So you have bought your first stock (If not then read the article “Buying the first Stock”). It was fun and now you want to build a portfolio. Mind you “the fun ends here”. Buying the first stock was relatively easy but building on a portfolio of stocks which generates consistent return is a different ball game all together. I am saying this because when you bought the first stock the capital invested was not much (10000 now a day is not muchL) and you bought the stock from the most familiar sector. Both these factors contribute towards reduction of risk.
Once you start increasing the number of stocks in your portfolio, capital invested goes up and the familiarity with company business also reduces. Can you sense the rise in risk level now? We applied pure common sense while buying the first stock but building a stock portfolio needs something extra. Let’s find out what it takes to build a portfolio intended to generate consistent returns.
First Step - Set Realistic Goals
Prior to building stocks portfolio one needs to define his return expectations and the level of risk he can undertake. So what should be your return expectation? Best way to set up the return expectation is to take reference from the historical return figure of equity market. Historical return of stock market investment has been in the range of 17 to 20%. As you are a beginner return in the range of 15% should be fine. Expecting fancy returns of 50% year on year will take you nowhere and there are ample chances you will lose money. Do not worry as this 15% return is not a fixed value. As you gain experience you will be able to beat this benchmark by a great margin.
What about the risk? Setting 15% return has already reduced the risk you are going to take as it’s relatively easy to generate return in this range by investing in blue chip companies like SBI, ICICI Bank, Reliance, TATA’s etc.
Second Step - Learn the necessary tools
Once the goals are set you need to focus on the basic tools which will help you in achieving your goals. Execution of investment strategy also requires patience and emotional control. Knowledge of tools will keep you informed about right entry and exit points wherein emotional control will help you in avoiding the trap of greed and fear.
Let’s try to figure out the tools necessary for becoming a successful investor. There are basically two theories which are invariably used by smart investors in stock market i.e. fundamental and technical analysis. There relative use depends upon the time horizon of investment. If the investor has broader time horizon he relies more on fundamental analysis and if he has shorter time frame he relies on technical analysis. Smart investors basically utilize a proper mix of the two theories. For the time being we will cover what fundamental and technical analysis is (please wait for a detailed article on how they are carried out)?
Fundamental analysis is basically used to assess the underlying strength of the company. Using this technique you are trying to gauge the viability and growth potential of the company in future under different economic environment. Successful investors prefer investment in those companies which indicates sustainable and superior growth prospects. Company’s financials are tested against the following parameters to gauge their strength.
- The overall Economic scenario and future outlook
- The Industry growth Scenario
- Individual Company performance inside the industry
All the above three parameters are of equal importance and should be studied together. More on this in another article so stay tuned.....
Fundamental analysis enables you to identify profitable investment options (companies) but buying the stocks blindly based on fundamental analysis is not recommended. Returns can be maximised if we enter and exit the stock at right prices. Now, what technical analysis does is, it helps you identify the correct entry and exits points based on the historical price performance of the stock. Technical analysis has the potential to enhance the return from the same investment in the same time frame. For example you can generate a return of 10% from a stock which you are planning to hold for 3 months with original return expectation of 5%. This is achieved by understanding the support and resistance concept of technical analysis. There are various other techniques which have the same effect. I will be covering those in the coming articles.
What Next - Where to start from
You know the tools now. Basic objective of writing this article was to make you familiar with the concepts. We will be doing detailed analysis of these concepts in the coming articles. In the mean while you can go through various articles on these topics available on internet to get a hang of it. You can also buy some good books on these topics or listen to business channels which run programs featuring these topics.
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