stock market.docx

7/27/2019 STOCK Market.docx

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H o w t o m a k e m o n e y i n t h e s t o c k m a r k e t ?

I n r o d u c t i o n

This article is a COMPLETE guide to the basics of making money in the stock

market! If you are considering investing in the stock market, you MUST read this

article! We have explained all the concepts and talked about all the "myths" that

people have about the stock market!

W h a t a r e s t o c k s ? D e f i n i t i o n :

Plain and simple, a stock is a share in the ownership of a company.

A stock represents a claim on the company's assets and earnings. As you acquire

more stocks, your ownership stake in the company becomes greater.

Note: Some times different words like shares, equity, stocks etc. are used. All these

words mean the same thing.

S o w h a t d o e s o w n e r s h i p o f a c o m p a n y g i v e y o u ?

Holding a company's stock means that you are one of the many owners (shareholders)

of a company and, as such, you have a claim to everything the company owns.

This means that technically you own a tiny little piece of all the furniture, every

trademark, and every contract of the company. As an owner, you are entitled to your

share of the company's earnings as well.

These earnings will be given to you. These earnings are called dividends and are

given to the shareholders from time to time.

A stock is represented by a "stock certificate". This is a piece of paper that is

proof of your ownership. However, now-a-days you could also have a demat


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account. This means that there will be no stock certificates. Everything will be done

though the computer electronically. Selling and buying stocks can be done just by a

few clicks.

Being a shareholder of a public company does not mean you have a say in the

day-to-day running of the business. Instead, one vote per share to elect the board of

directors of the company at annual meetings is all you can do. For instance, being a

Microsoft shareholder doesn't mean you can call up Bill Gates and tell him how you

think the company should be run.

The management of the company is supposed to increase the value of the firm for

shareholders. If this doesn't happen, the shareholders can vote to have the

management removed. In reality, individual investors like you and I don't own

enough shares to have a material influence on the company. It's really the big boys

like large institutional investors and billionaire entrepreneurs who make the

decisions.

For ordinary shareholders, not being able to manage the company isn't such a

big deal. After all, the idea is that you don't want to have to work to make money,

right? The importance of being a shareholder is that you are entitled to a portion of

the companys profits and have a claim on assets.

Profits are sometimes paid out in the form of dividends as mentioned earlier.

The more shares you own, the larger the portion of the profits you get. Your claim on

assets is only relevant if a company goes bankrupt. In case of liquidation, you'll

receive what's left after all the creditors have been paid.

Another extremely important feature of stock is "limited liability", which

means that, as an owner of a stock, you are "not personally liable" if the company is


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not able to pay its debts.

In other legal structures such as partnerships, if the partnership firm goes

bankrupt the creditors can come after the partners personally and sell off their

house, car, furniture, etc. To understand all this in more detail you could read our

How to incorporate? article.

Owning stock means that, no matter what happens to the company, the

maximum value you can lose is the value of your stocks. Even if a company of which

you are a shareholder goes bankrupt, you can never lose your personal assets.

Why would the founders share the profits with thousands of people when they

could keep profits to themselves? This is the obvious question that comes up

next. This what the next section is all about!

Why do companies issue stocks? >>

Why would the founders share the profits with thousands of people when they

could keep profits to themselves? The reason is that at some point every company

needs to "raise money". To do this, companies can either borrow it from somebody

or raise it by selling part of the company, which is known as issuing stock.

A company can borrow by taking a loan from a bank or by issuing bonds.

Both methods come under "debt financing". On the other hand, issuing stock is

called equity financing. Issuing stock is advantageous for the company because it

does not require the company to pay back the money or make interest payments

along the way.
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All that the shareholders get in return for their money is the hope that the shares

will someday be worth more than what they paid for them. The first sale of a stock,

which is issued by the private company itself, is called the initial public offering

(IPO).

It is important that you understand the distinction between a company financing

through debt and financing through equity. When you buy a debt investment such

as a bond, you are guaranteed the return of your money (the principal) along with

promised interest payments.

This isn't the case with an equity investment. By becoming an owner, you assume

the risk of the company not being successful - just as a small business owner isn't

guaranteed a return, neither is a shareholder. Shareholders earn a lot if a company is

successful, but they also stand to lose their entire investment if the company isn't

successful.

I t s a t r i c k y g a m e !

Note that: There are no guarantees when it comes to individual stocks. Some companies

pay out dividends, but many others do not. And there is no obligation to pay out

dividends. Without dividends, an investor can make money on a stock only through its

appreciation of the stock price in the open market.

On the downside, any stock may go bankrupt, in which case your investment is worth

nothing.


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Having understood this, we now want to know what makes stock prices rise and fall? If

we know this, we will know which stocks to buy. In the next section we will try to

understand what makes stock prices go up and down.

What makes stock prices change? >>

Stock prices change every day because of market forces. By this we mean that stock

prices change because of supply and demand. If more people want to buy a stock

(demand) than sell it (supply), then the price moves up!

Conversely, if more people wanted to sell a stock than buy it, there would be greater

supply than demand, and the price would fall. (Basics of economics!)

Understanding supply and demand is easy. What is difficult to understand is what

makes people like a particular stock and dislike another stock. If you understand

this, you will know what people are buying and what people are selling. If you know

this you will know what prices go up and what prices go down!

To figure out the likes and dislikes of people, you have to figure out what news is

positive for a company and what news is negative and how any news about a

company will be interpreted by the people.

The most important factor that affects the value of a company is its earnings.

Earnings are the profit a company makes, and in the long run no company can

survive without them. It makes sense when you think about it. If a company never
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makes money, it isn't going to stay in business. Public companies are required to

report their earnings four times a year (once each quarter).

Dalal Street watches with great attention at these times, which are referred to as

earnings seasons. The reason behind this is that analysts base their future value of a

company on their earnings projection.

If a company's results are better than expected, the price jumps up. If a company's

results disappoint and are worse than expected, then the price will fall.

Of course, it's not just earnings that can change the feeling people have about a

stock. It would be a rather simple world if this were the case! During the dotcom

bubble, for example, the stock price of dozens of internet companies rose without

ever making even the smallest profit. As we all know, these high stock prices did not

hold, and most internet companies saw their values shrink to a fraction of their

highs. Still, this fact demonstrates that there are factors other than current earnings

that influence stocks.

So, what are "all the factors" that affect the stocks price? The best answer is that

nobody really knows for sure. Some believe that it isn't possible to predict how stock

prices will change, while others think that by drawing charts and looking at past

price movements, you can determine when to buy and sell. The only thing we do

know is that stocks are volatile and can change in price very very rapidly.

Just remember this: At the most fundamental level, supply and demand in the market


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determines stock price.

There are many types of techniques and methods that investors use to figure out

whether a stock price will go up or down! We will try to give you an introduction to

these techniques in this article.

But before we go into the concepts of stocks picking, and the techiques of analysis,

let us understand one last basic thing....

What are the Sensex & the Nifty? >>

The Sensex is an "index". What is an index? An index is basically an indicator. It

gives you a general idea about whether most of the stocks have gone up or most of

the stocks have gone down.

The Sensex is an indicator of all the major companies of the BSE.

The Nifty is an indicator of all the major companies of the NSE.

If the Sensex goes up, it means that the prices of the stocks of most of the major

companies on the BSE have gone up. If the Sensex goes down, this tells you that the

stock price of most of the major stocks on the BSE have gone down.

Just like the Sensex represents the top stocks of the BSE, the Nifty represents the top

stocks of the NSE.
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Just in case you are confused, the BSE, is the Bombay Stock Exchange and the NSE

is the National Stock Exchange. The BSE is situated at Bombay and the NSE is

situated at Delhi. These are the major stock exchanges in the country. There are

other stock exchanges like the Calcutta Stock Exchange etc. but they are not as

popular as the BSE and the NSE.Most of the stock trading in the country is done

though the BSE & the NSE.

Besides Sensex and the Nifty there are many other indexes. There is an index that

gives you an idea about whether the mid-cap stocks go up and down. This is called

the BSE Mid-cap Index. There are many other types of indexes.

There is an index for the metal stocks. There is an index for the FMCG stocks. There

is an index for the automobile stocks etc. If you are interested in knowing how the

SENSEX is actually calculated...you must check-out our"How to calculate BSE

SENSEX?" article!

But, before we go ahead and try to understand "How to make money in the stock

market?" you MUST read the next page....

things every stock investor MUST remember >>

You need to KNOW some unforgettable basics before you enter the world of

investing in stocks. The stock market is a field dominated by savvy investors who

know the ins-and-outs of the market. For people who are not on the inside, the

stock market can be a VERY dangerous place. :
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Don't even consider "tips" that tell you about "hot stocks". Consider the source:

There are many people in the market who put in all their time and effort in

promoting certain stocks. They do this because they have their money invested in

those stocks. If they can get enough people to buy the stock and they can get the

stock price to rise, they will sell the stock for a huge price, the stock price will crash

and they will walk off to promote another stock.

Always use your own brain: It's extremely important. You must always use your

own brain. Relying on the advice of others, no matter how well intentioned it may

be, is almost always a complete disaster. Make sure you dig in and really examine

the "facts about the companies" before you invest. Ignore press releases which have

very little substance, and rely on "hype" to tell the company's story.

And finally the most important tip!!!

Only invest money you can afford to lose!! Sure this is a basic point, but many many

people miss it. You should only invest money that you can honestly afford to lose!!

Everyone enters into investments with the idea of earning big profits, but in many

cases, this never works. (Especially if you are new to investing in the stock market!)

Please understand that the above tips are tips for beginners. Once you really get into

the stock market you do not need to follow these rules anymore. But if you are a

new investor, you MUST follow these rules. They are for your own safety.

But then again, nothing comes free. Everything has a price. You will have to loose


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some money, make some bad decisions and then only will you really understand the

market. You cannot understand the market by just looking at it from far. By

following these rules, you will basically not loose too much!

How to decide which stocks to buy? >>

Having understood all the basics of the stock market and the risk involved, now we

will go into stock picking and how to pick the right stock. Before picking the right

stock you need to do some analysis.

There are two major types of analysis:

1. Fundamental Analysis

2. Technical Analysis

Fundamental analysis is the analysis of a stock on the basis of core financial and

economic analysis to predict the movement of stocks price.

On the other hand, technical analysis is the study of prices and volume, for

forecasting of future stock price or financial price movements.

Simply put, fundamental analysis looks at the actual company and tries to figure out

what the company price is going to be like in the future. On the other hand technical

analysis look at the stocks chart, peoples buying behavior etc. to try and figure out

what the stock price is going to be like in the future.
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In this article we will go into the basics of fundamental analysis. Technical

analysis is a little more complicated. It is much more of an "art" than a science. It

depends more on experience and involves some statistics and mathematics, so

explaining technical analysis is out of the scope of this article.

Basics of fundamental anallysis! >>

Depending on the reason behind which a particular partnership is made, partners

may be of different types. To understand this better, consider the following:

Active partners:

The partners who actively participate in the day-to-day operations of the business

are known as active partners. They contribute capital and are also entitled to share

the profits of the business. They also share the losses that the business faces.

Dormant partners:

Those partners who do not participate in the day-to-day activities of the partnership

firm are known as dormant or sleeping partners. They only contribute capital and

share the profits or bear the losses, if any.

Nominal partners:

These partners only allow the firm to use their name as a partner. They do not

have any real interest in the business of the firm. They do not invest any capital, or

share profits and also do not take part in the business of the firm. However, they do

remain liable to third parties for the acts of the firm.
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Minor as a partner:

In special cases a minor can be admitted as partner with certain conditions. A minor

can only share the profit of the business. In case of loss his liability is limited to the

extent of his capital contribution for the business.

Businesses suitable for Parnership structure >>

Having understood the basics of what a partnership business is all about, consider

the following guidelines to help you decide whether you should go in for a

partnership kind of business.

The following are just some examples of businesses that will be suitable for the

partnership legal structure:

A partnership firm is suitable in case of business where the initial capital

requirement is medium i.e. it is neither too large nor too small. Business like retail

and wholesale trade or small manufacturing units can be successfully started by

partners.

In a partnership firm persons having different ability, managerial talent, skill and

expertise join together. So it is most suitable for construction business, legal firms

etc. where each partner contributes the best as per his specialization and experiance.

How to start a Parnership firm? >>

As we have explained before, it is not necessary to registar a partnership

with the Govt. in most states of the country. (In Maharashtra it is almost

compulsary. Check the laws in your state to be sure.)
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However, if you do not register your partnership, you will not be legaly

protected from disputes between partners etc. as we have explained before.

So, it is always wise to register your parnership with the Govt.

In any case, even if you choose not to register your partnership, you should

still prepare a Partnership Deed which will help resolve problems when

disputes between partners arise.

The general procedure for registering a partnership firm all over India is quite

similar:

You have prepare a Partnership deed Fill in the required form at the Registrar Of Firms office near you. Submit the required form, the Partnership Deed and other

supporting documents to the Registrar Of Firms for approval.

P r e p a r i n g t h e P a r t n e r s h i p D e e d

The Partnership Deed, as stated above, must contain:

The amount of capital contributed by each partner Profit or loss sharing ratio Salary or commission payable to any partner, if any Duration of business, if any Name and address of the partners and the firm Duties and powers of each partner


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Nature and place of business; and Any other terms and conditions to run the business

The partnership deed is usually not very hard to prepare through a local

lawyer.

This partnership deed must be made on stamp paper as per the laws of the

place of signing. The whole process of drafting the partnership deed can be

done through a trusted lawyer. It should cost you around Rs.1000/- to prepare

the deed.

After preparation of the deed, it must be signed by all the partners. It must

also have signatures of independent witnesses.

The deed is then submitted to the Registrar Of Firms along with the

registration form and other supporting documents. On approval of these

documents by the Registrar Of Firms the Partnership Firm is established

as a legal entity and can start business under the chosen name.

Next - Understanding joint stock companies (Public & Pvt Ltd.) >>

U n d e r s t a n d i n g j o i n t s t o c k c o m p a n i e s ( P r i v a t e & P u b l i c L i m i t e d )

In a partnership, there can be a maximum of 20 people. Because of this limit, the

amount of capital that can be generated is limited. Also, because of the unlimited

liability of partnerships, the partners may be discouraged from taking huge risks and

further expanding their business. To overcome these problems a public or a private

company may be formed.
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Private and public companies are much better investments because of Limited

liability. This means that if an investor has invested Rs.1000/- in a particular

company, and the company goes bankrupt, the investor only looses the money he

has invested. To pay of the debt, the investors property, bank accounts etc. are "not"

used.

Because of this limited liability, many investors are interested in investing in these

private or public companies. Hence, a large capital can be generated and a huge

business can be run.

The major disadvantage of Private and Public companies, is that they have a costly

and elaborate process of setting up. They are also closely regulated by the

government.

S o w h a t a r e P u b l i c o r P r i v a t e c o m p a n i e s ?

These companies are also know as joint stock companies. The companies in India

are governed by the Indian Companies Act, 1956. The Act defines a company as an

artificial person created by law, having a separate legal entity, with perpetual

succession and a common seal.

What this means is that, the company is different from the investors. The investors

put in money and capital is raised. But the company is treated as a virtual person.

The company is treated as a person who is different from its investors. The

company has an identity of its own. If some one sues the company, he does not sue

the investors, he sues the virtual person that is the company.


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To understand the concept of joint stock (private and public limited) companies,

consider the following characteristics:

Legal formation:

No single individual or a group of individuals can start a business and call it a joint

stock company. A joint stock company can come into existence only when it has

been registered after completion of all the legal formalities required by the Indian

Companies Act, 1956.

Artificial person:

Just like an individual takes birth, grows, enters into relationships and dies, a joint

stock company takes birth, grows, enters into relationships and dies. However, it is

called an artificial person as its birth, existence and death are regulated by law.

Separate legal entity:

Being an artificial person, a joint stock company has its own separate existence

independent of its investors. This means that a joint stock company can own

property, enter into contracts and conduct any lawful business in its own name. It

can sue and can be sued by others in the court of law. The shareholders are not the

owners of the property owned by the company. Also, the shareholders cannot be

held responsible for any of the acts of the company.

Common seal:

A joint stock company has a seal, which is used while dealing with others or

entering into contracts with outsiders. It is called a common seal as it can be used by

any officer at any level of the organization working on behalf of the company. Any


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document, on which the company's seal is put and is duly signed by any official of

the company, becomes binding on the company.

For example, a purchase manager may enter into a contract for buying raw materials

from a supplier. Once the contract paper is sealed and signed by the purchase

manager, it becomes valid. The purchase manager may leave the company or may

be removed from his job or may have taken a wrong decision, yet, the contract is

valid till a new contract is made or the existing contract expires.

Perpetual existence:

A joint stock company continues to exist as long as it fulfills the requirements of

law. It is not affected by the death, lunacy, insolvency or retirement of any of its

investors. For example, in case of a private limited company having four members,

if all of them die in an accident, the company will not be closed. It will continue to

exist. The shares of the company will be transferred to the legal heirs of the

members.

Limited liability:

In a joint stock company, the liability of a member is limited to the amount he has

invested. While repaying debts, for example, if a person has invested only Rs.10,000

then only this amount that he has invested can be used for the payment of debts.

That is, even if there is liquidation of the company, the personal property of the

investor can not be used to pay the debts and he will lose his investment worth

Rs.10,000.


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Democratic management:

Joint stock companies have democratic management and control. Since in joint stock

companies there are thousands and thousands of investors, all of them cannot

participate in the affairs of management of the company. Normally, the investors

elect representatives from among themselves known as Directors to manage the

affairs of the company.

The above discription must have given you an idea about public and private limited

companies in general. There are some special charecterstics of Public and Private

limited companies that must be understood. There are given below.

S p e c i a l c h a r e c e r e s t i c s o f P r i v a t e L i m i t e d C o m a p n i e s

These companies can be formed by at least two individuals having minimum paid-

up capital of not less than Rupees 1 lakh.

As per the Companies Act, 1956 the total membership of these companies cannot

exceed 50.

The shares allotted to its members are also not freely transferable between them.

These companies are not allowed to raise money from the pub-lic through open

invitation.

They are required to use Private Limited after their names.


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The examples of such companies are Combined Marketing Services Private Limited,

Indian Publishers and Distributors Private Limited etc.

S p e c i a l c h a r e c t e r s e t i c s o f P u b l i c L m i t e d C o m p a n i e s

A minimum of seven members are required to form a public limited company.

It must have minimum paid-up capital of Rs 5 lakhs.

There is no restriction on maximum number of members.

The shares allotted to the members are freely transferable.

These companies can raise funds from general public through open invitations by

selling its shares or accepting fixed deposits.

These companies are required to write either public limited or limited after their

names.

Examples of such companies are Hyundai Motors India Limited, Jhandu

Pharmaceuticals Limited etc.

Next - Advantages of Joint Stock Companies >>

A d v a n t a g e s o f J o i n t S t o c k C o m p a n i e s

Large financial resources:

A joint stock company is able to collect a large amount of capital through

contributions from a large number of people. In a public limited company, shares
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can be offered to the general public to raise capital. The companies can also accept

deposits from the public and issue debentures to raise funds.

Limited liability:

In case of a joint stock company, the liability of it's members is limited to the value

of shares held by them. Private property of members cannot be confiscated for

overcoming the debts of the company. This advantage attracts many people to invest

their savings in the company and it encourages the company to take more risks.

Professional management:

Management of a company is in the hands of the directors, who are elected

democratically by the members or shareholders. These directors are known as the

"Board of Directors". They manage the affairs of the company and are accountable

to all the investors. So, the investors elect capable persons who have sound financial,

legal and business knowledge to the board so that they can manage the company

efficiently.

Large-scale production:

Since there is an availability of large financial resources and technical expertise, it is

possible for the companies to have "large-scale" production. This enables the

company to produce more efficiently and at a lower cost.

Research and development:

Only in joint stock company form of business, it is possible to invest a lot of money

on research and development so that new design, better quality products, etc. can be

achieved.


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Next - Disadvantages of Joint Stock Companies >>

D i s a d v a n t a g es o f J o i n t S t o c k C o m p a n i e s

Difficult to form:

The formation & registration of joint stock company involves a long and

complicated procedure. A number of legal documents and formalities have to be

completed before a company can start business. The process of formation requires

the services of specialists such as chartered accountants, company secretaries, etc.

Becuse of all this, the cost of formation of a company is very high.

Excessive government control:

Joint stock companies are regulated by government through the Companies Act and

other economic legislations. Especially, public limited companies are required to

complete various legal formalities as provided in the Companies Act and other

legislations. Non-compliance with these causes a heavy penalty. This affects the

smooth functioning of the companies.

Delay in policy decisions:

Generally policy decisions are taken at the Board of Directors meetings of the

company. Further, the company has to fulfill certain procedural formalities. These

procedures are time consuming and therefore, may delay action on the decisions.
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