Stock Market 101: What You Need to Know as a Novice Investor

The stock market is a lucrative place to be in, but only when you know what you are doing.

10:50 24 April 2020

While buying and selling stocks isn't rocket science, choosing which ones to buy and formulating a winning strategy requires knowledge, time, and effort. Today, I will discuss 3 most important aspects of stock trading you should know and remember before delving into this domain:-

1. Understand the Basics
   
   

Investment guru Warren Buffet once said: "Risk comes from not knowing what you’re doing". It is very tempting to jump into the stock market and start trading right away in the hopes of hitting the jackpot. However, if you are not familiar with the basics, you may not succeed for long, and most likely lose it all.

Take time to learn about the basics of investment and individual securities, and familiarize yourself with common financial metrics and definitions. These include Earnings Per Share (EPS), the Price-Earnings (P/E) ratio, Return on Equity (ROE), and Return on Investment (ROI), etc. Equip yourself with knowledge about short-term, medium-term, and long-term Investments. Research how Technical and Fundamental analyses work, and when should you perform these. You should also know about the different types of orders commonly used by investors and the ways to execute them. Blind luck and chance do not work in the stock market; you might get lucky once or twice, but if you rely on luck alone, you will most likely face losses without knowing how to reverse them.

2. Know the Importance of Diversification
   
   

In an ideal world, whatever you invest in should make you money with zero losses. However, this seldom happens in real life. In stock trading, there will be instances when some of your holdings will be profitable. At other times, you will lose money. This is why diversification is crucial in investment.

Diversification ensures that you are minimizing your risk and "not putting all your eggs in one basket". It acts as a cushion against the unpredictable movements in the stock market. For example, if one sector or industry goes down, another may go up at the same time. Now, if you have investments in both sectors, your gains in one will offset the losses in the other. You may be tempted to put all your money on your favorite company that is doing very well at present. This, however, is a recipe for disaster; for instance, when your favorite company faces unexpected losses or bad PR, its stock prices could go downhill along with your investment. Be sure to allocate your funds across a variety of industries and financial instruments. Also, rebalance your portfolio frequently based on thorough research and trends analysis.

3. Check Your Emotions
   
   

Decisions and trading over-activity fueled by emotions is a common way investors bear losses and hurt their portfolio returns. Keep your emotions in check and make rational decisions if you plan to be in stock trading for a longer time. Research companies and stocks thoroughly, and back your buying decisions with valid, logics instead of sentiments or blind luck. A stock API can help provide real-time or historic data on current stocks, thus is a good point to start your research.

Similarly, establish an exit strategy before you buy any stock. This means when things go south, you can liquidate your holdings and exit the market based on your pre-set strategy instead of doing it in a panic. In the short-run, the stock market is driven by overall investor sentiment. However, if you decide to jump on this short-term bandwagon driven by speculations and rumors, you are likely to lose in the long-run. This is because such decisions are not based on a systematic analysis of a company's profits, assets, and prospects, but rather on emotions of individuals that are seldom rational.

Now that you know the stock trading basics, I hope you are now ready to embark on this journey and start making some money. Remember, stock trading is a serious business, and requires a well-though-out strategy and commitment if you want to be successful.