money is like saying actors, cricketers and CEOs who earn millions are getting “easy” money, which is obviously not the case. They have worked extremely hard to get where they are today, which is the same for successful traders as well.

S : (looking thoughtful) Umm, ok. I get your point. But still, the stock market is dirty moneybecause the successful 5% are taking the hard-earned money of the remaining 95%. And I am not comfortable with that. So, I stay away from stock market.

Me : Isn’t that how it works in every profession in every sphere of life? The job that you are currently working at – there must have been scores of other candidates rejected so that you could be selected for the job. The prestigious University that you passed out of; you got a seat there edging out hundreds of other students. You recently got promoted, and you very well know that there were 5 other people from your office aiming for the post that you currently have. So, you got your degree, your job and your promotion by taking away what someone else was trying for and this is what each and every one of us has done at every stage of life. There is nothing “easy” or “dirty” about it; and the stock market works on the same principles. It is simply about survival of the fittest.

S : Ok buddy, I got your point. But the thing is I don’t know anything about the stock market; so I just prefer to stay away from it.

Me : That is OK. That is your decision, and actually a very good one. You should stay away from the stock market if you know nothing about it. Or you can choose to educate yourself, so that you avoid the common mistakes others make.

But you should have said this in the beginning itself, instead of saying things like stock market is easy money or dirty money. Because it is not!

Anyway, come on, let’s go grab a beer!

The biggest hurdle that a beginner in the stock market faces is to figure out from where to get information, and which books to read. A simple google search will give you more than 200 books, written over the years by various authors, almost all of which come under the “must-read” category. This overload of information and resources can feel a bit overwhelming for any beginner, which is why we have done the hard-work for you and curated a list of 6 books that you can read to kick off your journey in the stock markets.

There are 2 ways in which one can categorise the books you read:

  • Books that give “mile wide and an inch deep” coverage, and
  • Books that give “inch wide and mile deep” coverage

Our list will have a mix of both these types of books. Let’s have a look –

WHY ARE WE SO CLUELESS ABOUT THE STOCK MARKET?

The book by Mariusz Skonieczny introduces the basic concepts of value investing in simple and lucid language, in such a way that anyone can understand it.

Topics covered include the difference between stocks and businesses, what constitutes a good business, when to buy and sell stocks, and how to value individual stocks. The book also includes a chapter covering four case studies as well as a chapter on the pros and cons of real estate investing vis-a-vis stock market investing.

The easy to understand explanations of basic concepts make this a must-read for beginners who are looking to foray into the world of investing, and can also be used by experienced investors who want to brush up on their basic concepts.

F WALL STREET

This book by Joel Ponzio is the perfect follow-up to “Why are we so clueless about the stock market?”. It dives into slightly more detailed and complex investing terminologies, acronyms, concepts and investing ideas.

This book tries to teach the reader how to become a sharp value investor and how to use economic downturns to your advantage. It provides very insightful tips and tricks, especially in evaluating securities at a fundamental level, making this another must-read book for beginners in the field of stock market investing.

HOW I MADE $20,00,000 IN THE STOCK MARKET

This classic by Nicolas Darvas is a must-read for novice investors. Darvas talks in detail about his experiences in the American stock market in the 1950s. He explains in very readable terms how he made a fortune in a relatively short period of time. He explains a simple approach, now known as the Darvas Box or Box Theory for entering and exiting the market which many investors use even today. However, a couple of points need to be kept in mind while reading Darvas’ book.

  • The method used by Darvas and the results were in the US stock markets during the 1950s. It was a different time with very different macro-economic conditions than what we have now. At that time the US was enjoying a spectacular bull market and economic prosperity. Most stocks were in steady uptrends.
  • The other implication is, that this method will work well for trending markets, and should not be seen as a universal approach in all market conditions. Understanding the different market conditions and modifying our approach accordingly is the key to success in the markets.

Inspite of this, Darvas’ book is a must-read which gives a lot of learning and provides deep insights to readers and is not one to miss.

WHAT I LEARNED LOSING A MILLION DOLLARS

They say failure is a stepping stone to success. And in stock markets, losing money in markets is failure.

We often hear about big successes in the markets, but seldom about failures. However, failures often teach us much more than success ever will.

This book, one of my personal favourites, begins with a string of successes that helped Jim Paul achieve a jet-setting lifestyle and land a key spot with the Chicago Mercantile Exchange. It then describes the circumstances leading up to Paul’s $1.6 million loss and the essential lessons he learned from it; which can be summarised as although there are as many ways to make money in the markets as there are people participating in them, all losses come from the same few sources.

BERKSHIRE HATHWAY LETTERS TO SHAREHOLDERS

This book compiles the full, un-edited versions of every one of Warren Buffett’s letters to the shareholders of Berkshire Hathaway. Here, Warren Buffett has given us an insight into his mind and thinking and shows a high willingness to share his methods with the world for all of us to learn from.

Warren Buffett’s letters to his shareholders for the past 50 years contain wisdom on business and investing like no other book. It is the unparalleled journey of the greatest investor of our age and the study of the astounding success of Berkshire Hathaway, one of the best success stories in the history of the stock market.

It is recommended that you buy the kindle version of this book, as it is very reasonably priced and the letters get updated every year for free.

THE MOST IMPORTANT THING ILLUMINATED

This book is heavy in theory, practical application and deep thinking. Read through it slowly, and take plenty of notes as you go along.

In stock markets, getting a hold of your emotions, investing tendencies and psychology is one of the most difficult battles you will face.

Even from own personal experiences, I have learnt that most failures occur because of poor temperament and not because of poor knowledge or skill. Being successful in the stock market is 30% about skill and strategy and 70% about temperament and mindset.

You can learn about the stock market from scratch in a few weeks or months and start developing strategies too. But developing the right temperament and mindset to correctly implement those strategies while conquering some of the most basic and hardcoded human emotions like greed and fear can take years.

In this book, Howard Marks explains concepts such as “second-level thinking,” the price/value relationship, patient opportunism, and defensive investing. He does an honest assessment of his own decisions, including his mistakes, and provides valuable lessons for critical thinking, risk-assessment, and investment strategy.

This book is for advanced readers, and even for them might be challenging to read. But it worth the time it takes to read through, and is even a contender for multiple readings. It is that good!

Happy reading and all the best for your journey in the stock markets!

There is hardly anything about the stock market that is unwritten or unsaid.

If we search thoroughly enough, we will find volumes of content including books, articles, blogs, videos, etc. which would cover every aspect of stock markets and stock trading — from how to get your trading strategies and techniques right to how to get your trading mindset right.

However today, we are going to start with the very basics of stock markets and answer the basic question which comes into the mind of a person who would like to enter the stock market — What is a stock market, and how does it work?

In this post, we will understand some basic concepts of stock markets, how stock market works, and also about other market participants like stockbrokers and SEBI – the regulatory body that regulates the stock market.

What is Stock Market?

stock market as the name suggests is a marketplace for stocks, ie. a place where people can buy and sell shares of publicly listed companies.

Let us understand this with the help of a simple example –

Suppose you want to invest Rs 10,000 and decide to buy shares of ICICI Bank, which at the time of writing this article is trading at a price of around 380 per share. At this price you will be able to buy ~25 shares of ICICI Bank.

But from where and how will you buy these shares? Can you approach ICICI Bank in order to buy 25 shares? No, you cannot. Just like you, there would be thousands of other individuals who would want to buy or sell shares of the bank on a daily basis, and approaching the bank for such purpose would make the process very cumbersome for the bank and for you.

So to overcome this problem, we have a common platform known as a stock market, where shares of various companies are made available (listed) where buyers and sellers can meet and execute transactions and this facilitates a smooth exchange of shares between parties.

However, a buyer or seller themselves cannot buy or sell a share in the market. They can only do it through a registered intermediary, called a stockbroker who has access to the stock market platform. The stockbroker charges a commission (brokerage) from the buyer and seller, and executes the transaction on their behalf.

This buying and selling of shares takes place through an electronic medium.

Stock Exchanges in India

There are two main stock exchanges in India where most of the transactions take place –

  • Bombay Stock Exchange (BSE)
  • National Stock Exchange (NSE)

National Stock Exchange (NSE)

NSE is the leading stock exchange in India where one can buy and sell shares of publicly listed companies. It was established in the year 1992 and is located in Mumbai. The flagship index of NSE is called as NIFTY50. Nifty lists out top 50 companies comprising of various sectors which trade on the NSE stock exchange. This index is widely used by domestic and global investors to track the Indian capital markets.

Image source – Moneycontrol.com

Bombay Stock Exchange (BSE)

BSE is Asia’s first as well as the oldest stock exchange in India. It was established in 1875 and is located in Mumbai. It has more than 5,000 companies listed on its exchange. BSE SENSEX is the flagship index of BSE. It measures the performance of the 30 largest, most liquid, and financially stable companies across key sectors.

Image Source – Outlookindia.com

Different Stock Market Participants

There are a lot of individuals and corporate houses who trade in a stock market. Anyone who buys/sells shares in a stock market is termed as a market participant. Some of the categories of market participants are as follows:

Domestic Retail Participants

These are individuals in India who transact in the markets.

NRI’s and Overseas Citizen of India (OCI)

These are people of Indian origin who reside outside India and transact in Indian markets.

Domestic Institutions

These are large corporate entities based in India (for example LIC of India).

Domestic Asset Management Companies (AMC)

The market participants in this category would be mutual fund companies like HDFC AMC, SBI Mutual Fund, DSP Black Rock, and other similar entities.

Foreign Institutional Investors

FIIs are Non-Indian corporate entities such as foreign asset management companies, hedge funds, and other investors.

Regulator of the Indian Stock Market

The Securities Exchange Board of India (SEBI) is the regulatory body of the Indian Stock Markets. The main objective of SEBI is to safeguard the interest of retail investors, promote the development of stock exchanges, and regulate the activities of financial intermediaries and investors in the market. SEBI ensures the following:

  • The stock exchanges (BSE and NSE), brokers and sub-brokers conduct their business fairly.
  • Corporate houses should not use markets as a mean to unfairly benefit themselves
  • Small retail investors’ interest is protected.
  • Large investors with huge cash should not manipulate markets.
  • Types of Financial Intermediaries in the Stock Market

From the time an investor places his order to buy shares till the time it is transferred to his Dematerialisation account (DEMAT account), many participants are involved in the process to ensure a smooth transaction. These entities are known as financial intermediaries and they work according to the rules and regulations prescribed by SEBI. Some of the financial intermediaries are discussed below:

Stock Brokers

stockbroker also known as a dealer is a professional individual who buys/sells shares on behalf of its clients. A stockbroker is registered as a trading member with the stock exchange and holds a stockbroking license. They operate under the guidelines prescribed by SEBI. An individual needs to open a trading and DEMAT account to transact in the financial market.

Depository and Depository Participants

Depository is a financial intermediary that offers the service of the DEMAT account. A DEMAT account will have all the shares that an investor owns in an electronic format. In India, there are mainly two depositaries which offer DEMAT account services –

  • National Securities Depository Limited (NSDL)
  • Central Depository Services (India) Limited (CDSL)

An investor cannot directly go to the depositary to open the DEMAT account. He needs to appoint a Depository Participant (DP). According to SEBI guidelines, banksfinancial institutions and members of stock exchanges registered with SEBI can become DPs.

Banks

Banks help to transfer funds from a bank account to a trading account. The client needs to categorically mention which bank account has to be linked to the trading account to the stockbroker at the time of opening the trading account.

National Security Clearing Corporation Ltd (NSCCL) and Indian Clearing Corporation Ltd (ICCL)

NSCCL and ICCL are 100% subsidiaries of the National Stock Exchange and Bombay Stock Exchange respectively. They ensure guaranteed settlement of transactions carried in stock exchanges. The clearing corporation ensures there are no defaults either from the buyer’s or seller’s side.

DEMAT Account and Trading Account

To trade in equities, it is mandatory to have a DEMAT account as well as the Trading account.

DEMAT Account

DEMAT account or dematerialized account allows holding shares in electronic form instead of taking physical possession of certificates. It is mandatory to have a DEMAT account to trade in shares. DEMAT account holds all the investments an individual makes in shares, exchange-traded funds, bonds, government securities, and mutual funds in one place.

Trading Account

A trading account is used to place buy and sell orders in the stock market. One can open their trading account with a stockbroker who is registered with SEBI. An order can be placed either through an online or offline mode. In the online mode, one can buy/sell stocks through the trading terminal provided by the broker whereas; in the offline mode, an individual can ask the broker to place an order on his/her behalf.

Summary of key points:

  • A stock market is a place where people buy/sell shares or stocks of publicly listed companies.
  • NSE and BSE are the two major stock exchanges in India.
  • An individual has to mandatorily open a trading account to trade in the stock market.
  • There are different market participants like retail investors, domestic institutions and foreign institutional investors
  • The Indian stock market is governed by SEBI.
  • There are different financial intermediaries like stockbrokers, banks, depository participants, etc.
  • DEMAT account or dematerialized account allows holding shares in electronic form instead of taking physical possession of certificates.