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Stock Trading: Does it require technical skills to succeed?
Stock trading is considered a risky venture by majority opinion. However, if one reads about the successful stock investors like Jhunjhunwala and Buffet it comes to mind instantly that common sense plays great role in successful trading. Experience of the author of the hub also supports the same hypothesis. Whenever advice of the experts was followed the outcome had been very poor.I cite here few examples based on expert advice from a reputed brokerage firm in India.
Example 1. RBI announced cut in interest rates and broker immediately flashed the message to its clients that its best time to go for banking stocks. However, rate cut has adverse effects on the banking stocks.
Example 2. Experts from the brokerage firms advised the author of this hub to sell SBI stocks and author followed the expert advice. However, stock valuation improved within 2-3 days.
Example 3. Expers from the same brokerage firm advised the author not to go for averaging LICHSGFIN stocks on devaluation. However, reverse happened.
Such incidences give a feeling if these experts really render advice to investors or they act as commission agents? Anyways, lets come to the point whether one needs to possess analytic abilities to trade stocks or just common sense and basic knowledge of fundamentals?
In the business of trading, losses and profits compel even a layman to learn many new things about the trade. Everyone incurs small losses in the course of learning the trade and later makes substantial gains too. Based on the real life experiences, some of the useful tips by the author of this hub are given here.
When to enter and exit the trade are the important decisions in determining the profit & loss from the stock trading and these decisions require study of the performance charts of the stocks. It does not require mathematical skills to do so. New investors often ignore performance charts and risk their investments in stock trading. Before discussing intricacies of business it would be greatly helpful to know what charts needs to be studied.
1. Should I study the performance charts? One may find live share price chart searching stock with any browser. Study the changes in value of the stock in the past. Here, LICHSGFIN chart is being studied to help make buy and sell decision. One year chart (shown below) provides quarterly performance of a stock. Looking at the 1-Yr chart of LICHSGFIN will make it clear that stock has touched 463.60 on few occasions only and fluctuated mostly between 400 and 450 during the current quarter (May-June 2015). Buying a stock at a price of Rs 450 or more will make investment at this point either risky or engaging for long term. To earn any profit on short term basis at this juncture, one has to buy share in the price range of 400-420.
In short term perspective, we draw same inference looking at the charts of 1 month , 3 months and 6 months. One can earn profit on investment made during the recession if a stock is purchased at dips and sold at peaks looking at charts. Please don't be impatient in buying a stock and don't show any haste without looking lows and highs on graph would likely result in loss of revenue.
2. Should I go after big names: People usually prefer to buy shares of known firms like 'Navratnas, mini ratna's, Tata's, Ambani's, Reliance, SAIL, NTPC' etc. My experience shows that big name in the business may not give big returns on the investment of small investors. Hence, have a look at the financials of the share (EPS, net profit, share holding patterns etc. ). Details of the financials are provided in next paragraphs.
3. Should I get tempted by the discounts on disinvestment of Government shares: Past experiences of disinvestment of SAIL, COAL INDIA, NTPC shares suggest that small investors trading for short term may not get benefited from trading such shares
4. Should I go for buying shares after hearing news of huge profits in quarterly results, cuts in interest rates or news related to expansion, acquisition, merger etc.,
5. Should I look at the high and low values of a share in charts and wait for the low values to touch in a monthly chart. If share prices are near the lowest values, chances for high returns are more. Looking at charts for a period of one year or more is unlikely to help predict behavior of a stock in near future.
6. Should I need to compare the growth rates of different stocks and select top stocks from each sector. Study the behavior of individual stocks for few weeks and buy stocks when there is a dip. Buying a stock at highest ever price is unlikely to give high returns in short term trading.
7. Should I Invest in limited stocks? If an investor is willing to trade with limited money (thousands), he should invest in 2-3 stocks only. In case of a lakh or few lakh one may investment 5-10 stocks.
8. Should I track the changes? Time is the money. All the traders need to track the performance of the shares. Few good apps are available for android and windows mobile platforms. Traders need to make their portfolios to know the performance of their stocks on real time basis.
9. Should I look at gross values alone? Incurring costs involved in trading are important to consider while making short term or long term investments. Brokerage is charged on buying and selling of the shares. Majority of brokers hide the fact that a minimum amount (Rs. 25/-) is charged per order. If you frequently purchase shares in small numbers, a minimum amount has to be paid to broker on each order. To make the thing understandable, an example is given below.
Mr 'X' purchased fifteen (15) shares of Exide India at a rate of Rs. 152. Brokerage is calculated @0.4% on the order and it amounted to Rs. 18.4. Since amount is less than Rs 25, an amount of Rs. Rs 6.6 will be charged as 'handling charges' or 'other charges' on buying process of share in addition to miscellaneous charges levied as transaction charges, service tax, stamp duty etc.
Brokerage charges and other charges are levied on all the orders including buy & sell. Traders should deduct these charges while determining the profit or loss from any trading.
10. Should I wait for best time? When there is an overall decline in stocks and market is showing consistency in the decline of the value of share, do not buy share within few hours of market opening. It has been observed that usually shares touch the lowest point within 1-2 hours of market closure. Same holds true for sell process also during normal functioning of the market. Hence, one has to observe routines of the market carefully to succeed in the trade.
Learn the basics of stock market
An introduction to the basics of the business would help many novice traders to enter into the trade and understand the intricacies. A knowledge of fundamentals is prerequisite to understand things not to be ignored while investing in the stocks. Any investor to be able to start online trading should be aware of few things which are as follows:
The major products of stock trading are:
- Derivatives(Future and options)
- Mutual Funds
New investors may note here that they should mostly invest into equity shares as these shares can help the investors gain a huge profit at the cost of a small loss. After gaining some expertise in stock trading and sufficient knowledge of other products, traders may try their luck in other form of trading. Although equity shares trading can be done in several forms, two of them being prime are as follows.
- Intraday type stock trading
- Delivery type stock trading
In the case of intraday trading, we incur less brokerage commission but then the chances of facing losses are pretty high as the shares are bought and sold on the same day whereas in delivery trading the shares can be sold at an appropriate time. Hence, it is advisable for the new investors to involve themselves into delivery trading only. First of all, the new investors in order to start trading should start to purchase the shares. To buy the shares, investors basically have four options with them being:
1. Market Order: Purchasing or selling the share at market rate or market value.
2. Limit Order: Buying or selling at a specified rate (lower or higher than the market value).
3. Stop Loss - Limit order: A stop trigger price and a limit price to either buy or sell a stock is specified by the investor.
4. Stop Loss - Market: A stop trigger price to activate an open market order to either buy or sell a stock is specified by the trader.
I came across a new word today i.e. 'seasoned trader'. What do these traders do in the stock market? An expert suggested a trader on a brokerage site that beginners should opt for medium or long term trading and novice traders should not risk short term trading. What this advice indicate? It simply mean that a novice trader first needs to learn the game plan and than try his hands on this after learning all the tricks of the game.
An example must clear some of the dust. A company posted its results yesterday and it showed that it has earned a huge profit. News spread immediately and whoever heard the news tried to buy few shares of the firm. However, share dipped immediately about fifty rupees (within few minutes). It failed to recover on that particular day but it was supposed to gain within few days. It happened within a day or two. So its play of the seasoned traders and not the beginners. One needs to learn the trick.
What more beginners should know about stock trading?
The investors should know few other important facts also which are as follows:
- New investors should start to learn trading by starting with a small amount initially.
- An investor should invest only that much amount for which he is able to bear the losses as well.
- One should invest in 4-6 shares only initially.
- Instead of buying shares from only one sector, one should invest in shares of multiple sectors.
- An investor should keep himself aware and abreast with trading tips but then should even be cautious against tips and statements provided by promoters who wish to make more profit by luring these investors.
- It is advisable for the small investors to invest in lower worth shares but then they should keep an eye on the trading volume as the shares with lesser trading volume become stagnant and dormant for a very long time.
- Purchasing the shares of higher worth involves transaction tax and because of the number being less the profit earned become less.
- While doing online trading an investor should keep in mind that he has sufficient balance in his account and the broker can anytime sell your shares and square them off.
Most important thing to bear in mind
Insiders and promoters get first hand information of orders secured by a firm, profits or losses earned in a particular quarter and other matters that may influence valuation of a particular share. Hence, they are well aware when the value of a stock will go down or up and chances to harness the benefits to full extent are always there. Investors must watch the movements of a particular stock carefully immediately after declaration of results. Propaganda machinery is always active in the stock market and helps promoters and middlemen to achieve their calculated gains.
Stock valuation based on fundamentals
There is stiff competition among firms belonging to same sector and value of the stock of a company differs from peers. If a beginner understands the valuation criteria, it may help select a good stock to achieve handsome returns investing in the same. To help beginners understand the basics, important criteria are described in brief as follows.
Price/Earnings ratio (P/E ratio)
It helps in finding out the valuation of a stock in terms of market price of its share divided by earnings (annual) per share. Ratio becomes meaningful provided growth of the peers is identical. A P/E ratio varying between 10 - 18 is considered a fair value for a stock by the experts and believed to take care of inflation.
Ratio is also known as 'Price to Equity Ratio' or 'Market to Book Ratio' and calculated dividing closing stock price by the book value of the stock in the latest quarter. Formula to calculate ratio is as follows.
P/B ratio = Closing price of the stock/Total Assets-Intangible Assets and liabilities
Ratio is helpful in understanding whether a stock is overvalued or undervalued. A ratio greater than unity is considered to suggest that stock is overvalued and lesser than unity as undervalued. A low P/B ratio means that the company has tangible assets to support stock whereas a high P/B ratio suggests that investors have high expectations for the company. P/B ratio is reported to be more relevant in case of banks, financial and insurance institutions that are composed of liquid assets and less in case of companies having fixed assets and large R&D expenditures.
It is important to find out from the quarterly reports of a company that what is the shareholding pattern at present. Sizable chunk of stocks held by FIIs carries the risk of downfall if FIIs exit in a hurry. If stocks are held by mutual funds, insurance companies and diversified financial institutions it is a indicator of its being a good stock since institutions may have a great say in decision making. It is also important to know if promoters have pledged or not their shares as debt collateral. Selling of pledged shares by the lenders may prompt a fall in the price of a stock.
Return on Equity (ROE)
As its name indicates, 'ROE' is expressed as a percentage of net income on shareholder's equity. It is a useful criteria to evaluate the relative economic performance of a company belonging to a particular sector.One may compare the 'ROE' of a company with the 'ROE' of the sector and lower or higher ROE than the sector may help an investor to make financial valuation of a company.
Enterprise Multiple (EV/EBDITA)
It is a popular valuation criteria used either as an alternative to P/E ratio or in conjunction with the same. A low ratio is believed to suggest that a stock is undervalued. Industries with higher growth rate are reported to have a higher 'Enterprise Multiple' than the lower growth industries.
Stock valuation based on technical analysis
Relative Strength Index (RSI)
RSI measures directional price movements on a 0-100 scale as rate of fall or rise in the price of a stock and depicts the current and historical trends of strength or weakness of a stock based on closing prices for a particular trading period. High and low levels of RSI are marked at 70 and 30, respectively. As a general consideration it is suggested by the financial experts to buy a stock after RSI crosses above the oversold line (30) and sell when it crosses below the overbought line (70).
This measure is plotted using negative values (0 to -100) to indicate the oversold (-80) and overbought (-20) levels. Hence, buy and sell of a stock may be taken up when a stock rises to cross the overbought level and oversold levels, respectively. It is suggested by experts to use trailing buy and selling stops and stop-losses to enter or exit trade and protect from revenue losses. As a general rule, traders are suggested to take a long route when Williams%R drops below the oversold signal value (-80) and a short route if it rises above the overbought level (-20).
Simple Moving Average (SMA)
Short term (5-day) simple moving averages are calculated to compare with long term moving averages (8 or 15 day) and whenever the short term SMA crosses above long term SMA it signals to traders the beginning of an uptrend or bullish trend. On the contrary, a bearish trend is signaled if short term SMA moves below the long term SMA.
Changes in the stock price & volume
A comparison of change in the price of a stock and trading volume compared to previous day indicates the following facts:
- Uptrend: increase in price and volume
- Slow uptrend or downside risk: increase in price with a decrease in volume
- Downtrend: decrease in price with an increase in volume
- No change: unchanged price & volume