5 things you must know before buying shares
1. You own a part of the business
When you invest in stocks, you do
not invest in the market (despite what you think). You invest in the equity
shares of a company. That makes you a shareholder; you now own a small part of
that business without having to go to work there.
The good news is, since you own
part of the company, you are entitled to a share in its profits.
The bad news is that you are also
expected to bear the losses, if any.
That is why investing in shares
is risky. If the company does well, you benefit. If it does not, you lose.
There are no guarantees whatsoever.
2. In the short-run, the price of the share
can wildly fluctuate
Let's say the company fixes the
price of each share at Rs 10. This is called the face value of the share.
When the share is traded in the
stock market, this value may go up or down depending on supply of and demand
for the stock.
If everyone wants to buy the
shares, the price will go up. If nobody wants to buy the shares, and many want
to sell them, the price will fall.
The value of a share in the
market at any point of time is called the 'price of the share' or the 'market
value of a stock'.
A share with a face value of Rs
10 may be quoted at Rs 55 (higher than the face value) or even Rs 9 (lower than
the face value).
So you might have paid Rs 15 for
a share which is now quoting at Rs 12. Don't panic and sell. If it is a good
company, the share price will eventually rise.
The prices will get influenced by
the market sentiment and the general direction of the market. As a result, you
may see short-term slumps.
3. Always invest for the long-term
The best way to make money is to
buy low and sell high. This means you should buy the share when the price is low
and sell it when it is high.
That is why you must buy in a
bear market. This is a term used to describe the sentiment of the stock market
when it is low and the prices of shares have generally fallen. The best time to
sell is in a bull market, when the sentiment is high and the prices of shares
are rising.
But it is very difficult to time
the market. In fact, no one can do it. If we could, we would all be
millionaires, wouldn't we?
That is why, when you invest in
the market, it is best to invest for the long-term. Hold on to your shares for
a few years before you think of selling them.
Companies increase their sales
and book higher profits over the years. This will eventually reflect in the
share price, so ignore the short-term slumps.
Once you decide that you are in
for the long haul, you can ride over the bear and bull runs with no stress at
all. Over time, the price of your shares will appreciate.
If you are getting a good price
for your stock, keep selling small amounts at regular intervals. Keep booking
profits.
4. Decide how much you want to invest
Always remember one basic rule in
finance -- if something gives you higher returns, that's usually because it
carries a greater risk.
That's the reason why not-so-good
companies will pay you a higher rate of interest for your deposits.
The same reasoning goes for
stocks too -- they give higher returns than, say, bank fixed deposits because
they are more risky. So the amount of money you invest in the market depends on
your capacity to bear the risk.
If you are young with a steady
job, you can invest a larger proportion of your income in the stock market
than, say your parents who are close to retirement. If you have a lot of debt
to repay, avoid putting too much of your money in stocks.
It's best to decide how much of
your savings you will allocate to stocks, and stick to that plan. Don't get
swayed by how much your friend is investing.
5. Don't rely solely on 'good advice'
A smart investor should never
invest buy shares of companies he doesn't know much about. Relying on 'advice'
from friends is not always a great idea. Do some groundwork yourself.
It doesn't matter who is buying
the stock or who is recommending it. Steer clear of such ways of making a fast
buck. These tips will land you in a soup.
When you hear of a 'hot tip', dig
further.
Take a look at the company's
profit and loss statement, which would have been audited by chartered
accountants. There is a wealth of information here. To understand the
information in a Profit & Loss Account, read Want to buy a stock? Read this
first.
Do some basic calculations on
your own. The Earnings Per Share (net profit/ number of shares) and
Price/Earnings ratio (market price/ EPS) should give you a fair understanding.
Read How to spot a good stock to understand what these ratios mean and how to
use them.
These tips should get you
started. Tread cautiously though. If stocks intimidate you, consider a
diversified equity fund.
A mutual fund manager will
research many companies before investing in their shares. This way, you can
participate in the stock market even as you leave the research to
professionals.
Reference: http://www.rediff.com/getahead/2005/apr/26share.htm
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