Day: March 14, 2012

Part 1: How should beginners approach investing in the stock market?

Krishna left the following comment (slightly edited) a few days ago:

I am a techie and I am preparing myself to start investing in stocks. Google revealed your post & I really admire your work.It will be more helpful if there is a post describing investing for novices like me.

Regards,
KK

This is an interesting comment not only because of the nature of the question but also because of its timing. I wrote a post titled Why I continue to invest in stocks? in December of last year, and in that post I laid out the reasons that made me continue to invest in stocks in the pessimistic environment that existed then.

That title sounds fairly ridiculous today, but remember at that time and this is just 3 months ago, there was a lot of doom and gloom with respect to the situation in Europe and a lot of people were simply disgusted with the way stocks had dropped.

The common concern at the time was whether it made sense to continue with SIPs or should you sell all your stocks and invest in fixed deposits? Not many people were gearing up to invest in stocks because of all the pessimism that surrounded them and there were hardly any new entrants to the market.

From the time that I wrote the post to the time this comment appeared, the market had rose by some 15% and some smaller stocks had risen by a lot more than that.

I think it is important to remember the background here because a market that goes up rapidly draws a lot of first time investors who really are speculators at the time. I know that I was attracted to the market because of this and I know countless other individuals who were drawn to the market with the hope of a quick buck.

At this stage all you’re interested in is speculation and day trading, and you are getting quite the thrill out of it. You have no idea of fundamental analysis and you don’t care about any technical analysis as well.

I’ve seen people who stay at this stage for years, and you can easily identify people in this category by the the kind of reasons they give for why something will go up or down. The reason will always be rooted in something that they have personally seen like this share never goes under Rs. 80 or the share market does well before the budget or something similar to that, and this reason will usually sound very fantastical to anyone else.

You should try to get out of this stage as soon as possible losing as little money as possible. It’s very hard to convince anyone that they will lose money before they lose money so the next best thing I can say is that you should speculate with only small amounts of money and then don’t lose heart when you lose it because there is a better way to invest in the stock market.

At the end of the first stage, one of three things will happen –

  1. You will blame the market for your failure, be disgusted by it and never put any money in it again.
  2.  You will blame yourself for your ignorance and learn more formal methods of technical trading and trade.
  3. You will blame yourself and learn about long term investing and investing in stocks through mutual funds and SIPs.

Normally, the people who blame the market for their failure are the people who have been at it for a few years, and keep trying the same thing over and over again and hope that this time they get different results even though this has never worked for them earlier.

If you fall under this category meaning you’ve traded for a number of years but have never read a book on trading then instead of blaming the market you should blame your process and get into doing something more structured – whether it is technical or fundamental analysis.

Far more people fall from the first stage to the second category and I think that’s because trading is a lot sexier than long term investing and the kick you get out of trading – you can never get out of buying and holding.

In this category you will find people who are familiar with things like Elliot Waves, Head and Shoulders Patterns, RSI, MACD and other technical analysis tools and I think trading like this is better than trading without any knowledge of technical trading at all but I am skeptical on how effective this is.

I’ve not seen any really successful technical traders but then I’m not the kind of person who knows many traders either. However, I do feel that it must be very hard to do a full time job and trade on the markets since you have to be in front of the terminal so often and it can’t be practical for someone with a regular day job to do that.

In any case, this has not worked for me so I’m biased against it and I wouldn’t recommend anyone with a regular job to get into technical trading. If you’re interested in this then there are far too many investment sites and blogs that cater to this and you should follow one of them and see if it works for you. If it doesn’t, then, well, try long term investing after that.

In my opinion it is far better to take a longer term approach to investing and get into the third category of investors. This blog is primarily geared towards long term investors and later in the week I will have a second part to this post on what this constitutes, and how a newbie can approach long term investing.

This post is from the Suggest a Topicpage

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