For a newcomer to stock market, more important goal than just buying and selling stocks is building a strong portfolio over the time. It's very easy to drive away with sentiments flowing all around in the market and commit mistakes which finally brings down your total returns to negatives. A little self-discipline and lot of patience can get you very decent returns.
First year strategy would be quite different than strategy for later years. For the first year, a long term investor should totally concentrate on minimizing all the risks. The major risk for a newcomer is the risk of “not having enough knowledge”. Following is the guidelines for the first year of your stock investment :
1. Learn about valuations. Without understanding valuations, it's just guessing, nothing better than gambling. First year should be invested totally in learning and making your base strong. Either you will learn with your own mistakes or you can learn from others' mistakes, whichever way you prefer. Read a lot.
2. Diversification : Even though you think Reliance is the best company and share price will reach 3000 in 6 months, keep doubts for all your judgments. Avoid all bold judgments. For example, if you wish to invest 1 Lac Rs, then Diversify across 10 companies in 10 different sectors with 10k investment in each. Try to stick to best ones in each sector.
3. Do not invest in SmallCap companies. Yes they look very attractive due to 100-200 % annual growth. But they are riskiest ones. Market changes favoritism for such companies frequently and some times forgets it totally. You will never understand why P-E is going above 50 and sometimes below 5. Better stick to largecaps and midcaps.
4. Preferably keep you investment in Midcap to 40-50 % of total portfolio. Midcap companies can grow faster (sometimes more than 100 % annually), but not all. Large cap companies have already proven their performance over the time so risk is less. You must invest some part of your portfolio in companies like L & T, Infosys, TCS, ABB, BHEL, Indian Hotels, Reliance etc which are in high growth sector and are performing very well.
5. Spread your transactions over the time and don't buy until you have safety of margin. (Read guidelines for buying stocks here ).
6. Clear your fundamental concepts. Stock A at 100 Rs can be expensive and Stock B with 2000 Rs price can be cheaper. Don't dream about buying all stocks with price below 100 Rs.
7. For the first year, avoid investing in following sectors :
- Commodities – Steel, Cement companies : Their returns are cyclical and so better avoided. For example, Cement sector looks good today with cheap valuations but by FY08, most of companies will come up with Capex (capacity expansion), so over supply may bring down cement prices and profits.
- Textile and Jewellary : Avoid companies which are not market favorite. These both sector are being ignored by market for a long time and P-E ratios are below 10. No matter how much you get impressed by all those good stories, avoid them.
- Oil and Gas companies : Again lot of complexity involved in these companies profits and largely driven by oil gas prices and govt policies.
8. Minimum holding period for a stock should be one year. (so avoid short term capital gain tax also.) So basically you should be thinking that company will be doing good for next 4 quarters. For this logic, you should have some proper reasons, details and proofs etc. For example, you wish to invest in L & T because it has 30000 Cr order book, reports says order book will easily grow 20 % for few years etc etc. You don't invest in a stock for long term because it's share price has gone up or down or it has just declared a bonus.
9. Learn from mistakes : Believe me, first year you are going to make many mistakes and will buy lot of stocks at wrong price. But don't loose patience. If you buy a stock and want to sell it within 2 months due to loss, then analyze your judgments. You invested for one year and want to sell it without seeing even one quarter results. What went wrong. This is the best time to learn.
10. If you get some junk stocks in your portfolio which is not doing well for long time and you have enough reasons to get rid of it, then best time for getting rid of it is during correction. You will notice that during correction, if good stocks fall by 20-30 %, then your bad stock will fall only by 5-10 % only. Reason being, your bad stock price was already in bad shape and so couldn't go any worse. So just sell it during correction and immediately buy the blue-chip ones which are available at very cheap price.
When you are sitting on good amount of profit (probably second year onwards), your strategy will change. You will concentrate more on churning your portfolio, and you can increase concentration on one stock. Your profits will provide you good cushioning against risks and by then probably you would be mature enough to avoid certain mistakes.
