Make Money From Stock
In this piece of article, we shall be discussing the various ways to make money from the stock market.
Now when I say make money from the stock market, it doesn’t mean that it is guaranteed that one will make money without being able to bear risks.
Although these risks can be covered to a certain point and the methods of the same will be discussed later in the article.
Let us begin with the article.
1. Good Old Shares/Stocks of a Company
What is a stock? How does it work? What are the benefits? What are the risks associated with it? And other questions.
Well to start off, think of stock as a piece of ownership of any organization. This piece of ownership is the proof of your share in that particular company, hence the name “share”.
The important thing to remember here is that all the stocks in the market derive their values from the demand of that particular share.
The more the company performs well, the greater demand for it, and the better pay-out ratio for the stockholders. They are positively correlated.
- Now, what are the risks associated with them, you ask?
The biggest risk associated with any stock is its non-guarantee to perform.
A stock can make one rich, or make the same person bankrupt, although the latter is not so common anymore. Another risk associated with it is the risk of the company going bankrupt, which again is not so common anymore.
Seems like we don’t have much to worry about when it comes to stocks.
- How to make money from them?
There is no one guaranteed method of always profiting from stocks because their behaviour is very unpredictable.
Of course, shareholders get a certain amount of dividend on their shares, but even that is not guaranteed. You can lower the risk by having good knowledge, and a good stock market course can help you in this.
Although there are a few techniques that can help one in making the most of their investments and guarantee at least a somewhat stable income from them.
- First and foremost comes the HEDGING TECHNIQUE of diversifying your portfolio. A portfolio is a total of shares owned by a person.
THE MORE YOU DIVERSIFY YOUR PORTFOLIO, THE LESSER THE CHANCES OF A RISK AFFECTING YOUR ENTIRE INVESTMENTS.
By diversifying I mean choosing stocks that are negatively correlated to each other, i.e. if Stock A and Stock B have a negative correlation, you will not lose all your money even if one of them goes down.
- Second, comes the COMPOUNDING which should be done regularly. In simple terms – invest in a stock, it increases, cash it out, re-invest it again. The power of compounding is an extremely beneficial tool for a regular investor.
Allow me to give an example –
A bought a stock for 100$, and the guaranteed return on investment as provided by the company was 10%.
He kept the share for 6 years, at the end of which he sold it for 150$. The profit, in this case, is 50$.
*Now, Mr. B bought the same stock at the same return on investment. But Mr. B knew the power of compounding.
*He sold the share every year after getting the return on his investment.
*So to say, after the end of year 1, Mr. B sold the share for 110$ (100$ – stock price + 10$ ROI).
*What he did was then re-invest in the same stock, so the next year he got an ROI of 10% on 110$, which is obviously greater than 10% of 100.
*So at the end of the 6th year, Mr. B sold the stock for 161.051$.
*Mr. B is the clear winner here by a full 11.051$.
- The next step is to INVEST AT A REGULAR RHYTHM. Actually, this point has a lot to do with the previous one, because if you are not regular in your compounding and do not have a cadence then compounding will not be useful for you.
Other benefits are that regular investment makes sure that you have up-to-date knowledge about the stock market and the events taking place in it. So as to decide whether to keep the share or sell it.
Remember that news and rumors also play a very important role in the demand for a share. Shares have always had the majority investments when it comes to India Markets. So evidently the big part is over.
2. Next Comes “a Little Complex for Beginners to Understand” Derivative.
(I shall not go too deep about derivatives because our priority is shares).
- What is a derivative?
As the name suggests, derivative doesn’t have a value of its own and derives it from a “base” or more commonly used “underlying”.
These underlying can be either stock, bond, commodity, basically any instrument present in the financial market.
- How do they work?
The most common derivative being options, I will give an easy example on options. Think of buying an option as placing a bet.
The stock of the company XYZ Ltd. was a solid 1,000$. There was a rumour that it will be venturing with an MNC.
Looking at this, Mr. A (who has become a lot smarter since reading my article and understanding the power of compounding), said that the stock price of XYZ Ltd. will boom to a good 2,500$ in the next 4 months.
Mr. C, a rival of Mr. A objected, saying there is no way it will increase by 1,500$ in just 4 months, but maybe by 500$.
Mr. A challenges Mr. C to a bet, saying if the price of a stock of XYZ Ltd. does indeed rise to 2,500$ before or till 4 months, Mr. C will buy the stock at the market price of that time (i.e. 2,500$), and sell it to Mr. A at a pre-determined amount, obviously less than 2,500$ (say 1,500$ in this case).
If Mr. C wins this bet, he will get to keep the premium of the pre-determined amount, i.e. 1,500$-1,000$ = 500$.
This is the basic working of an options trade. There are other instruments under derivatives that can be saved for later because they need a thorough understanding of Call and Put (which I heard is explained beautifully in the stock market course.)
3. The other Instrument of the Stock Market is Mutual Fund
Have you ever contributed with your friends where you all pitched in money to buy a commonly used product, say a football, or a highly complex financial instrument such as a CDO? Just kidding about the latter.
Think of a mutual fund in the same way as your friends and you pooling in money to buy an asset.
The mutual fund works in a similar way.
It is a pool of funds gathered and then invested in securities in anticipation of returns from it.
Naturally, the risk is less than a direct investment in stocks because the main target investment is government securities.
4. Let’s Move to Bonds
Now there is a common confusion between bonds and debentures.
Bonds and debentures are two sisters, except that debenture is not backed by her parents.
Bonds are the debt-securities backed by the company’s, or rather the issuer’s assets.
They have a lower rate of interest than debentures.
Debentures, on the other hand, are entirely issued based on the issuer’s creditworthiness in the market and have a larger interest rate than bonds.
But on a serious note, in case you are wondering how to make money out of all the other instruments other than stocks, I seriously suggest the course The Thoughtful Tree provides.
They explain it better than I do. Really!