Top strategies that can lead you to win stock market game
When it comes to investing in stocks, many people hesitate.
Many find it difficult to take the first step towards the stock market as they believe conventional investments are safe.
By putting your money on conventional options, you are compromising on the returns as the profits of these investments are not enough to beat the inflation.
Due to its dynamic nature, the stock market may go up and down frequently. But through proper strategies, you can make money in either direction.
Normally, long-term investments in the equity market fetch positive returns as the long-term trend in the equity market has been upward, even though there have been times when the market has declined.
So here are few techniques that can help you to have a return that is higher than the benchmark returns and ultimately lead you towards winning stock market game as an pro.
- 4-Golden Rule to Follow Before Making the First Step
- Pick Stock Wisely
- Choose Long Investment Period
- Make a Diversified Portfolio
- Avoid FOMO
- Short-Selling on Steroids
- Cutting losses
- Profit Booking
- Avoid Market Tips and Recommendations
- Choose the Correct Broker
- Educate Yourself
4-Golden Rule to Follow Before Making the First Step
Throughout your investment journey, you should follow these steps.
- Never borrow to invest in equity. This can create a great degree of financial distress due to interim fluctuation in the market.
- Avoid impulsive buying/selling. This may reduce your profit.
- Use that money in equity investing which you are not going to use for the next 3-5 years. It’s always advisable to have an emergency fund that can meet your requirements for the next six months.
- A single trade can never make you rich. So it’s really important to be an active investor and keep track of your trades.
Many people are having the habit of buying penny stocks.
Low hanging doesn’t make them good. Nowadays even before buying a small product, we check the specifications, reviews, price comparisons, etc.
The same logic is applicable in stock picking also. Fundamental checking of the company is necessary before putting your money into its shares.
The following financial ratios will help in identifying how strong the fundamentals of the company are.
- P/E ratio (Price to earnings ratio): This is the most widely used one and can be calculated by dividing the stock price by the earning per share (EPS) of the previous financial year.
Sometimes people consider trailing twelve month EPS to calculate this.
It indicates how much the investors are willing to pay for every dollar of earning. It’s expressed as a multiple so stocks with a lower P/E ratio are considered superior.
Shares with a low P/E ratio indicate that the stock has experienced superior results relative to the market and at the same time, it’s undervalued.
So, investors can buy undervalued stocks at a discount and when the price moves-up, they can book the profit.
Comparing a company’s P/E with its peers will give a sense of whether it’s overvalued or undervalued.
- Price-to-Book Value (P/BV Ratio): This ratio compares the market price and the book value of a company.
This ratio shows how much an investor is paying for each dollar in the net assets. Since it’s a multiple, a lower value is considered as good. Usually, a value under 1 is considered as good.
This signals the stock is undervalued. A greater P/BV (more than 1) shows that the market price of the company is higher than its book value.
While buying stocks having higher P/BV, investor is paying a premium above the book value and expects the company will generate enough earnings in the future.
Book value is the value of the company’s asset expressed on the balance sheet. Suppose a company is going to liquidate, then it will sell all its assets and pay off all the debts.
The money left after paying the debt is called the book value of that company.
The P/BV ratio is useful to analyze a company having a lot of tangible assets like a manufacturing company that holds machineries, plot, property, etc. For firms with fewer tangible assets, like an IT firm, don’t have a meaningful book value.
So this ratio is less important for them.
- Return on Equity (ROE): It’s the ratio of net income to total shareholders’ equity and expressed as a percentage.
Total shareholders’ equity is nothing but total assets minus total liabilities.
This shows how much profit the firm generates for each dollar of equity it owns or in other words, ROE shows how effectively the company is using its assets to generate profits.
This ratio never tells us whether a stock is cheap or expensive instead, it tells only the profitability of the firm.
This ratio depends a lot on the firm’s debt level i.e. higher the level of liabilities, lower the shareholders’ equity and higher the return on equity.
So, while considering the ROE of a company, a check on its debt level is a must. In short, a company may have a higher ROE as it had a lot of debt, not because it’s more profitable.
Thus, a comparison of ROE of firms with the same debt level or from the same industry will only make sense.
- Debt-to-Equity (D/E Ratio): It’s a measure of the firm’s use of fixed-cost financing sources.
There are two ways that a company finances its capital requirements- either through debt or through equity.
D/E ratio tells us how much debt the company uses compared to its equity.
A lower value shows that the company uses a lower amount of financing through debt and higher one shows that the company is borrowing more.
And a higher level of borrowing indicates a greater chance for bankruptcy during tough times.
It’s always recommended to compare the D/E ratio of the companies of the same industries because this value varies from industry to industry.
BFSI sector will have comparatively more debt, so higher will be their D/E ratio. On the other hand, IT companies will have a lower level of debt, so their D/E ratio shall be on the lower side.
A company with a debt-free tag normally looks attractive as this tag shows that the firm can manage its fund requirement through internally generated cash and they are cash-rich.
- Operating Profit Margin (OPM): It’s also known as return of sales.
It measures the profitability of a company and is expressed as a percentage.
It shows how much percentage of profits a firm generated from its revenue, before paying interest and taxes.
It’s calculated by dividing the operating profit by revenue.
Since it’s expressed as a percentage, a higher value is considered good as it shows how well the firm manages its operating expenses like raw material expenses, employee cost, rent, etc.
It’s often used to check how efficient the management of the company is; as a superior management team will able to control the operating expenses smartly.
Even Technical Analysis will help to pick value stocks.
In a bull market, it’s very common that all the companies will show positive trends. Analyzing the long-term track record of a company will help you to have a clear picture of the stability and ability of the company.
The companies with strong long-term trends have always given good returns to investors in long run.
Stock picking is just the start of the investment journey.
There is a famous saying about cricket that “the more time you stay in the crease, the more runs you’ll make”.
Same theory is applicable for your stock market investments also. The more time you hold the stock, the higher will be your returns.
The short term opportunities never turned-out big success in the stock market. If you’re looking for quick money, then the stock market is not the place for you.
Moreover, frequent actions will reduce your returns. Frequent switching will result in paying more commissions and fees to the broker which will reduce your returns considerably.
Always invest for a time horizon of 3-5 years or even more. Remember the fact that when you’re buying the shares, you’re investing in a company, not in the stock market.
Consider the holdings as your own business and ignore the short term fluctuations.
Make a Diversified Portfolio
This is the most important strategy for a big win. It’s a risk management strategy.
There are some risks associated with all types of investments and higher the returns, higher will the risk.
Through diversification, you can spread the risk and reduce the volatility in the portfolio over time.
A diversifies portfolio is nothing but a combination of different assets that earn the highest returns for the least risk.
Stocks, bonds and commodities are integral parts of a perfect diversified portfolio.
This approach will help to take advantage of different economic cycles as different asset types move in different economic cycles.
FOMO is nothing but the Fear of Missing Out. FOMO is associated with volatility.
When a sudden volatility occurs in a stock, few people feel that it’s once in a lifetime opportunity to buy or sell that stock and they don’t feel like missing it.
In a hurry they take decisions. Often FOMO can lead to poor decision making. So it’s better to miss an opportunity than making losses.
Deciding in a hurry is not a long-term strategy. They may give small gains in the short term but in the long run, you’ll find them in deep red.
Have patience, plan and wait for the opportunities to come than chasing them. New opportunities constantly arise in the stock market.
Many people consider short-selling as a sin. But it’s a betting in the opposite direction of the market with the hope that the prices may decline soon.
In this technique, the investors sell the stock first and then buy them back at a lower price thereby making a profit.
It’s a very important feature in the stock market not only for providing the liquidity but also for the correction of overpriced stocks.
This is a risky affair because there is no limit to the amount you can lose if the stock continues its upward journey even after you short it.
Avoid shorting illiquid stocks because it’s difficult to get out of a position in an illiquid stock.
It’s not necessary that you may win all the time.
Losses are also an integral part of the stock market game. But never allow your small mistakes to grow into big disasters.
Cut your losses quickly and make them smaller.
This technique applies to those stocks which have undergone a significant correction in their value due to the reasons like bankruptcy, corporate governance issues, etc.
The shares of such stocks may find it difficult to bounce back and regain their past highs even in a bull market.
So it’s better to replace them with a more successful one.
You should start booking profits when you are a couple of years away from your investment goal as it’s difficult to get the right price at the right time.
The profit booking decisions can also be done depending upon the value of your portfolio.
If there is a sudden rise in the market, your investments may also show higher returns. In such a case, you can book the profits even earlier.
It’s always advised to book profit on a small portion of your investments when the market is in the uptrend instead of selling the entire portfolio together and then buying them back.
This will allow the remaining part to grow further.
Depending upon your risk tolerance, you should re-balance your portfolio.
Risk tolerance of a person depends upon his/her age, income, expenses, etc.
To bring your asset allocation in its required ratio, profit booking is very necessary.
Avoid Market Tips and Recommendations
There are many business channels and social networking sites that discuss multi-beggars, hot stocks, etc.
They claim that these stocks can fetch higher returns in the short term.
Never chase these stocks because these hot bubbles are created by these channels and they can burst at any point of time.
Most of the recommendations that are available on the TV channels and social media are biased.
Even for financial news, believe only reliable sources.
The best place to get corporate news is either on the sites of the companies or the stock exchanges.
Choose the Correct Broker
Selecting a broker for your investment journey is as important as stock-picking because a bad broker can spoil your journey towards your financial goals.
Without a broker, you can’t buy or sell stocks. You can change the broker later if you’re not satisfied with their service.
To start with the stockbroker selection, you can check the websites of the leading brokers to know their services, fees, and other charges.
Checking the reviews of the existing customers will give you an idea about how they serve their clients.
A beginner may require a lot of support from the broker.
There are two types of brokers
- A full-service broker and
- A discount broker.
A full-service broker provides stock recommendations along with trading platform while a discount broker will only provide a platform to trade.
For a beginner, a full-service broker is always recommended.
Nowadays some brokers offer $0 commission trading. Always check the demo videos of the trading platforms to know how user-friendly they’re.
A regular reading of business dailies and business magazines is necessary to keep yourself aware of what is happening in the corporate world and also in the stock market because many of these updates may have an impact on your portfolio value.
The hunger for knowledge shall always take you ahead.
Your wealth creation journey requires a lot of discipline. Emotions and greed will always try to dominate your game-plan but never allow them to succeed.