how to invest in stock market
Best stock market investing strategies are ones that generate great returns consistently by giving clear answers to three important questions.
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What to Buy?
Buy only quality companies. Shortlist companies that have a superior earnings profile i.e., companies that have delivered consistent double-digit growth in both sales and earnings in recent 2-3 quarters as well as in the last 2-3 years.
Sustainable growth is very important. There is no point in getting into stocks that have posted strong sales and earnings in the most recent quarter but lack consistency on annual basis. Companies can boost sales (one-time contract win) and earnings (cutting costs) which might not be sustainable in the long-run. 20% growth is a good number to start with.
Along with strong double-digit sales and earnings growth, look for high return-ratios (15-20% ROE/ROCE) and improving profit margins in recent quarters.
Once you use the above criteria to shortlist stocks, you will have the ones that are of top-notch quality. This is pretty important for retail investors, since they don’t have the time as well as resources to track a big universe of invest in stock market
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When to Buy?
Once you have a prepared a watch list of top quality stocks, your next task is to decide when you would buy them.
While fundamental analysis should dominate your stock selection process, a little bit of technical analysis will help in getting into a stock market at the time when the probability of it going up is high.
If strong fundamentals are primary reason behind a stock’s upward movement then why use technical analysis?
I will try to explain with an example. In the chart below, one can see how Eicher Motors’ stock market price advanced more or less in line with its 10 year EPS growth rate.
While long-term sales and earnings growth have been linear, fear and greed of market participants caused price volatility, resulting in periods of stock consolidation and periods of huge price gains.
While sales and earnings of many great companies move in a linear line over the long term, stock market is a different ball game. Stock movements depend mainly on fundamentals, along with demand and supply for a company’s stock and overall market sentiment.
Hence, incorporating technical analysis by studying common chart patterns will help you in getting into a stock at the time when the probability of the stock going higher is pretty good.
In a nutshell, buy fundamentally strong stocks when they break out of proper chart patterns.
When to sell?
When it comes to selling, one must need to have a stop-loss rule in place. This could depend on an investor’s risk appetite. However, if stocks are bought at proper buy points i.e., on breakouts from chart patterns, investors need to cut losses at 8%.
Quality stocks that breakout from proper chart patterns rarely fall more than 8% from their ideal buy points. And if they fall over 8%, it is better to come out of such stocks, because the stock could then go through a period of consolidation and it would be better to deploy your capital in a better opportunity.
Other sell rules that can be followed include breach of a key moving average such 50-day or 200-day on high volumes.
One final thing
Until now, I have highlighted buying and selling decisions that are based on a company’s fundamentals and its stock price action. However, investors also need to pay attention to how the overall market is doing. This is because three out of four stocks follow the general market direction and hence it is quite important to sit on the sidelines when market is showing signs of weakness and go all-in when market shows signs of strength.
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