Stocks Lesson 01

Little Things You Should Know Before You Start Investing in Stocks

Well, if you purchased this product it means that you are interested in trading stocks, aren’t you ? I assume the reply to be “YES” and without further ado let me explain the little things you should know before you start investing in stocks.

Stocks are a great means to earn money but it comes with a lot of risks. In this post I’ll explain you about the risks associated with trading stocks, how to minimize risks and maximize profit. Most of the things mentioned in this post is based on real market experience and not based on any arbitrary assumptions.

The first thing you need, to trade stocks, is a ‘Demat Account’, demat stands for dematerialization i.e. you can hold stocks in electronic form and to open a demat account you can either approach your bank or any broker who is registered under Securities and Exchange Board of India.

The things you need to check while choosing the broker is, the brokerage charges, annual maintenance charges and other terms and conditions.

Once you are done with opening an account you are ready to trade. But here comes the problems, “which company to invest in, how many stocks to buy, how to calculate the breakeven point, how to sell the stock that you bought, when to sell the stock that you bought ?”.

Here is the answers to the aforementioned questions. First of all, the key thing that an investor should have is patience. You might be familiar with the saying “A bird in hand is better than two in the bush”, the same applies to the investor, here the bird is your money. If you take a quick move just based on some newspaper headlines, predictions, rumours, then you end up losing money. As I mentioned earlier, that all the information here is based on real market experience, I will tell you an experience of my own. When I opened my account I was in a bit of hurry and I ended up buying some stocks based on recent news, little things that I had heard about stocks by acquaintances etc. and guess what happened next, I was unable to breakeven on the investment even after couple of months. The reason for it is, the movement of price of that stock hit stagnation at a particular price and the range of price being very less, I would make a loss if I sold that stock even at the maximum price it was being traded at. This particular problem is termed as ‘Chakravyuha Problem’ i.e. you can enter the battlefield by knowing the entry route but if you do not know the exit route, you’ll end up getting stuck in the battlefield. Here the battlefield is referred to the market.

From the aforementioned example you might have learnt one of the little thing that you should know before you start trading. Now I’ll teach you how to overcome the above problem. Before you start investing in a particular company you should know the entry and exit points. Entry point means the price at which you have to buy the stock and exit point means the price at which you should sell the stock. When you buy a stock you end up paying for the price of the stock, brokerage, securities transaction tax, stamp duty etc. And when you sell the stock you again end up paying the aforementioned fees, but if you are selling the stock for a greater price than the price you bought it for you will recover all the fees and you also make ‘some profit’. That ‘some profit’ can mean a lot depending on the type of trader one is. For a good trader ‘some profit’ can mean crazy ultra huge profit, for example 75% profit. Well if you think that is exaggeration then you might have to change your mind. Here is a real example, I bought a stock for a price around INR 10 and in a few days it hit around INR 17.5, sounds cool doesn’t it ? but here is another probability that can happen to the above mentioned stock, if the price of the stock falls from INR 17.5 to INR 10 then a person who entered the trade at INR 17.5 would make a loss of 75%. Bingo !!! you heard that right, that is exactly how volatile a stock can be.

Oops, I think we drifted a bit since I was supposed to teach you how to break even.

This is how you make the calculations, after few trades you will be in a position to know the brokerage fees, taxes etc. for a particular amount, for example say INR 1000. You should note it down in a book or just remember it in mind because after few months of trading you become used to taxation and fees and you can predict the fees much before you get the bill or contract note. For now, let us assume the fees to be INR 5 for easier calculations. Therefore when you buy the stocks for INR 1000 you actually end up paying INR 1005. Let us assume the price of one stock to be INR 100. It means you can buy ten stocks. The stock gets delivered to your demat account after T+2 days. When you sell the stock once it is delivered to you, along with taxes you will be charged something known as DP charge, i.e. the charge for book keeping and this charge is constant irrespective of the number of stocks you own i.e. the DP charge is same for one share, hundred shares etc. At the time of writing this the DP charge is INR 13.5 plus taxes which after taxes costs somewhere around INR 15.93. You might be wondering, why am I telling this aren’t you ? The reason is as follows, imagine after two days the price of the stock that you bought rose to INR 101. It means, now you’ve made a profit of INR 1 per share. This multiplied by the number of shares i.e. 10 gives the value INR 10, which is the profit you made. But since you’ve paid tax of INR 5 while buying the stock, now your real profit is INR 10 minus INR 5 = INR 5. I also spoke about DP charge right ? INR 5 minus INR 15.93 = … You know what the answer is, don’t you ? The answer is negative integer. Which means you haven’t made any profit yet and the rise of INR 10 is an apparent profit and not real profit. In the same example assume you had 100 shares, it means for rise of INR 1 you make a profit of hundred rupees since you have 100 shares. As I mentioned earlier that the DP charge is constant for any number of shares, now your profit would be INR 100 minus INR 15.93 minus taxes. As mentioned earlier if the tax, brokerage etc. for 10 shares is INR 5, then for 100 shares it would be INR 50. If you subtract DP charge and tax from profit, it would be INR 100 minus INR 15.93 minus INR 50, which is equal to INR 34.07. Bingo !!! that is a positive integer.

From the above example you can spot that the person with 10 shares was not able to make profit even after the price of share rose by INR 1 but the person with 100 shares made a profit of INR 34.07.

What if the price hit stagnation at INR 101 in the above example ? Then the person with 10 shares will be experiencing Chakrvyuha problem while the dude with 100 shares would have come out of the problem with a profit of INR 34.07.

Let us see another probability, if the price of the stock that was bought initially at INR 100 fell to INR 99. In this case the person with 10 shares would lose 10 rupees and the person with 100 shares would lose 100 rupees if they exited the trade at INR 99. Suppose the price fell further to INR 98, then the person with 10 shares would lose INR 20 and the person with 100 shares would lose INR 200. I guess this probability would have made some sense in your mind with regard to trading stocks.

The drop in the price of share example might have made you go pale, so let us look at an happy example. Assume the price of share that was initially bought at INR 100 climbed to INR 1200 after ten years. You do the mathematics now. If you are done with the calculations, try to find the name of the job that would pay you the profit that that you’ve calculated in the above example and the hard work and brain work involved in that job. The hard work involved with purchasing the right stock ten years back on your demat account was just tapping the screen on your phone. There was a change in tense there. Ten years back people would most likely have not used mobile banking, so ten years back actually refers to present and ‘after 10 years’ refers to 10 years from now. Hang on, I forgot to mention that companies pay dividend, some annually and some quarterly and some during particular months and some never pay at all since all companies don’t grow the way it was mentioned in the above example but some do. To verify this you should check ten years graph of those companies which prove that capital appreciation by many fold is possible. I have identified such companies and that is the reason why I trust in trading stocks. If you are that type of person who would sell the stock after a decade then you are known as a long term investor.

Many people say that long term investment is a good option but let us have a look at the loop holes in that statement. Well it is pretty true that price of stocks appreciate over long period and one can also compound the profit by reinvesting the dividends to buy more stocks, here are some drawbacks in this approach. The first drawback is the purchasing power of money with respect to inflation. You might see some posts on social media which reads that investing x amount a decade back would have given you a huge profit of y amount now. Well the problem with this statement is that people forget to notice what one could have bought with x amount a decade back. If you found it hard to interpret the statement here is an example, when I was in grade 5 I used to live by the country side and the price of 1BHK apartment was somewhere around 3.5 lakhs. It means that you could get an apartment for 3.5 lakhs 12 years ago and if you look at the purchasing power of 3.5 lakhs today, forget apartment you can’t even buy an iMac pro. Some days back I got an opportunity to check the brochure of a real estate company and the price of 1 BHK was 46 lakhs. Assume you invested INR 3.5 lakhs in stocks 12 years back and you got an appreciation of 12 fold on that capital. It means  INR 3.5 lakhs * 12, multiplying this would give you an answer of 42 lakhs. Well this is capital appreciation, if you add dividends to it the value would increase. Also an important thing to note here is that dividend doesn’t follow a particular pattern i.e. during that 12 years there could be some years where the company doesn’t pay you dividend and there could be genuine reasons for it, and one such reason is plough back. Plough back means a situation wherein a company would use its profits to expand the company. Going back to the 12 year story, there could also be some years like recession, drought, sudden economic reforms etc. that would slow down the rate of growth. In such a situation you mayn’t really achieve the target that you expected. Now imagine you invested in stocks instead of buying 1BHK and rented out a home for 12 years. Calculate the rent for 12 years. Now check the difference amount between capital appreciation in stock price + dividends and inflation in the price of 1BHK. Do you feel that you made profit ? An important thing to note here is that the price of the rent keeps increasing by a definite percent every year in accordance with the rental agreement.

What is the moral of the above example ?

Do not get carried away by what you see in social media or what somebody says. Work out the mathematics before you go in for a trade.

What should you do if long term investment should go in your favour ?

The answer is wise trading. Now if you want to know what this is, here is the answer. There is something known as compounding. Many of you might be knowing the magic that compound interest does. But how to do it in stocks. Imagine you have 1000 stocks of a company which pays 2% dividend per year, assume the price of the stock to be INR 100. 2% of that is INR 2. Multiplied by number of stocks gives you INR 2000. Assume the price of the stock hit 150 in the second year, it means that if you invest INR 2000 of that dividend amount back into the same stock you could buy 13.33 more stocks (ignore the decimals). So the next time you get dividends for 1013 stocks. Assume the dividend percent is constant for the second year which is 2%. 2% of INR 150 is INR 3, this multiplied by 1013 stocks gives you INR 3039 as dividend

If you keep on doing the aforementioned process again and again the number of stocks in your portfolio will increase and so do the dividend income. Sometimes companies may even issue bonus shares when they  don’t pay dividends.

That is it for this episode, we will continue forward from where we left in the next lesson.

Disclaimer : Trading stocks is subjected to market risks. Please read all the terms and conditions before investing. The motive of this lesson was to teach little things about stocks for those who do not understand much about stocks. Candidcanblog.com will not hold any responsibility for any losses incurred to the readers of this post.

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