A wise person once said that to make money in the stock market, you must have the vision to see them, the courage to invest in them and patience to hold them! But to have a clear vision, you need to be through with the basics. Here are the top five things that you need to know to get started:
Shares (also referred to as stocks) entitles the holder to become an owner (proportionate to the invested amount) of the issuing company. Shares can be bought either during IPOs (Initial Public Offering) or in the secondary market (i.e. stock markets).
Primarily, there are three types of shares:
i) Preference Shares
Preference Shares, true to their name, give the shareholders a “priority pass” in certain situations. For instance,
- At the time of dividend distribution, preference shareholders are the first ones to receive the same.
- In case of liquidation, these shareholders get priority for capital repayment.
ii) Equity Shares
Equity shares (also known as ordinary shares) are the most commonly traded shares in the stock market. If you invest in equity shares, you become a part-owner of the company and get the right to vote and receive dividends (as and when declared). However, equity shareholders receive dividend only after the preference shareholders have been paid their dividend.
iii) Shares with differential voting rights (DVR)
These shares too come with voting rights, however, their privileges are generally lesser than common or equity shareholders. Such shareholders usually get compensated with a higher dividend payout. Compared to equity shares, DVRs trade at a lower price level.
Dividend refers to the sum of money periodically given by a company to its shareholders as a reward for investing in their venture. This payment can be made out of the company’s profits or even reserves.
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Debentures are issued by a company when it raises money from the public in the form of a loan. They form part of the company’s debt and hence give no ownership or voting rights. Debenture holders receive pre-fixed interest. This interest is paid prior to dividend payouts. Debentures come with a pre-determined maturity date. Debentures can be categorized basis:
Secured Debentures are secured against the company’s assets. In case of insolvency, the debenture loan amount can be repaid from the sale proceeds of the concerned asset. Unsecured Debentures do not have such protection and remain at par with other unsecured lenders of the company, in the event of a re-payment default.
Debentures can be converted into shares (equity or preference) basis the level of permitted conversion. On the basis of convertibility, debentures can be classified as Non-Convertible, Partly Convertible, Fully Convertible or Optionally Convertible.
Redeemable debentures are issued with a redemption option – on demand, after completion of a fixed period or through a periodical drawing system. In the case of irredeemable debentures, the borrower does not have to repay the loan amount within a specified period.
Registered debentures are issued in the name of a specified individual who is registered as the debenture holder. The name of the person is mentioned on the debenture note or certificate. They can be transferred after completing all necessary formalities required as per Companies Act. Bearer debentures are made out to a bearer (rather than a particular individual). They are transferrable by mere delivery.
3) Bull and Bear Market
Broadly speaking, there are two types of market phases – the bull market and a bear market. In a bull market, prices increase or are expected to increase. In general, there is an upward or growth trend in the market. In terms of investor sentiment, there is widespread optimism, confidence and positivity. For instance, the period starting December 2011 till March 2015 is characterized as a bull market. The Indian Sensex jumped up by over 98% during this time. A bear market is the exact opposite of the bull market. Stock prices continuously go down (more than 20%) or are expected to do so in the near future. These times are usually marked with rampant negative sentiment amongst the investors. For instance, the dot com bubble burst (the early 2000s) and the fall of the US housing market (2008) led to a bear phase.
One important factor in both these market phases is that the trend (whether growth or fall) needs to be for a sustained time period, to be characterized as a phase.
4) Pre-requisites for stock trading
If you are eligible to enter into a contract, you can buy or sell shares as well. In order to do the same, you need to get a
i) Trading Account
Trading Account is the account through which you will place your trading bids in the stock market. It can also be used to make other online investments such as mutual funds, etc.
ii) Demat Account
This account will act as a common repository wherein all your shares are stored in a digitalized or electronic manner. In our country, these accounts are maintained by Depository Participants – NSDL (National Securities Depository Limited) and CDSL (Central Depository Services Limited).
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5) Risk Tolerance
Risk tolerance is one of the most important deciding factors in stock market trading. It refers to the quantum of fluctuation in returns or principal investment value that you are willing or able to bear. In simple words, how much risk (or losses) can you comfortably absorb.
This factor is influenced by a host of factors –both positively as well as negatively. For instance, aspects such as education, professional qualification, income levels, wealth etc. generally have a positive impact on your risk tolerance. As these factors witness an increase, your risk-taking ability also rises. Factors such as age tend to have a negative impact on your risk tolerance. As you grow older (and take on more responsibilities) you tend to be wary of taking risks.
Your investment choice should be in sync with your risk profile. For instance, if you have a healthy risk appetite, you can opt for higher equity exposure. Debt schemes are suitable for conservative investors with low-risk tolerance.
Learning is a never-ending process. But these five aspects will get you started on your stock market trading journey!
Read our blog on 7 golden rules of stock market investment for becoming a successful stock market investor
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