The journey from financial awareness to actual market participation is shorter today than it has ever been in India’s investing history. A first-time investor can download one of the many trading apps available on any smartphone, complete the account opening process in under thirty minutes using Aadhaar-based e-KYC, and place their first order on the same day. The demat account is created simultaneously during this process, and within a matter of days the investor has a fully functional brokerage setup ready for action. The speed and ease are remarkable – but they also mean that many first-time investors enter the market without the foundational knowledge needed to navigate it wisely.
Equity Markets Are Not the Same as Gambling
One of the biggest misconceptions that rookie investors carry with them into the market is the idea that equity investing is some form of gambling on steroids. This unfair stigma does great disservice to the concept because buying shares in a company means buying ownership in real businesses that employ real people, generate revenues, own assets, and earn profits. Over time equity markets are reflective of how well businesses do and as the economy grows – as in the case of India – businesses too create value.
The speculative outcomes that equity markets are sometimes associated with are the results of leveraged trading, momentum chasing, concentrated positions, and short-termism – all of which can be avoided. The investor who takes a long-term view and buys quality businesses at reasonable valuations can have a very different experience to the trader who opens a DEMAT account and starts trading on the intraday momentum of stocks.
Understanding Order Types and Execution
Most new investors that I meet are not aware that there are multiple ways to execute a trade and that the choice of order type could impact their trade outcome. The default for many is a market order, which is essentially an instruction to the broker to buy/sell at the best available price. For highly liquid stocks, the execution price will not differ much from the price that the investor might have seen on their trading platform.
In illiquid counters, however, the difference can be significant. A limit order on the other hand allows the investor to decide the price at which they are willing to buy/sell. The key difference is that the market order asks the broker to execute the trade immediately at the best available price, while the limit order sets a price the investor is willing to accept.
While the assured execution of a market order makes it attractive, inexperienced investors are often better served by limit orders, which prevent the slippage that comes with executing immediately against a counter with insufficient liquidity. The lesson to learn here is that one should use market orders for large-cap stocks and avoid them in mid and small-caps. Limit orders on the other hand, should be used to target specific price levels.
The Psychological Traps That Destroy New Investor Returns
Decades of research on behavioural finance have uncovered a large number of cognitive biases that lead investors to make irrational decisions, at the wrong time, more often than not. New investors should be especially mindful of recency bias, anchoring, and confirmation bias. Recency bias causes investors to extrapolate recent events into the future. Since human beings are wired to believe that whatever has happened in the past has a higher probability of recurring, investors often buy stocks when the market has already gone up significantly and sell when it has fallen sharply – they are doing the exact opposite of what they should be.
Anchoring is the tendency for an individual to rely too heavily on one piece of information when making subsequent decisions – this applies to equity investing as well. An investor who buys stock in a company has anchored on the price that they paid for the scrip. So, if the value of that company falls by thirty per cent at any point in the future, they are likely to hold on to their position because they believe it to now be a bargain.
Confirmation bias is perhaps the most harmful of all since it causes investors to believe information that confirms their existing viewpoint while disregarding information that contradicts it. An investor who has decided to buy a stock will pay more attention to news reports that are positive about the company while ignoring any that might raise doubts about continuing to hold the investment. Awareness of the bias is often enough to help an investor avoid making rash decisions.
Setting Realistic Expectations for Your Portfolio
Historically, Indian equity markets have delivered compounded annual returns of twelve to fifteen per cent for diversified portfolios. Within this range, there may have been years when the portfolio delivered a return of thirty per cent, or a year when it lost thirty per cent of its value – the overall average remains in the range mentioned above.
New investors need to set realistic expectations from their portfolio and understand that equity markets are volatile in the short term, but rewarding in the long term. One way to contextualise this correctly is to compare returns against a relevant benchmark. Rather than comparing the absolute returns of the portfolio to some arbitrary number, do the comparison against the returns generated by the benchmark over the same time period. If the market fell twenty per cent and your portfolio fell fifteen per cent, it really is a good performance.
