If you are new to investing, understanding the stock market, how it functions, and the risks associated with it will come in handy. First things first, what are stocks? Harsh Jain, co-founder and COO, Groww, an investing platform, explains, “A stock is an ownership in a company. When a company wants to raise capital and decides to utilise its authorised share capital, it issues shares to the public. Investors who purchase stocks have an ownership in the company, and are entitled to a share in the profits of the company proportional to how much stock they own.”
The next obvious question in this regard is the relationship between stocks and the stock market. “When a company sells all or a part of itself to the public in the form of shares, it is called a public company. These companies are listed on a stock exchange, and are called publicly listed companies. A stock market is a place where you can buy and sell shares of such publicly listed companies,” Jain says.
The stock market is of two parts: Primary market (a place where a company registers itself for issuing shares or getting listed in the exchange) and secondary market (after the shares are sold in the primary market, the buyers can choose to sell them to other investors. These transactions are done in the secondary market).
There is no denying that the stock market is constantly buzzing and also requires one to have a thorough knowledge of what goes behind before moving forward. Jain offers a simple step-by-step explanation of the workings of the stock market.
• A company gets listed in the primary market via an initial public offering (IPO), and allots shares to the investors who have applied for the same.
• Once the company is listed, the stocks can be traded in the secondary market.
• Since there are thousands of investors, allowing everyone to access the markets can be chaotic.
• Hence, trading happens via intermediaries like stockbrokers and brokerage firms that are registered with the stock exchange
• Investors cannot place an order (buy/sell) directly in the market. They need to go through a registered stockbroker.
• Once the buy or sell request meets the agreed price, it is executed.
• The stock exchange ensures that there is no party defaults, and settles the trade.
Considering there are many factors which might contribute to fluctuations in the market, one has to take into account several risks that are associated with trading on the platform. “First, market risk which occurs due to the daily price fluctuation in the stock market. Second, business risk (if the company performs poorly, the management changes, or you pick the wrong company to invest in), third, liquidity risk (if the company has high debts, it might cut dividends, or may even go bankrupt). Others are interest rate risk, taxability risk, regulatory risk, and inflationary risk,” elaborates Jain.
With experience comes the ability to make sound judgements. However, if you are a beginner, the best time to buy or sell a stock is an aspect that you might need guidance for. Jain explains how to go about it.
Buying stocks
If you are investing in stocks for the long term, then it is important to buy based on strong fundamentals. Look at the financials of the company and assess if it has consistent profitability that is higher than the industry standard, low levels of debt, and ability to repay its near-term obligations. Management quality is another factor to look at. Also, look at the competitive advantage of the company, if any. If you find a company that has strong fundamentals, then you can consider investing in it for the long term.
Selling stocks
Usually, while buying we recommend investors to assess the strength of the company. However, even if you have purchased shares of a fundamentally strong company, some policy or tax changes can impact its performance. If you feel that these changes will cause long-term problems for the company, then you must start looking for a good price to sell. If you see the strong fundamentals have been compromised, regulator/corporate governance issues, there is consistent financial underperformance, hasty exits of top management or questionable management practices, the company no longer has a distinct competitive advantage and is falling behind in innovation etc., then it may be a time to reassess the performance of the stock, or sell it.