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Friday, February 15, 2013

So, you think you can make money in the stock market?

Wait! You don’t have to answer that question yet, because there are a few more questions in a similar vein: ‘So, you think you can become a high court lawyer?’ or, ‘So, you think you can become a professional tennis player?’ or, ‘So, you think you can become a chef at a 5-star hotel?’.

A short answer to the questions are: Yes, but. Why ‘but’? Because one needs to have an inclination towards or an interest in a profession or activity, and then go through the necessary training and experience to become successful.

Can’t a lawyer (or doctor) or tennis player (or chess master) or 5-star chef (or sales manager) also make money in the stock market? Yes, but. Again ‘but’? Just because one is successful in a profession doesn’t mean the same success can be repeated in the stock market.

A classic example? What happened to Sir Isaac Newton – the discoverer of the Laws of Motion and inventor of Calculus – when he invested in the shares of the South Sea Company back in 1720. He lost 90% of his stake, and was quoted as saying: “I can calculate the movement of the stars, but not the madness of men.”

The point is: You can make money in the stock market, but it is not as easy as opening a demat account and punching in a buy or sell order. There is a learning process that one has to go through. The learning includes some basic knowledge of economics, mathematics, accounting, human psychology, and business operations.

Unless you can understand concepts like supply and demand, GDP, ratio analysis, depreciation, inventory, cash flow, herd mentality, confirmation bias - and how the inter-relation of these concepts eventually reflect in the price of a company’s share – chances are that your fate will be similar to that of Sir Isaac.

All of this understanding won’t happen in a few days, or by reading books. Though reading some well-known investment books will be a step forward in your understanding. The real test of your investing mettle will occur when the stock market starts correcting, and the stock that you just bought for Rs 18 (a ‘sure shot’ gainer because it can’t go down any more) drops to Rs 6.

Do you book a loss to preserve what little is left of your capital? Or, do you hold on, hoping against hope to get back your ‘buy’ price? Or, were you smart enough to set a 5% stop-loss and got out when the stock price dropped to Rs 17? If you don’t know the answer to the first two questions, or the concept of a stop-loss, you are not going to make money in the stock market.

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