The stock market holds an attraction for many investors, both budding and seasoned. While for budding investors the stock market can prove to be an avenue for quick returns, for seasoned investors, the stock market is an avenue for wealth creation. In fact, after the pandemic, the popularity of stock trading has intensified further as the numbers indicate.
As per the data furnished by CDSL and NSDL, the two primary depositories in India, active Demat accounts increased by 10.4 million in the year 2020.
Moreover, in the third quarter of 2020, retail ownership of 1500+ companies listed on the NSE jumped by 9%, which was the highest since March 2018.
While the stock market popularity is increasing, its technical aspects should not be ignored.
The stock market has the potential of delivering attractive returns but only if you invest in it wisely.
The stock market for beginners might look like a challenging platform and so, there is a need to simplify it.
So, here are some important principles of stock trading for beginners, which should be kept in mind when investing in stocks –
1. Principles of stock trading for beginners
Invest your surplus funds
While investing is good, you need to pay your bills too.
So, meet all the necessary expenses to arrive at your disposable income, i.e. the income earned minus the expenses. This disposable income is your savings which you can invest in stocks and other avenues to generate returns.
These savings, or surplus, can then be invested in the stock market.
Do not go all in
When you are starting your journey in the world of stock trading, you need to be very careful.
Start with baby steps so that you do not expose all your savings to the volatility of the equity market.
Moreover, when you start with small steps, you can also learn the ropes without too much to lose.
So, even when you have a considerable disposable income or surplus to invest, don’t go all in. Start with testing the waters of stock trading. Invest in a few stocks at a time.
Do not put all your savings in the stock market. If there is a sudden tumble, you would suffer a considerable loss.
Expose a part of your savings to the stock market. The rest of your savings should be allocated to other investment avenues which would give a diversified portfolio.
This would ensure that even if the stock market is in a downturn, other investment avenues deliver returns on your investments.
Do not borrow to invest
This is the worst mistake that many failed investors have made.
When the stock market is giving good returns, many investors want to maximize the growth potential.
If they have limited savings at their disposal, they resort to debt to invest. Their belief is simple – they can earn good returns on the borrowed money and make an additional gain.
Does this belief work?
It might not, especially if the stock market turns volatile.
The stock market is highly dynamic. While it might be scaling new heights, a small factor can reverse the trend and make it volatile.
Spotting this trend reversal is difficult, and for beginners, it can prove to be impossible.
So, borrowing to make more money is a fatal flaw. Invest only what you can spare from your income. No matter how high the share market is climbing, never get tempted to borrow. You never know when the tables can turn.
Speculate with your money, not with others’ or you might not only suffer a loss but also find yourself in debt when the market tumbles.
Be careful when picking the right stocks
There are more than a thousand stocks trading on the stock exchange. Can you invest in all?
To earn attractive returns from the stock market, you need to choose the right stocks for your portfolio.
The choice depends on your investment strategy and the profit-generating potential of the stock.
There are three main types of stocks in the share market –
- Large-cap stocks belong to companies that have a high market capitalization. Such companies are established companies that are financially stable.
- Mid-cap stocks belong to companies that have a medium market capitalization. Such companies are in their growth stage or in the stage of establishing themselves in the industry.
- Small-cap stocks belong to small-cap companies, i.e. companies that have just listed on the stock exchange and are on their way to growth.
Large-cap stocks have the most stable profile while small and mid-cap stocks are volatile.
As a beginner, you can pick large-cap stocks for lower risks.
Also, when investing in stocks, make a technical and fundamental analysis of the company.
In other words, check the stock’s past trends, its previous highs, and lows, growth, etc.
Moreover, check if the company has strong management, has the potential to grow or not, has financial stability, etc. This assessment would help you know which stocks might generate a profit on your investment.
What is right for your friend, colleague or neighbor might not be right for you. You need to make investment decisions based on your investment strategy, financial goals, risk profile, etc.
You should not be driven by herd mentality. Even if the herd is following a particular stock, assess the stock first before you invest it. Don’t invest because others have done so.
You need to make sure that the stock that you pick matches your investment needs, not others’.
Stock investing is not a magic wand, spin it and you get rich. It needs patience.
If a stock is doing well, don’t be in a hurry to sell it off and make a profit. It can deliver higher returns if you allow it to grow.
Similarly, if the market suddenly turns volatile, don’t panic.
The stock market experiences cycles of volatility but if you are patient, the market rebounds and recovers. Take the pandemic for instance.
While the market became highly volatile when the pandemic struck, it has doubled up now that the pandemic’s scare is subsiding.
You need to be patient if you are investing in the stock market because it is a roller coaster ride with many ups and downs. If you can be patient in challenging times, you would come out the other side a winner.
Have a long-term vision
Though the stock market can deliver quick returns, time can multiply the returns further.
Moreover, if the market becomes bearish, you need to give it time to recoup the losses and enter the bullish trend.
Stock market investing is not a short-term game. If you really want to really earn a return from stock investing, give it time and see your portfolio grow exponentially.
Diversification is the golden rule of investing. In simple terms, diversification means allocating your investments into different avenues. While portfolio diversification means investing in different types of assets, when it comes to diversification in the stock market, it is all about the types of stocks that you pick.
To diversify in the stock market, invest in large-cap, mid-cap as well as small-cap stocks. Moreover, choose stocks of companies in different industries like IT, metal, pharmaceutical, FMCG, etc. Do not invest in only one company.
When you diversify, the volatility risk of one type of stock is offset by another. Not all stocks might fall. Some might fall while some might rise. The returns earned from rising stocks, thus, balances out the loss suffered from falling ones.
For instance, during the pandemic, stocks across most sectors fell but the pharma and FMCG sector stocks grew due to high demand.
So, when you have a diversified portfolio, you can mitigate the volatility risks of stock investing by investing in different types of stocks.
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Review your portfolio, regularly
Lastly, monitor and track your portfolio on a regular basis. This is important for two reasons. One, you can see which stocks are performing well and have the potential to grow so that you can make additional investments in them.
Two, you can keep a tab on non-performing stocks and weed them out of your portfolio so that you don’t incur an opportunity cost by staying invested in them.
So, track your portfolio regularly to watch how your investment is performing. It would also give you an idea of the corpus that has been created so that you can plan your financial goals.
2. How to start trading in stocks?
To start trading in stocks, you need three things –
- A Demat account
- A trading account
- Bank savings account linked to the trading account
The Demat and trading accounts are opened with a depository participant authorized by SEBI (Securities and Exchange Board of India). A trading account is linked with your bank savings account.
Any buying or selling in shares is done through the trading account. The Demat account is like a storehouse wherein the shares that you buy are stored in a dematerialized (electronic) format.
Also, you need a broker through whom you can buy or sell shares. As per SEBI’s rules share trading in India can be done only through brokers.
When it comes to stockbrokers, there are two main types of brokers that you can choose from –
Full-service brokers are those who charge a fee for their services. Moreover, they might also charge a brokerage on each trade that you place. For the fee charged, however, full-service brokers provide their expert recommendations on the stocks that you should pick.
They also help you create a diversified portfolio and advise you on stock investing by picking the right stocks on your behalf. For beginners, full-service brokers can prove to be a good choice for expert guidance on stock investing.
Discount brokers have become the rage in recent times as they charge minimal or zero brokerage on your trades. They only charge a low fee when you join them and after that, no brokerage is charged on equity trading. However, discount brokers might not give you expert guidance on picking the right stocks and help you with your portfolio.
3 Things To Keep in Mind While Investing in Stock Market
3. Tax implication of stock trading
Before you start stock trading, you need to understand its tax implication as well.
Stocks are equity instruments and so, they attract equity taxation. If you sell off a share within 12 months of buying it, any returns earned from the transaction would be called a short-term capital gain.
Such a gain would be taxed at 15%. On the other hand, if you sell off a share after 12 months of buying it, the returns earned from the transaction would be called a long-term capital gain.
Such a gain would be tax-free up to Rs.1 lakh. However, if your gain exceeds Rs.1 lakh, the excess would be taxed in your hands at 10%.
For example, say you bought 10,000 shares of ABC Limited on 1st January 2021 at Rs.50/share. In June 2021, you sell off 6000 shares at Rs.70/share. Thereafter, on 2nd February 2022, you sell off the remaining 4000 shares at Rs.80/share. The tax implication of these trades would be as follows –
- For June 2021, the period of holding is less than 12 months. The gains earned would be Rs.20/share. Total gains would be Rs.120,000 (6000*20) which would be taxed at 15%. So, on the June 2021 trade, you would have to pay a tax of Rs.18,000.
- For February 2021, the holding period is more than 12 months. The gains would, thus, be called long-term capital gains. The gain would be Rs.30/share which would amount to Rs.120,000 (4000*30). Gains up to Rs.1 lakh would be tax-free. The excess gain of Rs.20,000 would be taxed at 10% and the tax liability would come to Rs.2000.
Tip – Long-term stock holding is also beneficial from the tax point of view. It gives you the benefit of long-term capital gains tax wherein gains up to Rs.1 lakh can be claimed as tax-free income. As can be seen in the above example, though the gain is the same in both cases, the tax liability is lower in the case of long-term capital gains compared to the short term.
When it comes to stock trading, there is no restriction on who can trade. You just need to be 18 years and above and have a valid Demat account, trading account and bank savings account to start trading in stocks.
If you are a housewife or a student, you might not have a regular source of income. If you have a part-time hustle or if you save regularly, you can start trading in the stock market.
However, be careful when picking stocks. Choose stocks after understanding their profit potential. Also, be disciplined in your investing habits. Do not panic when the stock market suffers volatility.
Be patient and wait for the volatility to pass. If you exercise patience, you can end up multiplying your investments with time.
Also, students and housewives should invest only what they can spare. Do not invest all your savings into stocks. Keep some aside for other avenues too since the stock market is a risky place. If there is a downswing, you might lose your savings and be in the red, a situation that is best avoided.
5. Stock trading for working professionals
For working professionals, stock trading can be a good way to accumulate wealth for future financial goals. When you are young and you have a source of income, you can set aside a part of your income for stock trading, every month.
Invest small amounts every month and slowly create a diversified portfolio. Since you are young, you can afford equity exposure and create wealth over a long-term horizon.
Follow the aforementioned principles of stock trading whether you are a beginner or a seasoned stock investor. Do not speculate too much but invest in other avenues as well to create a diversified portfolio that does not depend only on the stock market for wealth creation.
- Ride out market volatilities and invest with a long-term horizon
The bottom line
Trading on the stock exchange is simple. However, before you start your journey, learn the basic principles of stock trading. Know how the stock market works so that you can use it to your advantage to make money. Learn the tips and tricks of stock trading and become a smart investor.