Tips for trading

Understanding Stocks is an essential guide for those craving to make money in the stock markets. It acts as a tutorial for learning basic as well as sophisticated trading strategies.

twitter-logoSameer Bhardwaj | Print Edition: March 20, 2008

Understanding Stocks

To be an equity master

Understand trading jargon: Bid price, ask price, stop orders, limit price orders, volume, market capitalisation, yield

Learn fundamental analysis: Analysing balance sheet and income statement, economic & industry analysis, ratios like P/E, RoE, ROCE

Learn technical analysis: Use price charts to get an idea of the market direction. Understand supports, resistance and moving averages

Identify factors affecting equity markets: Central bank and government policies, interest rates, inflation

Diversify your investments: Different stock categories like sector stocks, growth and income stocks and value stocks

Nothing fascinates people more than an opportunity to make a quick buck on the stock market. Enthusiastic risk-takers and the more sober risk-averse investors alike find it difficult to stay away from equities. That’s largely because investing in equities is one of the few investment avenues that eliminates purchasing power risk.

That is the returns offered on investment in direct equities best beat the inflation in the long run. But volatility in the stock markets could put off many investors, although there are money making opportunities even in falling markets. However, such opportunities can be converted into fortunes only if one can correctly predict the market direction.

That’s why it’s necessary to understand market basics and functioning, the factors influencing it, the ways to reduce risk, as well as trading strategies, before you enter this market. Whether you’re a new investor or if you want to study advanced market concepts, Michael Sincere’s book, Understanding Stocks, could prove the perfect guide.

The book is divided into four sections, starting, appropriately enough, with the fundamentals. Sincere then moves on to discussing sophisticated concepts, trading strategies, stock picking methods, influence of macroeconomic factors and even some nuggets of financial advice. In the first section, the author explains the concept of equity shares.

According to him, the primary reason for investing in stocks is the capital appreciation or capital gains. Other investment alternatives like bonds, mutual funds, exchange traded funds, money market instruments and index funds are also explained. The section also explains the concepts of stock split, float, market capitalisation, stop loss and limit orders.

Market capitalisation is the base for classifying stocks as large, mid and small cap. Generally, companies with low float are considered to be highly volatile due to demand-supply mismatch. A stop loss order enables an investor to sell the stock at a specified price. The author also advises investors to avoid margin or leverage trading, as any wrong judgements (in terms of market direction) can put them into severe losses. The concept of short selling is explained, and Sincere adds that short selling is often used to make money in falling markets.

The second section covers some trading or money-making strategies. Some of the strategies explained are “buy and hold”, “buy on the dip”, “dollar cost averaging”, “value investing” and “growth investing”. The author mentions that an investor must do thorough research before trying these strategies, as not all strategies work during all market conditions.

The third section covers fundamental and technical analysis. Fundamental analysis aims at calculating the intrinsic worth of a stock, whereas technical analysis looks at historical price charts to forecast future price movements. The author also explains how to analyse balance sheets, identify the best performing companies in the industry, use financial terms like P/E ratio, PEG ratio, RoE, etc.

In technical analysis, it covers simple charts—line, bars and candle stick, various patterns like head and shoulders, double top and advanced tools like moving averages, relative strength index and on balance volume. Though technical analysis is not comprehensively covered, it still gives a basic idea of the tools and techniques used by professional traders.

Target Audience: All investors

Quick Read Tip: Read “Introduction to Fundamental Analysis” to learn about the basics of buying stocks

Language: Easy

Style: Illustrative

Visuals: Tables and Charts

The final section identifies some of the macroeconomic factors that influence global equity markets. US central bank policies, strength of dollar, inflation and unemployment are cited as some of the major factors. It explains why a reduction of interest rates by the US Federal Reserve leads to a bull run in emerging economies’ equity markets.

The book also mentions some of the mistakes investors make while trading in equities. Lack of diversification, herd mentality, believing in stock tips and lack of liquidity are mentioned as some of the mistakes. The author has given some good stock market advice in the final chapter.

According to him, investors should use both technical and fundamental analysis while investing in stocks, keep healthy cash reserves, question earning estimates given by analysts, listen to traders (as short-term traders have a good idea about the market direction), research companies before buying stocks and invest only a reasonable proportion of savings in the stock market.

The book serves the purpose of both long-term and short-term investors, as it meticulously explains longand short-term trading strategies. It acts as a step-by-step guide for those who are new to equity markets and are not familiar with its functioning. All tools and concepts are well explained in simple and clear language. Even the technical (economics and finance) jargon is explained clearly. It could prove to be an asset for students, investors and traders alike.

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