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 money, because 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!