Tips to risk-free investing in stock markets

Tips to risk-free investing in stock markets

Speculation, hope, fear, and greed - Graham has very effectively summarised the ailments that stock market investors suffer from. Here are the eight common mistakes to avoid.

"Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or give way to hope, fear and greed."
-Benjamin Graham, US economist and professional investor

Overlooking Fundamentals

In a haste to make a quick buck from the market, retail investors tend to overlook the fundamentals of the company they're planning to invest in. Some investors buy shares without sparing time to gather the basic information about the company, most importantly the product or service that the company sells and the probable future for that business.

"Retail investors get carried away by a management's overoptimistic speeches, tentative expansion plans and are always biased towards short-term play, never wanting to miss the current surge in the price of the stock," says Hemindra Hazari, head of research, Karvy Stock Broking.

Investors should look at companies that have consistently delivered earnings growth and good corporate governance. Never invest in a firm without understanding the dynamics of the business.

Cheap, yet expensive

A successful investor looks for bargain stocks-the ones which are available for prices lower than their worth and have a strong growth potential. Newbie investors often misinterpret this golden strategy as buying 'cheap' stocks for high percentage gains.

Assume that you can buy a dozen fresh eggs for Rs 36, while rotten eggs are available for only Rs 3 per dozen. If you have Rs 3 in your wallet, will you buy one fresh egg or a dozen rotten ones?

"Retail investors look at the share prices of the stocks. They tend to buy cheap stocks, which might not be very valuable," says Sarabjit Kour Nangra, vicepresident of research, Angel Broking.

Returns from your investment in shares do not depend on the number of shares, but the performance of the company. You will have a higher chance of making a profit if you buy just one share of a blue-chip company rather than buying thousands of penny stocks.

Myopic Vision

Retail investors often look for short-term gains. If you want to make a quick profit from stocks, you should have the ability to time the stock market. Stock prices fluctuate wildly over short periods. Your profit or loss depends on your ability to clinch the deal at the right moment. Due to the turbulent nature of stock markets, it is difficult to profit in short time periods.

"Retail investors feel left out during phases of a secular bull trend or in times of short-term surges. Retail investors should judge their risk appetite and then take a long-term view," says Hazari. The equity market almost invariably gives a positive return in the long term, in this case a time horizon of at least three or more years will be most prudent.

Also, when you stay invested in a stock for longer than one year, the taxman won't come knocking for his share of the profit. Income from stocks held for more than one year is a long-term capital gain, which does not attract any tax. For investments less than one year, you will have to pay short-term capital gains.

Ignoring a Portfolio

You must have heard stories about investors who bought a company's shares, forgot about them and after a decade or so discovered that they had returned a fortune. While this is an example of how long-term investment is profitable, it's not the best.

If you are among those who think that long-term investment means buying shares at low prices and forgetting about them, you are taking a huge risk. The economic environment and market scenario are very dynamic. Apart from global and local policies and macroeconomic factors, there can also be changes in company strategies or management.

An investor should review his portfolio at regular intervals. If the outlook of a company improves, or at least remains stable, he should buy or hold the stock. When the assumptions under which he bought the shares no longer hold true, it might be time to offload them.

Unwillingness to Book Losses

Investors eagerly cash out small profits on retail investments, but they are often unwilling to book losses on stocks that are sinking. Even when stock prices keep declining, they continue to hold on in the hope that the stock will bounce back and turn profitable sometime. This often results in bigger losses for the investor.

When prices decline, some investors buy more shares in an attempt to reduce the average cost of their stock portfolio. Buying on dips is recommended, but only when the decline is due to a temporary setback and growth prospects remain positive.

"Retail investors should stop averaging every second stock unless they have a thorough understanding of the company. They should try to explore of the reasons for its underperformance. Averaging is not a tool to minimise losses but should be treated as a maximisation instrument," says Hazari.

When investing in a stock, you should also set a stop-loss instruction for it. When the price of a stock falls to the stop-loss level, the broker will sell them. If you set a stop-loss order at 10% below your purchasing cost, your loss will be limited to 10%.

Entry at Peaks, Exits at Lows

The stock market always overreacts to news, be it while rising or falling. Ideally, the price of a share should be proportional to the total capital and earnings prospects of the company. However, a market frenzy results in shares being, generally, overpriced or underpriced.

In a bullish market, investors often invest in overpriced shares because everyone else is buying. They become too optimistic and expect stock prices to continue rising. Conversely, in a bearish market, investors become pessimistic and tend to sell shares when they should be buying.

Stock markets tend to take wild decisions in the short run but behave rationally in the long term. Successful investors always base their investment decisions on a shares' intrinsic value and hunt for bargain stocks. They will buy shares of a company with strong fundamentals when it's beaten in the market and sell when prices surge.

Following Tips

Thanks to cheap bulk messages, you might have received SMSes tipping you about a 'golden opportunity' to earn huge profits. If you have acted on any of these tips, you probably have lost some money. If you haven't, you've done well to stay away from such unsolicited mails and messages.

Even solicited tips can do you harm. If you try to find trading tips on the Internet, you will get a large number of websites and blogs that offer you free advice. Don't take the advice on these sites as gospel. It's equally dangerous to buy shares because a friend told you that "its price is going to double in six months". Stock tips by analysts published in newspapers or aired on television should also be subjected to scrutiny.

Always perform due diligence before placing an order with your broker.

Allowing your Broker to Trade

If you just sign the forms on your agent's instructions and allow him to buy and sell shares on your behalf, be ready for a few shocks. Unscrupulous brokers often use this opportunity to misuse clients' money.

Brokers don't get a commission on the profit you earn, but get paid for trade volume. There have been cases of brokers using investor money for intra-day trading without investors' consent. When you get a statement from your brokerage house, you might see your portfolio running losses with a huge amount paid as brokerage.

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