Basics of Share Market Investment (PDF)

BASICS OF SHARE MARKET https://www.kotaksecurities.com/ksweb/Research/Knowledge-Bank/Investment-Knowlegde-Bank By: KOTAK SECURITIES CHAPTER. 1.STOCK / SHARE MARKET A share market is where shares are ei...

BASICS OF SHARE MARKET https://www.kotaksecurities.com/ksweb/Research/Knowledge-Bank/Investment-Knowlegde-Bank By: KOTAK SECURITIES CHAPTER. 1.STOCK / SHARE MARKET A share market is where shares are either issued or traded in. A stock market is similar to a share market. The key difference is that a stock market helps you trade financial instruments like bonds, mutual funds, derivatives as well as shares of companies. A share market only allows trading of shares. The key factor is the stock exchange – the basic platform that provides the facilities used to trade company stocks and other securities. A stock may be bought or sold only if it is listed on an exchange. Thus, it is the meeting place of the stock buyers and sellers. India's premier stock exchanges are the Bombay Stock Exchange and the National Stock Exchange. TYPES OF SHARE MARKETS: PRIMARY AND SECOND MARKETS. Primary Market: This where a company gets registered to issue a certain number of shares and raise money. This is also called getting listed in a stock exchange. A company enters primary markets to raise capital. If the company is selling shares for the first time, it is called an Initial Public Offer. Secondary Market: Once new securities have been sold in the primary market, these shares are traded in the secondary market. Secondary market transactions are referred to trades where one investor buys shares from another investor at the prevailing market price or at whatever price the two parties agree upon.Normally, investors conduct such transactions using an intermediary such as a broker, who facilitates the process. SHARE MARKET INVESTMENT A person need to open a Savings Bank account , Trading account and a Demat account to invest in share market. This trading and demat account will be linked to your savings account to facilitate smooth transfer of money and shares. Why a demat account required? 1. You cannot buy or sell stocks without a demat account 2. You cannot invest in equity directly without it 3. Mandated by SEBI for transactions of listed company securities What is a demat account? Demat (Dematerialised) account, facilitates to hold company shares and securities electronically. Dematerialised securities can be stocks, mutual funds, bonds, exchange-traded funds (ETFs), etc. On purchase, the shares get credited to demat account, and on sale of securities demat a/c gets debited. Demat account can opened separately or a 3-in-1 account can be opened, which links trading and demat account to bank account. What are the benefits of demat account? One of the biggest benefits of demat account for investors is that it is digital. Having said that, there are many other advantages of demat account that can be listed as follows. 1) Digital Account:It is an electronic account. 2) Security of shares: The most important benefit of demat account is that it is safer than holding physical shares which can get lost, damaged, or stolen. 3) No forgery or theft: Since the demat account is electronic in nature, the risk of documents getting stolen, damaged, or lost does not exist. 4) Seamless trading and transfer: Unlike transporting physical certificates, demat accounts allow the transfer of shares quickly and securely. This has lowered order processing times. 5) Lower cost: Physical share certificates attract paperwork and stamp duty, which increases costs. With a demat account, all this is eradicated and you can get a demat account in no time. 6) Multiple access points: A demat account is operated electronically, which essentially means that users can access the account from multiple touch points—mobile, tablet, PC, laptop, etc. Documents needed to open a demat account a) Proof of identity. (Aadhaar Card /Passport/Driver’s License) b) Proof of address (Ration card/Passport / Rent Agreement / Recent Electricity or Telephone Bills) c) Income proof (Income Tax Return/Salary Slip)d) PAN Card e)Photographs FINANCIAL INSTRUMENTS TRADED IN A STOCK MARKET. 1. Bonds: A bond is a means of investing money by lending to others. This is why it is called a debt instrument. When you invest in bonds, it will show the face value – the amount of money being borrowed, the coupon rate or yield – the interest rate that the borrower has to pay, the coupon or interest payments, and the deadline for paying the money back called as the maturity date. 2. Secondary Market: Companies issue shares to public, through IPO / FPO. This is called primary market. The buyers of these shares, when require money sell the shares in the secondary market ( Stock Exchange ), through brokers. 3. Mutual Funds: These are investment vehicles that allow you to indirectly investing in share market or bonds. It pools money from a collection of investors, and then invests that sum in different financial instruments. This is handled by a professional fund manager.Every mutual fund scheme issue units, which have a certain value just like a share. The Investor become a unit-holder. The source of income to the unit holders is either rise in the value of the units or through the distribution of dividends. 4. Derivatives: The value of financial instruments like shares keeps fluctuating. So, it is difficult to fix a particular price. Derivativesare instruments that help you trade in the future at a price that you fix today. OBJECTIVES OF SEBI. a) Protecting the interests of investors in stocks  b) Promoting the development of the stock market c) Regulating the stock market CHAPTER. 2: STOCK MARKET TERMINOLOGY DIVIDENDS A share is a portion of the company and when the company makes profits,companies distribute a small amount of profits to investors as dividends. This is the primary source of income for long-term shareholders – those who don’t sell the stock for years together. MARKET CAPITALIZATION Different companies issue varied amounts of shares when they get listed. The value of one share also differs from that of another company’s stock. Market capitalization smoothens out these differences. It is the market stock price multiplied by the total number of shares held by the public. It, thus, reflects the total market value of a stock taking into consideration both the size and the price of the stock. For example, if a stock is priced at Rs. 50 per share, and there are 1,00,000 shares in the hands of public investors, then its market capitalization stands at Rs. 50,00,000. Market capitalization matters when stacking stocks into different indices. It also decides the weightage of a stock in the index. This means, bigger the company’s market value, the more its price fluctuations affect the value of the index. ROLLING SETTLEMENTS A rolling settlement implies that all trades have to be settled by the end of the day. Hence, the entire transaction – where the buyer pays for securities purchased and seller delivers the shares sold, have to be completed. Settlement is the process whereby payment is made by the buyers, and shares are delivered by the sellers. In India, we have T+1 settlements cycle. This means that a transaction conducted on Day 1 has to be settled on the Day 1 + 1 working days. Thus, 'T+2' here, refers to Today + 2 working days. Saturdays and Sundays are not considered as working days. So, if you enter into a transaction on Friday, the trade will be settled not on Sunday, but on Tuesday. Even bank and exchange holidays are excluded. SHORT-SELLING An investor sells short when he anticipates that the price of a stock may fall from the existing price. So, the investor borrows a share and sells it. Once the share price dips, he will buy the same share at a lower price, and return it back. Short-selling helps traders’ profit from declining stock and index prices. Since this is usually conducted in anticipation of a stock movement, short-selling is considered a risky proposition. CIRCUIT FILTERS AND TRADING BANDS Some stocks are more volatile than others. Too much volatility is not good for investors. To curb this volatility, SEBI has come up with the concept of circuit filters. The market regulator has specified the maximum limit the price of a stock can move on a given day. This is called a price trading band. If a stock breaches this limit, trading is halted in that stock for a while. There are three levels of limits. Each limit leads to trading halt for a progressively longer duration. If all three circuit filters are breached, then trading is halted for the rest of the day. NSE define circuit filters in 5 categories including 2%, 5%, 10%, 20% and no circuit filter. BULL AND BEAR MARKETS Markets are often described as ‘bull’ or ‘bear’ markets. These names have been derived from the manner in which the animals attack their opponents. A bull thrusts its horns up into the air, and a bear swipes its paws down.If stock prices trend upwards, it is considered a bull market; if the trend is downwards, it is considered a bear market. MARGIN TRADING Many traders trade on the stock market using borrowed funds or securities. This is called margin trading. It is almost like buying securities on credit. Margin trading can lead to greater returns, but can also be very risky. While it lets you actively seize market opportunities, it also subjects you to a number of unique risks such as interest payments charged for the borrowed money. TOP-DOWN, BOTTOM-UP APPROACHES These are ways to select stocks from amongst the thousands listed on the exchange. The top-down approach first takes into consideration the macro-economy. Industries reacts to overall economic conditions like inflation, interest rates, consumer demand and so on, in a different way. Select one amongst the industries after in-depth analysis. Next, understand the workings of the industry, the players and competitors and other factors that affect the sector. Based on this, select one of the companies in the industry The bottom-up approach is just the opposite. You do not look at the economy or select an industry first, but concentrate on company fundamentals. This depends on the investor’s priorities like – high growth or steady income through high dividends. Using appropriate ratios like the Price-to-Earnings ratio or the Dividend- yield, a bunch of stocks are selected. Next, analyze each of these companies; find answers for questions like what factors drive profits? Is the company management efficient? Is the company heavily indebted? What is the future outlook? And so on. Based on the results, select the company that best fits in to your requirements.The bottom-up approach is most suited for weak market conditions. COST AVERAGING Rupee-cost averaging is a concept of buying a stock in small bunches, instead of buying in lump-sum. This helps reduce the average cost of investment. Example. Suppose you bought 100 shares of a company costing Rs. 10 each, your total investment cost is Rs. 1000. Instead of that, if you buy 50 shares for Rs. 100 and 50 for Rs. 95, your total cost of investment would be lower. Not just that, even your average cost per share would be lower. This is called rupee-cost averaging. This concept comes handy when a stock falls after you have bought it. The fall in share price gives you an opportunity to buy more and reduce your average cost of investment. This way, when you finally sell the shares at some time in the future, you end up making more profits. STOCK VOLATILITY Stock prices constantly fluctuate. This is because the demand for the stock changes. As more stocks change hands, greater is the change in its share price. This is called stock volatility. Even the amount of volatility in the market changes on a daily basis. To measure this volatility, the National Stock Exchange introduced the VIX India index, also called the fear gauge. VIX is often used as an indicator of stock price trends. This is because, VIX rises when there is more fear and uncertainty in the market. PRICE-TARGETS AND STOP-LOSS TARGETS As an investor, to maximize profits, need to get rightpricing – both when it comes to buying and selling. However, sometimes, prices fluctuate more than expected. So, it can become a little difficult to gauge whether to trade now or wait a little more. Analysts put out price targets and stop-loss measures, which let you know how long you should hold a stock. A price target indicates that the price of share is unlikely to climb above the level. So, once the share price touches the target, you may look to sell it and pocket your profits. A stop loss, meanwhile, acts as a target on the lower end. It lets you know when to sell before the stock falls further and worsens your loss. WHAT IS INSIDER TRADING? Insider trading is 'the trading of shares based on knowledge not available to the rest of the world’. It is illegal to trade after receiving 'tips' of confidential securities information. For example, when corporate officers, directors, or employees trade the company’s stocks after learning of significant, confidential corporate developments, it is considered an illegal form of insider trading. This applies to employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded. Even government employees, who trade after learning of such information, are considered to have broken the law on insider trading. It is a punitive offence CHAPTER. 3.DIFFERENT TYPES OF STOCKS Stocks can be classified into multiple categories on various parameters – size of the company, dividend payment, industry, risk, volatility, as well as fundamentals. (A). STOCKS ON THE BASIS OF OWNERSHIP RULES: This is the most basic parameter for classifying stocks. In this case, the issuing company decides whether it will issue common, preferred or hybrid stocks. Preferred & common stocks: Preferred stocks promise investors that a fixed amount will be paid as dividends every year. A common stock holder may not get dividend even though the company made profit. Dividend payment depends on the decision of board of directors. For this reason, the price of a preferred stock is not as volatile as that of a common stock. Preferred stockholders enjoy greater priority over equity shareholders, when the company is distributing surplus money.At the time of liquidation, preferred shareholders rank prior to equity hare holders but subsequent to company’s creditors, and bond- or debenture-holders. Another distinction is that preferred shareholders do not have voting rights unlike holders of common stocks. Hybrid stocks: Some companies issue preferred shares that come with an option to be converted into a fixed number of common stocks at a specified time. These kinds of stocks are called ‘convertible preferred shares. Since these are hybrid stocks, they may or may not have voting rights like common stocks. Stocks with embedded-derivative options: Some stocks come with an embedded derivative option. This means it could be ‘callable’ or ‘puttable’. A ‘callable’ stock is one which has the option to be bought back by the company at a certain price or time. A ‘puttable’ share gives the stockholder the option to sell it to the company at a prescribed time or price. (B). STOCKS ON THE BASIS OF MARKET CAPITALIZATION: There are three kinds of stocks on the basis of market capitalization: 1). Small-cap stocks: ‘Cap’ is the short form of ‘Capitalization’. Small Cap stocks are with smallest values in the market. They often represent small-size companies. Generally, companies that have a market capitalization in the range of up to Rs. 250 crores are small cap stocks. These stocks are the best option for an investor who wishes to generate significant gains in the long run; as long he does not require current dividends and can withstand price volatility. This is because small companies have the potential to grow rapidly in the future. So, an investor may profit by buying the stock when it is cheaply available in the company’s initial stage. However, many of these companies are relatively new. So, it is difficult to predict how they will perform in the market. 2). Mid-cap stocks: Mid-cap stocks are typically stocks of medium-sized companies. Generally, companies that have a market capitalization in the range of Rs. 250 crore and Rs. 4,000 crores are mid-cap stocks. These are stocks of well-known companies, recognized as seasoned players in the market. They offer you the twin advantages of acquiring stocks with good growth potential as well as the stability of a larger company.Mid-cap stocks also include baby blue chips – companies that show steady growth backed by a good track record. They are like blue-chip stocks (which are large-cap stocks), but lack their size. These stocks tend to grow well over the long term. 3). Large-cap stocks: Stocks of the largest companies in the market such as Tata, Reliance, ICICI are classified as large-cap stocks. They are often blue-chip firms. Being established enterprises, they have at their disposal large reserves of cash to exploit new business opportunities. However, the sheer size of large-cap stocks does not let them grow as rapidly as smaller capitalized companies and the smaller stocks tend to outperform them over time.Investors, however, gain the advantages of reaping relatively higher dividends compared to small- and mid-cap stocks, while also ensuring the long-term preservation of their capital. (C) STOCKS ON THE BASIS OF DIVIDEND PAYMENTS: Dividends are the primary source of income until the shares are sold for a profit. Stocks can be classified on the basis of how much dividend the company pays. 1). Income stocks: These are stocks that distribute a higher dividend in relation to their share price. This is why these stocks are also called income stocks.Income stocks usually represent stable companies that distribute consistent dividends. However, these companies often are not high-growth companies. As a result, the stock’s price may not rise much. Preferred stocks are also income stocks, since they promise regular dividend payments. Income stocks are thus preferred by investors who are looking for a secondary source of income. They are relatively low-risk stocks.Investors are not taxed for their dividend income. This is another reason that long- term, relatively low-risk investor prefer income stocks. The dividend yield gives a measure of how much an investor is earning (per share) from the investment by way of total dividends. It is calculated by dividing the dividend announced by the share price, and then written in percentage format. For example, a stock with a price of Rs. 1000 offers a dividend of Rs. 5 per share has a dividend yield is 0.5%. 2). Growth stocks: Not all stocks pay high dividends. This is because, companies prefer to reinvest their earnings for company operations. This usually helps the company grow at a faster rate. As a result, such stocks are often called growth stocks.Since the company grows at a faster rate, the value of the shares also rises. This helps the investor earn a higher return when the stock is sold, although this comes at the expense of lower income through dividends.For this reason, investors choose such stocks for their long-term growth potential, and not for a secondary source of income.However, if the company ceases to grow, it cannot be called a growth stock. This makes such stocks riskier than income stocks. 3). Stocks on the basis of fundamentals. Followers of value investing believe that a share price should equal the intrinsic value of the company’s share. They, thus, compare recent share prices with per-share earnings, profits and other financials to arrive at the intrinsic value per share. If a share price exceeds this intrinsic value, the stock is believed to be overvalued. In contrast, if the price is lower than the intrinsic value, the stock is considered to be undervalued. Undervalued stocks are also called ‘value stocks. They are preferred by value investors, as they believe the share price will eventually rise in the future. 4). Stocks on the basis of risk: Some stocks are riskier than others. This is because their share prices fluctuate more. However, just because a stock is risky does not mean investors should avoid it. Risky stocks have the potential to make you greater profits. Low-risk stocks, in contrast, give you lower returns. 1). Blue-chip stocks: These are stocks of well-established companies with stable earnings. These companies have lower liabilities like debt. This helps the companies pay regular dividends. Blue-chip stocks are thus considered safe and stabile. 2). Beta Stocks. Analysts measure risk by calculating the volatility in its price. Beta values can have positive or negative values. The sign merely denotes if the stock is likely to move in sync with the market or against the market.Higher the beta, greater the volatility and thus more the risk. A beta value over 1 means the stock is more volatile than the market. Thus, high beta stocks are riskier. However, a smart investor can use this to make greater profits. 3). Stocks on the basis of price trends: Prices of stocks often move in tandem with company earnings.  a). Cyclical stocks: Some companies are more affected by economic trends. Their growth moderates in a slow economy, or fastens in a booming economy. As a result, prices of such stocks tend to fluctuate more as economic conditions change.They rise during economic booms, and fall as the economy slows down. Stocks of automobile companies are the best example of cyclical stocks. b). Defensive stocks: Unlike cyclical stocks, defensive stocks are issued by companies relatively unmoved by economic conditions. Best examples are stocks of companies in the food, beverages, drugs and insurance sectors.Such stocks are typically preferred when economic conditions are poor, while cyclical stocks are preferred when the economy is booming. CHAPTER 4: STOCK QUOTES Several stocksare listed on the exchange. Each needs to be identified in a way that sets it apart from the other stocks listed. This is where stock quotes play an important role. WHAT ARE STOCK QUOTES? A ticker on a business news channel on the TV or on the huge billboard outside the Bombay Stock Exchange, constantly show a bunch of letters and numbers in green or red lettering. These are stock quotes. The bunch of letters seen is a stock symbol, while the numbers that follow signify the stock price. Stock Symbols A stock symbol is a unique code given to all companies listed on the exchange. Once the stock code or symbol of the company is known, one can easily obtain information about the company. This is important for investors who wish to conduct a financial analysis before purchasing a company’s shares. For example, TCS stands for Tata Consultancy Services, while INFY stands for Infosys. In such a case, the stock symbol comes handy and it is just 3-4 letters. Stock symbols are also referred to as ticker symbols. Stock Quotes Stock quotes are available on the internet and business news channels. Pink papers or business newspapers also regularly publish a list of stock quotes, called the stock table. READING A STOCK QUOTE? When a person wants to invest in a stock, he should know the stock price as well as its historical trends. This is imperative if invest is to be made in a valuable company at the right time. This will ensure that the investor not only gets the stock right, but also the share price. If one wishes to maximize profits in the stock market, one need to buy at lows and sell at highs A stock quote gives the information required to make this buying/selling decision.So, one should track stocks continuously for a period of time before making a buying or selling decision. Company Name and Symbol: The stock table needs space to fit in details of as many shares as possible. There is thus a space crunch. For this reason, company symbols, and not names, are used. On the internet, though, company’s names too are given. High/low: During market hours, live share prices keep changing as more trades are conducted. This is because buying makes the stock more valuable, while selling makes it less valuable. This in turn affects the share price. To give an investor a basis for comparison, the stock quote mentions the highest and lowest prices the stock hit in that day. If the share price is constantly rising, the ‘high’ would keep climbing. In the same way, the ‘low’ would keep falling in a down market. Once the market closes, the difference between the highest and the lowest prices gives an idea about the volatility in the stock’s price. Net change: The closing price also helps calculate how much the stock’s price has changed. This change is written in both percentage as well as absolute value format. It is calculated by subtracting today’s price from the previous closing price, and then dividing with the closing price to get the percentage change. A positive change indicates the stock price has increased from the previous day. When the net change is positive, the stock is written in green colour, while red colour is used to denote share price has fallen. Dividend details: Companies distribute a portion of their profits to shareholders as dividends. While an investor holds the share, dividends are the primary source of income. For long-term investors, this is of great importance. This is because higher dividends mean greater returns for the investor. For this reason, many stock quotes mention the dividend yield, which helps compare the dividend with the share price. The dividend yield is calculated by dividing the dividend per share with the stock price. Higher the dividend yield, greater is the investor’s income through dividends. Stock price: This is the price an investor or trader pays to buy a single share of the company. This fluctuates constantly during market hours. It reflects the value the market has allotted to the company. Close: Stock prices stop fluctuating once the market is shut for trading. The ‘close’ or the ‘closing price’ thus reflects the last price at which the stock traded. During the market hours, it represents the previous day’s closing price, again giving investor a benchmark to compare against. Since the newspaper is delivered in the morning, it reflects the price at which the stock closed the previous day. 52-week high/low: This shows the highest and lowest stock price in one year or 52-weeks. This too helps the investor understand the stock’s trading range over a broader period of time. PE Ratio: Some stock tables and quotes also mention the PE ratio. This is the amount an investor pays for each rupee the company earns. It is calculated by dividing the stock price with the company’s earnings per share. The PE ratio, thus, helps give perspective about the share’s value in comparison to the company’s financial performance. A high PE ratio means the stock is costly, while a low PE ratio means the stock is cheaply available. Volume: If a company has a stipulated number of shares floated on the exchange, not all of them may be traded in a single day. It depends on demand for the stock. This is understood in the ‘volume’ section of the stock quote, which shows how many stocks changed hands. A higher trading volume is usually followed by a significant change in the stock price.  CHAPTER. 5: STOCK MARKET INDICES There are thousands of companies listed on stock markets, making it almost impossible to monitor each company. This is why stock market indices are created. Market indices bring together a select group of company stocks and regularly measures them to show the performance of the overall market or a certain segment of the market. In short, an index helps investors understand the health of the stock market, enables them to study the market sentiment and makes it easy to compare the performance of an individual stock. The Sensex and Nifty-50 are two popular benchmark indices that largely reflect the performance of Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). To understand how each sector of the stock market is doing, there are sectoral indices such as Nifty Bank. Nifty Auto etc. WHAT ARE STOCK INDICES? From among the stocks listed on the exchange, some similar stocks are selected and grouped together to form an index. This classification may be on the basis of the industry the companies belong to, the size of the company, market capitalization or some other basis. For example, the BSE Sensex is an index consisting of 30 stocks. Similarly, the BSE 500 is an index consisting of 500 stocks. The values of the grouped stocks are used to calculate the value of the index. Any change in the price of the stocks leads to a change in the index value. An index is thus indicative of the changes in the market. Some of the important indices in India are: Benchmark indices – BSE Sensex and NSE Nifty Sectoral indices like BSE Bankex and CNX IT Market capitalization-based indices like the BSE Small cap and BSE Midcap Broad-market indices like BSE 100 and BSE 500 WHY DO WE NEED INDICES? Indi ces are an imp orta nt part of the stoc k market. Here is why we need stock indices: 1) Sorting 2) Representation. 3) Comparison. 4) Reflection. 5). Passive Investment 1). Sorting: In a share market, there are thousands of companies listed. How to differentiate between all of those and pick one or two to buy? How do you sort them out? This is where indices come into the picture. Companies and their shares are classified into indices based on key characteristics like size of company, sector or industry they belong to, and so on. 2). Representation Indices act as a representative of the entire market or a certain segment of the market. In India, the BSE Sensex and the NSE Nifty are considered the benchmark indices. They are considered to represent the overall market performance. Similarly, an index formed of IT stocks is supposed to represent all stocks of companies from the industry. 3). Comparison An index makes it easy for an investor to compare performance. An index can be used as a benchmark to compare against. For example, in India the Sensex is often used as a benchmark. So, to find if a stock has outperformed the market, you simply compare the price trends of the index and the stock. On the other hand, an index can also be used to compare a set of stocks against a benchmark or another index. For example, on a given day, the benchmark index like Sensex may jump 200 points, but this rally may not extend to a certain segment of stocks like IT. Then, the fall in the value of index representing IT stocks could be used for comparison rather than each individual stocks. This also helps investors identify market trends easily. 4). Reflection Investor sentiment is a very important aspect of stock market movements. This is because, if sentiment is positive, there will be demand for a stock. This will subsequently lead to a rise in prices. It is very difficult to gauge investor sentiment correctly. Indices help reflect investor’s mood – not just for the overall market, but even sector-wise and across company sizes. An index cam be compared with a benchmark to see if it has underperformed or outperformed. This will, in turn, reflect investor sentiment. 5). Passive investment Many investors prefer to invest in a portfolio of securities that closely resembles an index. This is called passive investment. An index portfolio helps investors cut down cost of research and stock selection. They rely on the index for stock selection. As a result, portfolio returns will match that of the index. For example, if Sensex gave 8% returns in one month, an investor’s portfolio that resembles the Sensex is also likely to give the same amount of returns. Indices are also used to construct mutual funds and exchange- traded funds (ETFs). FORMATION OF STOCK INDICES. An index consists of similar stocks. This could be on the basis of industry, company size, market capitalization or another parameter. Once the stocks are selected, the index value is calculated. This could be a simple average of the prices of the components. In India, the free-float market capitalization is commonly used instead of prices to calculate the value of an index. The two most common kinds of indices are – Price-weighted and market capitalization-weighted index. What is stock weightage? Every stock has a different price. So, a 1% change in one stock may not equal a similar change in another stock’s price. So, the index value cannot be a simple total of the prices of all the stocks. Here is where the concept of stock weightage comes into play. Each stock in an index has a particular weightage depending on its price or market capitalization. This is the amount of impact a change in the stock’s price has on index value. Market-cap weightage Market capitalization is the total market value of a company’s stock. This is calculated by multiplying the share price of a stock with the total number of stocks floated by the company. It thus takes into consideration both the size and the price of the stock. In an index using market-cap weightage, stocks are given weightage on the basis of their market capitalization in comparison with the total market-capitalization of the index. For example, if stock A has a market capitalization of Rs. 10,000 while the index it is part of has a total m- cap of Rs. 1,00,000, then its weightage will be 10%. Similarly, another stock with a market-cap of Rs. 50,000, will have a weightage of 50%. The point to remember is that market capitalization changes every day as the stock price fluctuates. For this reason, a stock’s weightage too changes every day. However, it is usually a marginal change. Also, the market capitalization-weightage method gives more importance to companies with higher m-caps. In India, most indices use free-float market capitalization. In this method, instead of using the total shares listed by a company to calculate market capitalization, only the amount of shares publicly available for trading are used. As a result, free-float market capitalization is a smaller figure than market capitalization. Price weightage In this method, an index value is calculated on the basis of the company’s stock price, and not market capitalization. Stocks with higher prices have greater weightages in the index than stocks with lower prices. The Dow Jones Industrial Average in the US and the Nikkei 225 in Japan are examples of price-weighted indices.There are also other kinds of weightages like equal-value weightage or fundamental weightage. However, they are rarely used by public indices. CHAPTER 6: THE WORKING OF SHARE MARKET Share market works in the following order: 1. A company gets listed in the primary market through an IPO. 2. Shares get distributed in the Secondary Market 3. The stocks issued can be traded by the investors in the secondary market. 4. Stock brokers and brokerage firms are entities registered with the stock exchange which offers you to buy particular share at said price 5. Your broker passes on your buy order to the exchange, which searches for a sell order for the same share. 6. The process takes T+1 days i.e. you will get your shares deposited in your demat account in ONE working day. The stock market is one of the largest avenues for investment. As many as Rs. 6 lakh crore-worth stocks have been traded in the two stock exchanges in India on some occasions. Stock market investing is often called a gamble. It would cease to be a gamble if you understood the basics of the share market. But before starting, you might want to get acquainted with a few market-related concepts. HOW SHARE MARKET WORKS: A stock exchange in the platform where financial instruments like stocks and derivatives are traded. Market participants have to be registered with the stock exchange and SEBI to conduct trades. This includes companies issuing shares, brokers conducting the trades, as well as traders and investors. All of this is regulated by the Securities and Exchange Board of India (SEBI), which makes the rules of conduct. First, a company gets listed in the primary market through an Initial Public Offering (IPO). In its offer document, it lists details about the company, the stocks being issued, and so on. During the listing, the stocks issued in the primary market are allotted to investors who have bid for the same. Once listed, the stocks issued can be traded by the investors in the secondary market. This is where most of the trading happens. In this market, buyers and sellers gather to conduct transactions to make profits or cut losses. Stock brokers and brokerage firms are entities registered with the stock exchange. They act as an intermediary between you, as an investor, and the stock exchange. Your broker passes on your buy order to the exchange, which searches for a sell order for the same share. Once a seller and a buyer are fixed, a price is agreed finalized, upon which the exchange communicates to your broker that your order has been confirmed. This message is then passed on to you. Even at the broker and exchange levels, there are multiple parties involved in the communication chain like brokerage order department, exchange floor traders, and so on. However, the trading process has become electronic today. This process of matching buyers and sellers is done through computers. As a result, the process can be finished within minutes. CHAPTER 7: HOW TO INVEST IN SHARE MARKET To invest in Share market, the following steps shall be followed. Step1: Know your investment requirements & limitations Step2: Decide on your investment strategy Step3: Enter the market at the right time Step4: Do the trade Step5: Monitor your portfolio Step 1 First, understand your investment requirements and limitations. Your requirements should take into account the present as well as the future. The same applies to your limitations. For example, you just got a job and earn Rs. 20,000 a month. Your limitation could be that you need to set aside at least Rs. 10,000 for instalment payments for your car, and another Rs. 5,000 for your monthly expenses. This leaves aside only Rs. 5,000 for investment purposes. Now, if you are a risk-averse investor, you may prefer to invest a larger portion of this amount in low-risk options like bonds and fixed deposits. This means, you have only a small portion left for stock market investing – Rs. 1,000. Further, take into consideration your tax liabilities. Remember, making profits on short-term buying and selling of shares incurs capital gains tax. This is not applicable if you sell your shares after a year. So, ensure that your cash needs don’t force you to sell your shares on short-term unnecessarily. Better to take a wise well-thought decision, than attract unnecessary costs in the future. Step 2 Once you understand your investment profile, analyse the stock market and decide your investment strategy. Find out which stocks suit your profile. If we continue the above example, with a budget of Rs 1,000, you can either choose to buy one large-cap stock or multiple small-cap stocks. If you need an additional source of income, opt for high-dividend stocks. If not, opt for growth stocks which are likely to appreciate the most in the future. Deciding the kind of stocks, you wish to collect is part of your investment strategy. Step 3 Wait for the right time. Have you ever seen a cheetah or tiger hunt? They lie low for a while waiting for their prey, and then they pounce. Exactly the same way, time is of utmost importance in the stock market. Merely getting the stock right is not enough. Your profits will be maximised only if you buy at the lowest level possible. The same applies if you are selling your shares. This need times. Do not be impulsive. You might be interested to do some analysis while you’re waiting. Step 4 Conduct your trade either online or on the phone through your broker. Ensure that your broker confirms the trade and gets all the details right. Recheck the trade confirmation to avoid errors. Step 5 Monitor your portfolio regularly. The stock market is dynamic. Companies may seem profitable one moment, and not-so profitable the next due to some unforeseen factor. Ensure you regularly read about the companies you have invested in. In the case of some unfortunate situation, this will help you minimize your losses before it is too late. However, this does not mean you panic every time the stock falls. A stock’s price will fall at some point in time, because there will be some investor in the market with a shorter investment horizon than you. So, he will sell his stock and pocket whatever profits possible in that shorter time. Patience is a key virtue in the markets. HOW TO BUY STOCKS? Step 1 Open demat and trading accounts. Without these two accounts, you cannot trade in the stock markets. Read how to open a demat account here, and a trading account here. Step 2 First, analysis stocks and select ones that fit your investment profile. Read how to conduct stock market analysis. Step 3 Once you have selected your stock, monitor it for a while. This is to ensure you buy at the lowest price possible in the near-term. Understand how the stock price moves. First, analysis stocks and select ones that fit your investment profile. Read how to conduct stock market analysis. Step 4 Decide when you want to place your order – during market times or after markets. This depends on the share price you are targeting. If you want to buy a stock at a fixed price, and the stock closed at that price, place the order after markets. If you feel you are likely to get a lower price during market hours, place it when the market is open for trading. Step 5 Decide the kind of order you want to place. There are three kinds of orders – a limit order, a market order and a stop loss order, IOC (Immediate or cancel). A market order is the simplest of the lot – you simply place an order without any other specifications. In a limit order, you set an upper price limit. Suppose you have placed a limit order for 10 shares with a limit price of Rs. 100 when the share price is Rs. 99. You trade will be processed as long as shares are available at Rs. 100 or below. So, if only 8 shares are available, only 8 out of the 10 requested will be purchased. This ensures you don’t pay more than a specified amount.  Step 6 Once you have decided the specifics of your order, you either go online to your trading account to place the order, or call your broker. Give your bank account details so that the purchase money can be deducted from your account. Step 7 Once you have decided the specifics of your order, you either go online to your trading account to place the order, or call your broker. Give your bank account details so that the purchase money can be deducted from your account. HOW YOUR ORDER IS PROCESSED However, there are tens and thousands of investors. It is impossible for all to converge in one location and conduct their trades. This is where stock brokers and brokerage firms play role. Once you place an order to buy a particular share at a said price, it is processed through your broker at the exchange. There are multiple parties involved in the process behind the scenes. Meanwhile, the exchange also confirms the details of the buyers and the sellers to ensure the parties don’t default. It then facilitates the actual transfer of ownership of shares. This process is called settlement. Earlier, it used to take weeks to settle trades. Now, this has been brought down to T+2 days. For example, if you conducted a trade today, you will get your shares deposited in your demat account by the day after tomorrow ( i.e. two working day). The exchange ensures that the trade is honoured during the settlement. Whether the seller has the required stock to sell or not, the buyer will receive his shares. If a settlement is not upheld, the sanctity of the stock market is lost, because it means trades may not be upheld. As and when trades are conducted, share prices change. This is because prices of shares – like any other goods – are dependent on the perceived value. This is reflected in the rise or fall of demand for the stock. As demand for the stock increases, there are more buy orders. This leads to an increase in the price of the stock. So, when you see the price of a stock rise, even if it is marginal, it means that someone or many placed buy order(s) for the stock. Larger the volume of trade, greater the fluctuation in the stock’s price. CHAPTER 8: THE ANNUAL REPORT Corporate earnings announcements and annual reports are a must as per law. This is to keep investors informed about the company’s operations and financial performance. WHAT ARE COMPANY EARNINGS? Companies undertake activities that produce a good or service. This is sold to customers who pay a certain amount of money for it. The total amount the company receives is called 'revenue'. A company also incurs expenses on employees, utility bills, costs of production and other operating expenses. Once these expenses deducted from the revenues, the surplus left is the company’s earnings, or net profit. Usually, income earned from operations is the key source of profits. Many companies also earn additional income from different kinds of investments. Investments generate income for businesses by way of either interest on loans, dividends from other businesses, or gains on the sale of investment property. Thus, company earnings are the sum of income from sales or investment left after the company has met its obligations. WHAT ARE QUARTERLY AND OTHER FINANCIAL REPORTS? Every three months, every company has to submit details about its financial performance. These are called quarterly reports. In addition, companies may also provide with special reports called statistical supplements. These provide investors with additional financial information. These, however, are not as comprehensive as the annual report. Thus, quarterly reports are very similar to the annual reports, except they are issued every three months and are less comprehensive. These are filed with the stock exchange, which inturn makes them available to investors. WHY ARE EARNINGS ARE IMPORTANT TOAN INVESTOR? An investor who holds shares, has part ownership of the company. As such entitled to get a portion of the company's profit as dividends. As long as the company earns income, until the shares are sold, the investor keeps on getting the dividend. Not just that, it will also drive up the inherent value of investor’s shareholding. This implies more returns. Sometimes, when a company is in the initial stages of growth, it may choose to reinvest its earnings for operations and expansion. While you are temporarily at a loss as an investor, this increases the likelihood that you will get higher dividends in the future. Company earnings are important to you, even if you hold its bonds. This is because, when you lend money to the company by investing in its bonds, the company uses part of its earnings to repay you through interest payments. The greater the company’s earnings, the more secure you can be that you will receive your interest payments. So, company earnings are important to you because you make money when the business you invest in makes money. INSIDE THE ANNUAL REPORT: A letter from the chairman on the high points of business in the past year with predictions for the next year. The company philosophy – a section that describes the principles and ethics that govern a company's business. An extensive report on each section of operations within the company, describing the company's services or the products. Financial information that includes the profit and loss (P&L) statements, cash flow statement and a balance sheet. Depending on its income and expenses, the company will either make profits or show losses for the year. The cash flow statement, as the name suggests, reflects where the money came from and how it was utilized. It is an important financial statement as it helps one understand if the company is generating enough money from its operations to fund the costs, or if the company is constantly reliant on external funding like debt or equity. The balance sheet describes assets and liabilities and compares them to the previous year. The footnotes will also give you reveal important information, as they discuss current or pending lawsuits or government regulations that may impact the company operations. An auditor's letter in the annual report confirms that the information provided in the report is accurate and has been certified by independent accountants. The annual report also includes a section called management’s commentary. In this section, the management explains how the balance sheet and income statements have been prepared, where the funds have come from, and how they have been utilized. This is also an important section as it reflects the management’s mindset and outlook UNDERSTANDING THE BALANCE SHEET The balance sheet is one of the most important financial statements of a company. The logic behind producing a balance sheet is to ensure that all of the company’s funds are accounted for, and that financial accounts are always in balance. It is reported to investors at least once a year. You may also receive quarterly, semi-annually or monthly balance sheets. The contents of a balance sheet include what the company owns, what it owes, and the value of the business to its stockholders. Let’s look at these three components in detail: WHAT ARE ASSETS? This is the component that details all that the company owns. Assets, then, are any items of economic value owned by a corporation that can be converted into cash. There are two main kinds of assets – current and long-term assets. CURRENT ASSETS: Are assets that can be easily converted to cash in the short term within one year. Bondholders and other creditors closely monitor a firm's current assets since interest payments are generally made from current assets. It is also important because assets can be easily liquidated into cash, which could help prevent loss of your investments incase of bankruptcy. Also, current assets are important to most companies, as they are a source of funds for day-to-day operations. It is, thus, evident that the more current assets a company owns, the better it is performing. Cash and cash equivalents are also a kind of current assets. Cash equivalents are non-cash items, but which can be converted into cash quite easily. For this reason, they are considered equal to cash. Cash equivalents are generally highly liquid, can be sold easily, short-term and safe investments like bank deposits. Accounts Receivable is another kind of a current asset. It is the money customers – either individuals or corporations – owe the firm in exchange for goods or services that have been delivered or used. For example, suppose your shopkeeper is willing to supply goods on an account-basis, and you pay for all the goods at the end of the month, whatever money you owe him will be counted as accounts receivable until you actually pay for it. Simply put, this is business being done on credit instead of cash. For this reason, it is a significant component of the balance sheet. Although accounts receivable is money owed to you, it is recorded as an asset on the balance sheet as it represents a legal obligation for the customer to pay the cash. A firm’s inventory is the stock of goods produced that have not been sold yet. It sometimes also includes the materials already bought for manufacturing a particular good. For this reason, a manufacturing company will often have three different types of inventory: raw materials, works-in-process, and finished goods. A retail firm's inventory, generally, will consist only of products purchased that are still to be sold. Since inventory is likely to earn the company money in the future, it is recorded as an asset on the balance sheet. LONG-TERM ASSETS: Are those assets that cannot be converted into cash in the current or upcoming fiscal year. They are grouped into several categories like: A long-term tangible asset is one that is held for business use and is not expected to be converted to cash in the current or upcoming fiscal year. Examples include manufacturing equipment, real estate, and furniture. Fixed assets like equipment, buildings, production plants and property are a kind of long-term tangible asset. They are very important to a company because they represent long-term investments that will not be liquidated soon and can facilitate the company’s earnings. On the balance sheet, these are valued at their cost. As the value of the asset declines over the years, depreciation is subtracted from all such assets, except land. Depreciation gives you an estimate of the decrease in the value of an asset that is caused by 'wear and tear'. Sometimes, it also occurs because the asset has become obsolete. Depreciation appears in the balance sheet as a deduction from the original value of the fixed assets. This is because the value of the fixed asset decreases due to ‘wear and tear’. Intangible assets are non-physical assets such as copyrights, franchises and patents. Since they are intangible and not concrete like tangible assets, it becomes difficult to estimate their value. Often there is no ready market for them. However, there are times when an intangible asset can be the most valuable asset that a company possesses. WHAT ARE LIABILITIES? This is the component of the balance that deals with a company's debt to outside parties. They represent the rights of others to expect money or services of the company. A company that has too many liabilities may be in danger of going bankrupt. Examples of liabilities include bank loans, debts to suppliers and debts to its employees. On the balance sheet, liabilities are generally broken down into current liabilities and long-term liabilities. CURRENT LIABILITIES: Are debts that are due within one year. They include the money owed for taxes, salaries, interest, accounts payable and notes payable. A company is considered to have good financial strength when current assets exceed current liabilities. Accounts payable is the amount the company owes to suppliers that it has bought raw materials and other goods from. You will often see accounts payable on most balance sheets. Let us take the example used earlier for accounts receivable. When you purchase goods from the shopkeeper on a monthly-account basis, whatever money you owe him before the end of the month is counted as ‘accounts payable’ in your balance sheet. Since the money is paid over a short-term, accounts payable is counted as a current liability. LONG-TERM LIABILITIES: Are long-term loans that are to be paid back over a period greater than one year. These debts are often paid in installments. If this is the case, the portion to be paid off in the current year is considered a current liability. WHAT IS SHAREHOLDER'S EQUITY? This is the value of a business to its owners after all of its obligations have been met. Shareholder’s equity is calculated as the value of a company's assets subtracted from the value of its total liabilities. Shareholders' equity is also calculated by the sum of the amount of capital the owners invested, and the portion of the profits that the company reinvests rather than distributing as dividend. Recollect that companies distribute a portion of their income as dividends to shareholders. Whatever left is called retained earnings. This is reinvested in the company for its operations. Thus, shareholder’s equity reflects how much the business is funded through the two key common sources – owners’ capital invested initially and the money accumulated over time from profitable operations. WHY SHOULD THE BALANCE SHEET BE IMPORTANT TO YOU? As an investor, you need to ensure that the company you have invested in has good potential for future growth, and will yield good returns. The balance sheet helps you get answers to questions like: Will the firm meet its financial obligations? How much funds have already been invested in this company? Is the company overly indebted? What are the different assets that the company has purchased with its financing? Is the company using its funds efficiently? These are just a few of the many relevant questions you can answer by studying the balance sheet. The balance sheet provides a diligent investor with many clues to a firm's future performance. HOW DO I OBTAIN AN ANNUAL REPORT? Annual reports are mailed automatically to all shareholders on record. If you wish to obtain the annual report about a company in which you do not own shares, you can call its public relations (or shareholder relations) department. You may also look at the company website, or search the internet; there are several sources on the internet providing such information on public companies. All listed companies are required to submit the financial reports available in the public domain as per SEBI regulations. These may, hence, also be available with the two exchanges – Bombay Stock Exchange and National Stock Exchange. HOW DO YOU USE EARNINGS INFORMATION TO MAKE AN INVESTMENT DECISION? Your investment goals, determine how you use information about company earnings. If you are an income investor – one interested in earning immediate income from your investments – you probably want to invest in a company that is paying high dividends. If you have a long-term investment strategy, dividends may not be as important to you. In this case, you may choose to compare company financial, which indicates whether a company is oriented for income, growth, or a bit of both. By comparing the financials for different companies in the same industry, you can find characteristics best suited to your investment goals. A convenient way to compare companies is through Earnings per Share (EPS). It represents the net profit divided by the number of outstanding shares of stock. When you compare the EPS of different companies, be sure to consider the following: Companies with higher earnings are financially stronger than companies with lower earnings. Companies that reinvest their earnings may pay low or no dividends, but may be poised for growth. Companies with lower earnings and higher research and development costs may be on the brink of either a breakthrough or a disaster, making them a risky proposition. Companies with higher earnings, lower costs and lower shareholder equity, might go in for a merger.  CHAPTER.9: STOCK MARKET ANALYSIS & MORE There are many kinds of share market analyses. The important ones are fundamental and technical analyses WHAT IS FUNDAMENTAL ANALYSIS? This method aims to evaluate the value of the underlying company. It takes into account the intrinsic value of the share keeping in mind the economic conditions and the industry along with the company’s financial condition and management performance. A fundamental analyst would most definitely look at the balance sheet, the profit and loss statement, financial ratios and other data that could be used to predict the future of a company. In other words, fundamental share market analysis is about using real data to evaluate a stock's value. The method uses revenues, earnings, future growth, return on equity, profit margins and other data to determine a company's underlying value and potential for future growth. The basic belief is that as the company grows so will the value of the share increase. This in turn will benefit the investor in the long run. WHAT IS AN OVERVALUED STOCK OR AN UNDERVALUED STOCK? Once you look at the balance sheet and other financial details, you use ratios to compare the financials with the price of the stock. This helps understand how much an investor is really paying in comparison with the company’s growth. The most common ratio used is the Price-to-Earnings or PE ratio. This is computed by dividing the share price with the company’s earnings per share. If the share price in comparison with its earnings per share is less than industry average, then the stock is said to be undervalued. This means the stock is selling at a much lower price than what it is actually worth. In contrast, an overvalued stock is where the investor is paying more for each rupee the company earns. This means, the stock’s price exceeds its intrinsic value. This often happens when investors expect the company to do well in the future. A high PE in relation to the past PE ratio of the same stock may indicate an overvalued condition, or a high PE in relation to peer stocks may also indicate an overvalued stock. However, as an investor you have to be very careful. Compare the fundamental value of the stock with its historic values. If there is a sudden increase in valuation, there are high chances that the price may fall to correct the mispricing. In case of a sudden fall in valuation, check for any latest news about the company. It is quite likely that some new factor may have emerged that may be detrimental to the company’s profits. Since the PE is computed using the earnings per share for the year gone by, it is called a trailing PE. This is not a perfect way to understand the stock’s value. For this reason, analysts often use the forward PE, where the estimated earnings per share for the current or another year is used. Let us understand using an example. Suppose a company ABC earns Rs 50 per share. Its current share price is Rs 100. Its PE ratio is thus 2. Suppose, the average PE ratio for the industry is 5, then the company is undervalued. If there is another company in the same industry with a PE ratio of 10, then its stock will be considered to be overvalued. However, an analyst expects the company to earn Rs 100 per share in the next financial year. Then the forward PE would be 1. This shows that the price is even more undervalued when you consider the company’s growth. WHAT IS TECHNICAL ANALYSIS? Unlike fundamental analysis, technical analysis has nothing to do with the financial performance of the underlying company. In this method, the analyst simply studies the trend in the share prices. The underlying assumption is that market prices are a function of the supply and demand for the stock, which, in turn, reflects the value of the company. This method also believes that historical price trends are an indication of the future performance. Thus, instead of assessing the health of the company by relying on its financial statements, it relies upon market trends to predict how a security will perform. Analysts try to cash in on the momentum that builds up over time in the market or a stock. Technical analysis is often used by short-term investors and traders, and rarely by long-term investors, who prefer fundamental analysis. Technical analysts read and make charts of prices. Some common technical share market analysis measures are the day-moving averages (DMAs), Bollinger bands, Relative Strength Indices (RSI) and so on. INVESTING PHILOSOPHIES: So now you know about stock market analysis techniques. How does that really help you invest? These investing philosophies will help you understand. What does value investing mean? Value investing is an investment style, which favors good stocks at great prices over great stocks at good prices. Hence, it is often referred to as ‘price-driven investing’. A value investor will buy stocks that may be undervalued by the market, and avoid stocks that he believes the market is overvaluing. Warren Buffet, one of the world's best-known investment experts, believes in value investing. For example, if a stock of a company growing at 10% is selling at Rs 100 with a PE ratio of 10 and another stock of company that also grows at 10% is selling at Rs 150 with a PE ratio of 15, the value investor would select the first stock over the second. This is because the first stock is undervalued in comparison with the second. Value investors see the potential in the stocks of companies with sound financial statements that they believe the market has undervalued. They believe the market always overreacts to good and bad news, causing stock price movements to not move in tandem with long-term fundamentals. For this reason, they are always on the hunt for undervalued companies. Value investors profit by taking a position on an undervalued stock (at a deflated price) and then profit by selling the stock when the market corrects its price later. Value investors don't try to predict which way interest rates are heading or the direction of the market and the economy in the short term. They only look at a stock's current valuations and compare them to their historical range. In other words, they pick up the stocks as fledglings and cash in on them when they are valued right in the markets. For example, say a particular stock's PE ratio has ranged between a low of 20 and a high of 60 over the past five years, value investors would consider buying the stock if its current PE is around 30 or less. Once purchased, they would hold the stock until its PE rose to the 50-60 ranges, before they consider selling it. In case they expect further growth in the future, they may continue to hold. What is contrarian philosophy? As the name suggests, the contrarian philosophy suggests trading against the market sentiment. This means you buy stocks when they are out of favor in the market place, and avoiding stocks that everyone is buying. They then sell these stocks when they gain back the favor. Contrarians believe in taking advantages that arise out of temporary setbacks or negative news that have caused a stock’s price to decline. A simple example of the contrarian philosophy would be buying umbrellas in the winter at a cheap rate and selling them during rainy days. Value investing is a kind of contrarian philosophy. HOW TO PLACE CONTRARIAN TRADES? If you are a contrarian trader: Conduct stock market analysis. Find out stocks with low PE ratios. Once you do that, compare with historical PE ratios and share prices. Read up about the company, its financial performance and future outlook. If you are satisfied that the company is inherently worthy, select the stock. Wait for the prices to decline. Buy at lows. You could also look at market indicators like mutual fund cash positions, and put/call ratios, and investment advisory opinions. Mutual funds hold a portion of their assets as cash. A greater cash holding suggests that mutual funds are bearish, while a low cash holding means mutual funds are investing money in the markets. This means they are bullish. Once you understand this, take an exactly opposite position. Sell when MFs are buying and buy when they are selling. A put option is an agreement to sell in the future in the derivatives market, while a call option is when you agree to buy in the future. The put/call ratio helps you understand the proportion of put options and call options. The higher this ratio, the greater the put options, and vice versa. An increase in put options suggests that the market is bearish, while demand for call options means the market is bullish. As a contrarian trader, you should prepare accordingly. Investment advisories are issued by many brokerage firms and investment banks, which regularly conduct analysis of individual stocks, industries and the overall economy. A positive recommendation often leads to an increase in share price as investors buy the stock. Contrarian  traders could buy when negative investment advisories are issued, and sell after positive recommendations..