When you hear the word stock trading, which is the first thought that comes to your mind? Shouting, commotion, crowd – right?
There was an age when online trading was not practiced. Trading in stocks were done directly on share market floors. People used to shout their way out to find potential buyers and sellers.
If this is the kind of image you have in mind, you are not wrong. But as on today, this has changed. These days, stock market floors have become silent. The trades are mostly executed online.
Moreover, individual investors have also matured. More are investing than trading. The two are different? Yes. Investing is done for long term, while trading is for quick gains.
We’ll see how both can be practiced together as a package.
Investors can trade?
Every time you buy or sell stocks, you are actually trading. Hence the term ‘trading’ is commonly used to mention both ‘investing’ and ‘trading’.
Why to trade in stocks? Stocks has potential to elevate ones financial position. This is especially true for long term goals like retirement.
There is a mixed feeling about stocks in society. Few people are there who love it, and there are people who also dislike it.
There are stories of people making a living from stock trading. There are also alternative theories of stocks being too risky. Both sides are true.
What I think about stocks: For me it is one of the most powerful tool to become rich in long term. But it is also true that short term trading is risky. Hence better is to follow the “investing” path. But if the situation demands “trading” (short term holding), we must not shy away from it.
How to trade in stocks? It is not so difficult. Let’s start with the basics.
What are stocks?
A stock (or share) is small portion of a total company. When a person owns one stock of a company, he/she actually has a proportional ownership in that company.
This ownership is not exactly like what Ratan Tata may enjoy on Tata Group, but shareholders have a “claim”. The claim is limited to the company’s earnings.
Example: Suppose there is a company which has 100 shares in the market. You own 1 share of that company. The company makes $1,500 in net profit. Then as a shareholders, your claim is $15 ($1500/100).
You may not go about suggesting how to run the business, but the company is strategically obliged (not binding) to share $15 with you.
Stock Price and Business
Stock price move up and down every few seconds. This price volatility makes stocks both interesting and risky at the same time. But why stock price move up and down?
There are two types of movements in stock’s price:
- Short Term change: Price movements in short term are due to demand and supply imbalance. When demand for a stock is higher (more buyers), price goes up. When supply is higher (more sellers), price falls. Between 1 day to 1 quarter, price fluctuation is mostly random. It’s either triggered by some non-financial news about the company, or when it is suddenly attracting attention of investors. Beyond one quarter (3 months), there can be a rational behind price fluctuations because company’s publish quarterly statements. But generally speaking, price movements within one year, are less driven by business fundamentals and more by market sentiments.
- Long Term change: Long term price movements follow a definite trend. If a company’s business fundamentals are good, stock price will rise and vice versa. Though the quantum of price rise/fall may not match the change in business fundamentals but at least they are relatable. What are business fundamentals? Sales, profits, net worth, asset base, profitability, cash flow etc.
It is essential for investors to understand the relationship of time and price of stocks before trading. This understanding helps in knowing how a change in holding time translates into risk of loss and potential profits. Read: Invest risk free for high returns.
Investing in a Good Business
You may be buying stocks of a company, but focus should NOT be only on stock or its price. Attention should be more on the business. It is the business which ultimately influences stock’s price in long term
But if we are trading in stocks for short term, we need not care about business fundamentals, right? “Yes” is what most traders would give you for an answer.
But for me, combining investing and trading works best.
People who are pro traders, they have “tools” which can suggest them when to buy and when to sell. Moreover, these investors trade in stocks in volumes. For them even 1-2% gains are enough.
But for people who invests $100 at a time in stocks, volume game will not work. They rely more on assured high returns (say 12% p.a.).
How to do it? By buying stocks of good business. Let’s see how to combine investing and trading. These are the steps:
- Step #1: Buy stocks of only fundamentally strong business. This is the step, if implemented well, can substantially reduce the risk of loss associated with stocks.
- Step #2: Make sure to buy it at undervalued price levels. Buying good stocks at a discount can seal the deal. From this point onwards, the investors almost has a cent percent chance of making profits from stock investing.
- Step #3: When you buy stocks do it with an intention of long term holding. Why? Because in short term, stock’s price is volatile. Hence a combined strategy of buying stocks of strong business, at low price, and for long term holding is ideal for a beginner.
- Step #4: Buy stocks by fixing an incremental milestones. Example: 3% up: 1 day holding. 4%: 1 month holding. 6%: 3 month holding. 8%: 6 month holding. 12%: 1 year holding…etc. This kind of milestone fixing makes trading possible even for long term investor.
- Step #5: If your stock meets any of the above milestones, make sure to sell it and book profits. At this point of time, do not become greedy. As per your fixed rule, if it is time to book profits, do it.
How to trade in stocks?
As I’ve told you before, whenever you are buying or selling stocks, you are actually trading. So whether it is for long term or intraday, it’s all trading.
So, a more specific question will be, how to trade stocks for short term? My suggestion will be – don’t do it.
A common man does not have the right tools available to trade stocks. As tools are not there, we’ll not be able to ‘time’ the stock buy/sell as accurately.
So what to do? See step #1 to Step #5 shown above in this article.
Use a online trading platform. It is a refined form of investing in stocks. One can use a trading platform and buy/sell stocks from comfort of home. These days there are online brokers (like ICICI Direct, Axis Direct, Sharekhan, Zerodha etc) who provide such platforms.
Using these trading platforms, one can self-trade stocks. The dependency on broker is gone. Agents/brokers do not execute buy/sell orders on share market floors. All is done automatically.
Follow a process…
Investing in stocks has become too easy. If you have a smart phone, and internet connection, you can trade stocks within minutes.
But do no start so quickly. Get your process right before buying your first stock. Start from here…
1. Answer – why you are investing?
What is your goal of investing in stocks? Why you are buying these stocks in first place? What you want to achieve? What is your expectation?
If you can answer these questions, you will know how far is your goal and what value you need to build through stock investing.
If your goal is less than 3 years away from today – do not go for stocks. If goal is further away – stocks could be a good choice.
Follow these sub-steps to finalise your goal:
- Name: Make sure to name your financial goal. It can be like retirement, child’s fund, marriage, car, home purchase etc. Example: Down payment for home.
- Quantify: What is the funds you are looking to accumulate for the goal? Indicate the value in your local currency. Example: $15,000.
- Time: How much time you have in hand for the goal? This is the time horizon you have in hand for investing and building the corpus. Example: 3 years.
- Cost: Ask, how much it will cost me to start investing from today. Suppose your mutual fund calculator told your that you need to invest $360 per month for next 3 years. Ask yourself, “is this cost within my budget?”.
|Corpus to be Built (Rs.)|
|Expected Return p.a. (%)|
|Time (in years)|
|SIP (monthly contribution) (Rs.)|
How I fix my goals? I do not like investing for goals like vacations, car purchase etc. I prefer investing money either for a “priority” or for “asset building”.
Priority – can be like child care, parents care, education fund, emergency fund etc.
Assets building – buying such assets which can eventually generate streams of passive income for me. Example of such assets can be like a real estate property, annuity, dividend stocks etc.
2. Stock Purchase
Stocks of only fundamentally stocks business shall be purchased. It is also essential to buy stocks which are undervalued.
We know this, right?. But how to identify such companies?
There are two steps involved here:
- 1. Fundamental Analysis: Here we will identify stocks of good business. How to do it? First create your own list of stocks. How I do it? I keep a list of blue chip stocks always ready in my google finance spreadsheet. These are stocks of big companies whose brand names are well known in the market. I also make sure to eliminate such brand names of current sick companies (Example: Idea, Jet Airways, Kingfisher, NBFC’s etc).
- 2. Price Analysis: Once the list is ready, start tracking its price in a google sheet. Whenever a stock’s price falls too low, it at sign of undervaluation. But you cannot be sure. So what I do? I use my stock analysis worksheet to do a thorough fundamental and price check on the company.
Before buying any stock, it is better to do as much digging as possible about its business. Read latest news about the company. How? Read about it’s board of directors. Look into its website and product base. Try to know who are its customers etc.
Do Not Want To Trade in Stocks? Alternative…
Stock trading may not be for everyones appetite. Hence, what is the alternative available for such people?
There are two excellent walk-arounds. First is index funds, and second is exchange traded funds (ETFs). Read about mutual fund basics.
People who who are busy and cannot do self-research about stocks can follow a simple approach. Start a systematic investment plans (SIPs) in these type of mutual funds.
- Index funds: offers the best investment diversification in equity based investing. Here the investor can earn average market returns with minimum volatility and risk. But the only control point is that, the investor must stay invested for long term (5 years). Read: Index vs active funds.
- ETFs: Exchange Traded Funds (ETFs) are a hybrid product of stock and mutual fund. In India, they are basically index funds which can be traded like stocks. Price of ETFs are as volatile as stocks, hence prospective investors can take advantage of price volatility and trade in ETFs. Read: About ETFs.
For a beginner who is just starting to invest money, ideal starting point will be index funds. Once some investing experience is built, including ETF’s in portfolio will be a good idea.
Stick to ETFs for some time. There will be a point, when you will feel that you are ready for direct stock trading. At this point of time – go for it. Read more: How to make money in stock market.