Investing in shares and choosing a stock requires detailed research before putting in your hard-earned money into the market. This can get a little tricky and overwhelming for first-time new investors. Even amateur investors can research a stock, invest in a good stock and earn high returns if they know what to look for.
The primary stage of choosing a stock is determining the type of portfolio you wish to create for yourself considering your goals and objectives. It is always advisable to have a diverse portfolio containing holdings of varying risks and returns.
A good stock can be determined by studying the balance sheet and income statement of a company. However, it is impossible to go through the reports of every company. Therefore, it is essential to follow certain basic steps to choose a good stock –
Always keep yourself updated with the market trends and opinions by reading financial news, blogs, etc.
Armed with the information and research, select companies you wish to invest in. You can browse through ETFs for the holdings of a specific sector.
The research will not always result in you finding the right stock; however, it does save you from investing in a bad one. Once you have understood how to identify sectors or holdings you wish to invest in, it is important to perform an in-depth analysis of the financial reports to solidify your research further and ensure profitable investment.
Do not get enamoured by the past growth of a company; there is a possibility that it may have reached saturation. Always look for the prospect of future growth.
Reading the quarterly earnings report will help you to understand the growth policies and metrics of the company. It helps you to understand the debt load, top line and bottom line of the company.
It is crucial to study the valuation of a company based on the valuation report to determine whether a company is over-valued or under-valued. You can study ratios like Price/Earnings (P/E), Price-to-Book (P/B – for banks), and EV/EBITDA for cash-intensive companies.
Compare the debt ratio of a company against the industry average, the lower it is, the better the company is.
Technical analysis merely is analysing and understanding the demand and supply of a product or service in the market and then make assumptions about the price. It moves beyond the general features of a company and portrays the market sentiment regarding the price of the security.
Technical analysis involves using charts or tools like indicators and oscillators to understand the market and invest in it. There are three underlying assumptions in technical analysis –
Stock price includes everything from the fundamentals of the company and the market component. This means "the market discounts everything."
The stock price is less erratic and more based on past movements. This means "Price moves in trends." The usage of similar tools to determine prices until now implies that price movements are often repetitive and follow predictable market emotions. This means "History repeats itself."
Technical analysis is nothing but identifying patterns.
Identifying patterns for movement of stock prices is done mostly through studying different types of chart patterns. Charts have an established understanding and market acceptance. There are different types of patterns seen in a chart that reflect stock price movement.
1. Reversal – the prior price trend will reverse
2. Continuation – the prior price trend will continue
There are similar trends including head and shoulders, gaps, triple bottom/top, double bottom/ top, saucer, etc. that reflect stock price movement in a chart and helps investors to make assumptions for investment.
Separate orders combine together to make a complete trade. A trade generally consists of two orders – order to buy and order to sell. Let us understand some basic types of orders –
1. LIMIT ORDERS – buy or sell a stock at a specific price or higher.
2. MARKET ORDER – buy or sell a stock at the current price, irrespective of what the price may be.
3. STOP ORDER – market order effected at a certain specified price.
4. STOP LIMIT ORDER – combine stop and limit pricing to set a range of price for buy order and sell order.
5. MARKET IF TOUCHED ORDER – This is placed as a price touch-point for buying at lower than the current price and selling at higher than the current price
6. LIMIT IF TOUCHED ORDER – a market if touched order that has an additional limit price to enable order between a threshold of prices.
An investment strategy based on the assumption of a drop in stock prices is called shorting or short selling. Profit in trading can be earned by buying low and selling high. Shorting does it in reverse order. You borrow securities from another investor and sell them at a higher price. For opening your short position, you will have to open a margin account, which incurs interest on the value of the shares till the position is open. You expect the price to drop so that you can buy the shares at a low price, closing the short position, and return them to the buyer, thus making a profit off the price difference.
Short selling is an extremely risky trade as the losses can be extremely high. If the price does not go down as expected, you may have to bear high losses. Hence, only experienced traders go for shorting a stock.
With a basic knowledge of these concepts, you will be able to avoid common mistakes when trading or investing with your demat account.
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