Opportunities to make money in the stock market are ample. The returns can be crazily high, but the risk is equally huge.
Several investors and traders still lose badly and see an early exit from the markets as well.
This book is beginner friendly, informative, and contains simple language. So let’s get in.
First things first
The author explains through a story that investing or trading in the stock market should be done only when you are aware of what you are doing. Several new-age investors/traders similar to counterparts of yesteryears have lost their hard-earned money in the stock market.
They have handed over their account either to a broker to trade or to someone who has talked them into the capital markets. There are numerous stories of how novice traders lose money by following tips of self-proclaimed successful traders.
The author suggests that novice traders should never start with trading, rather should gain knowledge about the markets and enter the cash market first.
Lack of knowledge of how options work results in similar losses as ‘Rohit’ the narrative character in the book faces. No knowledge or, for the matter, half-knowledge and a poor mindset results in most losses for a new trader.
Is Trading Risky?
Prasenjit claims that trading for a retail trader is no less than gambling. He further says that trading is meant for institutional investors and hedge funds. Trading is a sure-shot way to lose money in the stock market for the retail trader.
Trading can be a risky affair if you are going to trade on tips provided by someone else. It could be free tips shared over media or paid calls by promising hefty returns through their calls for a subscription.
Traders placing trades on tips could be caught up in the midst of operators who push stock prices up only to get a better exit of their holdings. Retail is easy prey for many scammers who run paid services promising quick and hefty returns.
The novice trader needs to realize that quick money can be made only in gambling and can be lost similarly.
The author suggests that retail embrace equity investments rather than jump into trading. The author feels equity investing is not risky if you know what you are doing.
Where Does one Start with Equity Investments?
Many new traders tend to look at profit numbers to decide to invest in a stock. However, these numbers can be altered, so the top priority should not be only given to profit or sales numbers.
As an investor, you should be more interested in how well the company is utilizing your funds. So, as an investor, you would rather focus on return on equity as a priority.
A stock that can show increasing ROE (Return on equity) and stable or increasing margins can prove to be a better bet. If a company can generate cash flow along with increasing ROE and margins can go on to be a multi-bagger as well.
Stocks that have a debt-to-equity ratio that is above 1.0 should be avoided. Many companies may need to borrow for various reasons like working capital, purchase of land or equipment, or business expansion. However, excess debt can be very dangerous for investments as it affects profitability and margins.
There’s no substitute for Analysis and Research
According to Prasenjit, if a stock is trading at a high PE, it also suggests that the stock might perform well in the future as well. Investors are anticipating higher growth which is why the PE is higher than an average stock. The general public usually stays away from high PE stocks thinking they are overvalued.
There are several parameters the author describes in the book elaborately. Some of the ratios may vary from sector to sector, and PE valuations may vary from stock to stock. You should not be comparing one stock with another just with their PE ratios.
Below are some criteria shared by the author on stock selection. These are explained in detail, which will help you understand how to go about things.
Avoid stocks if their current PE is in the upper band of the last 5-year average.
Avoid if the promoter pledge is more than 30% of the total holding.
Don’t pick a stock if its PEG ratio is above 2 and the last of the last 3-year average.
Stocks at 52-week lows in a bull market are a strict no even if they look to be a value buy.
ROE of over 4-5 years is below 12%. If you are not able to beat benchmark indices, then the stock can be given a pass.
The high debt-to-equity ratio of a stock is a strict no.
Stocks that have corrected more than 61.8% on Fibonacci levels can be avoided. There is every possibility that they might fall further.
When is the Best Time to Buy a Stock?
The author thinks that there is no right time to buy stock. Investors make common mistakes like attempting to sell the exact top or bottom fishing a stock. This can never be achieved unless you have precise information or insider information.
Do thorough research and study a stock's technicals before entering it. Identify support for the stock and start accumulating it in smaller portions. Averaging down is an art; never venture into it if you don’t when to execute it. It’s never too late to invest in a truly high-quality business.
Have clear reasons why you invested in a stock and never sell to buy at lower levels. Do not look at stock prices daily if your horizon is for a longer time frame.
You are bound to be influenced by the noise created by daily volatility in a stock and might end up selling a winner too soon. These are some common mistakes new traders/investors make. They hold on to losers too long and sell winners too soon.
Portfolio Management and Diversification are the keys
Always diversify your portfolio, so you are not affected by a stock's sector rotation or time-wise correction. Do not over diversify thinking a healthy portfolio is one that has 50-100 stocks invested in.
Diversification can be made in different asset classes to diversify your portfolio. Gold is considered to be the best hedge against your equity portfolio. For diversification, you may also want to look at bonds, exchange-traded funds, or index funds.
Accumulate high-quality stocks when they are available at fair value. You will find such stocks in market correction or sector rotation. Never invest in one go, even if your investments are diversified. Always have cash in hand so you can look to invest when you see stocks coming close to fair value or their demand zones.
Success in the stock market depends on knowledge, skill, and ‘incidental good luck’. Prasenjit Paul’s book is a simple beginner-friendly book you can start with.
Get your copy of the book if you want to read the concepts discussed in detail.
(Amazon paid link)
Guest Post - Written by Mr. Lal Bajaj, Bangalore
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