Introduction
After doing his MBA, Naresh has recently joined a MNC. Naresh has been reading about the frenetic rise in the stock markets from 17k levels to 20k levels. He has been reading in the newspapers how equity investors have increased their wealth with the phenomenal rally in stock prices. Naresh also wants to invest a certain portion of his salary in equities every month. But Naresh doesn't know anything about the stock markets. He doesn't know how stock markets work, what influences the prices of individual stocks but at the same time by not participating in the stock markets he is feeling left out. Do you also feel the same? Then don't worry. This article explains the different ways of investing in stock markets.
What is a Stock Market?
Stock Market or Stock Exchange is like an intermediary which brings the borrowers and lenders together. There are 2 types of markets.
Primary Market: Companies that want to borrow money for expansion, working capital, acquisitions, debt repayment etc come to the stock market with an equity issue. When the company hits the market for the first time it is known as an Initial Public Offering (IPO). Lenders who want to lend money to these companies can do so by subscribing to shares of these companies. This is known as the primary market when the company is in the process of getting listed.
In return for the capital raised from investors the company offers them a certain percentage of ownership in the company in the form of shares. Shares represent fractional ownership of the company. The percentage of ownership is directly proportional to the number of shares held.
Secondary Market: Once the gets listed, its shares start trading in the secondary market. In the secondary market buyers and sellers come together for buying and selling shares of listed companies through the stock exchange. The demand and supply of these shares and the financial performance of the companies decide the prices of the shares of that company.
What are the Ways in which one can Invest in the Stock Market?
"The beauty of investing in the stock market is that for every Buyer there is a Seller and they both think they are clever". The following investment options are available for investing in the stock market. Let us have a brief look at them
1) Direct Investing in Cash Markets
To use this route of investing in the stock market, the investor first needs to open a demat account through a broker. Once the account is opened the investor can start trading (buy or sell) in shares. The orders can be placed through phone by calling up the broker or by visiting the broker's office or directly through the broker's website. The Cash Market segment can be used to trade with a relatively less amount of risk.
2) Derivatives – Futures
A Futures Contract is basically a Contract between 2 persons for Buying / Selling an asset of a fixed quantity and quality at a specified Future Date at a price Fixed Today.
For example a Person X wants to buy 100 shares of Reliance Industries, 2 months down the line. So he can get into a contract with another Person Y who agrees to sell 100 shares of Reliance Industries to him 2 months down the line. This is an example of a Futures Contract. Even though the delivery of Reliance shares and the payment will be made 2 months down the line, however the terms and conditions of the contract like the quantity of shares, price of shares and the date of delivery will be decided today itself i.e. the date of getting into the contract.
Investing in futures involves picking a direction in which the stock price is expected to move and the extent. This is the Riskiest / Most Rewarding of all investment options mentioned here.
3) Derivatives – Options
Options are a contract between 2 persons that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date. To invest in options you can take a Long Position (buy a Call) of a specified Strike Price if you expect the price to rise. Else you can take a Short Position (buy a Put) of a specified Strike Price if you expect the price to fall. Since you are not obligated, it means that the Profits are Unlimited but the Losses are Limited.
In Futures Contracts the profits as well as the losses are unlimited, depending on the direction in which the price of the stock moves. But in case of options, when options are bought the profits can be unlimited but losses are limited. So for a person who wants to take limited risk, options are the preferred way to trade in the derivatives market.
4) Mutual Funds
Mutual fund is a Collective Investment Scheme that pools money from numerous like minded investors and invests that in various investment avenues as per the scheme objective. The unit value (NAV) depends on performance of the securities in which the fund has invested. This a good option for those who have a limited risk apetite. Based on the investment objective of the scheme it can either be an equity fund or debt fund or a balanced fund.
5) Insurance – ULIPs
ULIP stands for Unit Linked Insurance Plan. ULIP is a life insurance solution that provides for the benefits of protection and flexibility in investment. The investor can choose to invest his money in an equity fund or debt fund or balanced fund. The investor can also switch his money from one fund to another fund. The fund value (NAV) of the policy depends on the value of underlying assets at that point of time.
6) Exchange Traded Funds (ETFs)
This is a recent phenomenon and is gaining popularity rapidly. ETF's are like Mutual Funds but are very flexible, don't have a minimum investment attached to them, can be traded on the Stock Exchange during market trading hours.
Conclusion
We have looked at what are Stock Markets and the various ways of investing in the market. So now you and people like Naresh who have no idea or little idea about ways on investing in the stock market can choose from any of these 6 options to invest in the stock market. Ideally if investors don't want to take risks they should invest through mutual funds or ULIPs. The investment decisions in these are taken expert Fund Managers who understand the markets very well and have lot of experience of handling big investments in stock markets. In the next part of the series we will be reviewing these investment options in detail individually and how to make money using these options. What are the Risks involved? What kind of returns can we expect? Till then happy investing!!!
