How to invest safely

5 ways of making equity investing safer

Veena Venugopal, Outlook Money (January 09, 2008 )

You may have stood outside, watched the dancers and wondered when was a good time to join the equity party. You may have taken a step forward, heard the thunderous music and then jumped backwards.

With the indices marking record highs in 2007, the equity party was certainly one where latecomers were kept out. Even as the party continues to be loud, don't be afraid to join in. But, be careful and don't get swept off your feet.

As the new year begins, let safety be your resolution. Outlook Money defines five ways of making equity investing safer.

1. Pick 'safe' stocks
Stock picks are paramount in any kind of market, and especially so in a market like ours that has had a significant run up. The market is now trading at around 20 times one-year forward earnings, an unprecedented level. Even at the best of times earlier, valuations have not exceeded 16 times one-year forward earning.

The first mistake to avoid is to assume that the cheapest way to enter this market is through initial public offers.

Says Gaurav Mashruwala, a Mumbai-based financial planner: "Many people say that the market is too expensive and putting money in an IPO would be cheaper. That is a wrong strategy. Companies just getting listed are more risky than established blue-chips."

The safest way to enter the market is by investing in large companies, ideally those that are part of the market index.

Once you gain some experience, you can diversify. Even then, it's better to stick to well-known players. Try and get research reports from reputed brokers. Learn to read balance sheets and understand the industry the company operates in. Ignore hype and, most importantly, do not depend on 'market tips' your friend always gives.

Another important factor to investing safely is knowing when to sell.

2. Read between the lines
Beware of hype. One of the recent trends to emerge from trading patterns in the last few months is that delivery-based transactions are sometimes less than half of actual volumes in the market.

This indicates that the price rise in a lot of stocks is purely speculative and not backed by any fundamentals. This is true even for large-cap, well-known stocks.

Try and understand the reason why certain scrips are gaining. Check data from the exchanges.

If volumes for delivery constitute a major portion of trades transacted during a period, it indicates genuine buying and selling. If only day traders or speculators are interested in the stock, you may be buying into an artificial demand.

As the Sensex reaches unthinkable levels, massive volatility is par for course. Do not get caught on the wrong foot.

3. Do not over-leverage
You had a good run last year and have substantially improved your portfolio. You wish you had more funds to make an even bigger killing. Your broker suggests margin trading. At just 10 per cent of the investment you get to take a position on a stock that is definitely going up. Sounds great? Well, resist.

Even brokers are of the opinion that the current market is not one for retail investors to try and test their skills in.

As our bourses get increasingly aligned to foreign ones, short-term market movements will be driven by forces we cannot foresee or predict. Avoid buying stocks to trade them in a few days, and even more importantly, avoid over-leveraging yourself.

If your call goes wrong and you have utilised the margin trading facility, you will have to cough up the remaining 90 per cent overnight. You may have to liquidate other investments or even borrow at a higher cost to cover up the losses.

"Margin trading is not safe even in the most placid of market conditions. Though we do offer this facility, it is inadvisable to use it in the current market conditions. In 2008, we expect more volatility, not ideal conditions for a novice to leverage market positions," says the head of a large broking house.

4. Be vigilant
As more investors are entering the market, regulators, exchanges and depositories have been tightening the rules. However, this does not mean that all fraud is eliminated. Choose your broker carefully. If you are picking the stocks yourself, then you can go with the cheapest broker. If you are going to rely on your broker for investment advice, then choose one that has the best research capability.

Even if you have picked a reputed broker, be vigilant. After every buy or sell transaction, check your contract note. It should have the order number, trade number, trade time, quantity, price and brokerage, and should be signed by the authorised persons.

If you have an online broker, check your depository participant status. Shares must reach you on the second day after you have put in your buy order and cash must be in your account the second day after you sell.

Keep a daily check on your DP account even if you have not transacted. Sometimes brokers move your shares to their common pool and transact on them. Call them and ensure that they reverse this. If a record date for dividend payment has been set on the day your broker does this, you may lose the dividends.

5. Be diligent
The best way to ensure the safety of your money is to be diligent. Get yourself organised and keep your papers in order. If you are applying for an IPO, keep a copy of your application form and cheque.

If you are buying and selling through a broker, check your contract notes and file them away safely. If you have all your documents in one place, it is easy for you to spot fraud and take action against it.

Market regulator Securities and Exchange Board of India as well as the Bombay and National Stock Exchanges have investor complaint cells. You can write to them and follow up to ensure that action is taken against the broker or the registrar if you face problems with your transactions or IPO allotment. But, for this, you need to have all your evidence in place and in the right order.

Stockmarket investing is fraught with risks and not for the faint hearted. But facing the risk of an intelligent and calculated transaction going wrong is one thing, and having to lose your money because of greed or laxity is another.

If 2006 was a year when even your pet dog could stock pick and make a decent profit, 2007 has taught us that, ultimately, markets favour the intelligent. Indications are that 2008 will teach us more of this. Brace yourself and enjoy the party.

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