Frequently Asked Questions (FAQs) About Stocks And Stock Market

What determines stock prices?

Stock prices are driven by market information in the short term. In the long term, dividends, bonus, capital expenditure plans, mergers and acquisitions, and government regulations affecting the sector together add up to impact stock prices.

How much does a share cost?

The market sets the price and it all depends on how many buyers and sellers think the share is worth that much on that day. Some stocks sell for less than Rs 10 a share, others for more than Rs 1,000 a share. But do not be misled that a Rs 10 share is better than a Rs 1,000 share. The market determines the price of each stock, depending on the company’s potential.

What returns can one expect from his/her investments in equity shares? What are the risks?

Equity shares are ‘high-risk, high-return’ investments. The major distinction of equity investment from all other investment avenues is that while the return from many avenues such as bank deposits small saving schemes, debentures, bonds, etc. are fixed and certain, the earnings from equity investments are highly uncertain and varied. A good scrip picked up at the right time could fetch great returns and the return on a mediocre or poor company’s scrip may be meagre or it may even turn negative; that is, the invested fund itself may be eroded. In short, if the investment in fixed income category instruments is secured and risk-free to a large extent, investment in equities and related fields could be termed as risky.

What are market orders, limit orders and stop orders?

There are several types of orders that you can dictate to a broker. The most common type, which is a regular buy or sell order, is called a market order. Another type of order is a limit order wherein you ask the broker to trade only if the price reaches a specific level. In a stop order, you tell the broker to sell your shares if the price drops to a certain level to prevent significant losses because if it drops to that level it is likely to drop further and your losses are likely to increase.

What do bullish and bearish trends mean?

When the market goes up it is called a bullish trend and when the market goes down it is called a bearish trend.

What is ‘taking a position’?

When you act upon a stock and buy into it, you are taking a position. A position is an amount of money committed to an investment in anticipation of favorable price movements.

There are two kinds of positions:

• Long positions are what most people do. When you buy long, that means you are anticipating an upward movement in the price, and that is how you profit. People usually buy stocks expecting to sell them later at higher prices and hence make profits.
• Short positions are the tricky ones. When you buy short, you are anticipating a fall in the price and the fall is the source of your profit. The shares will be sold and when the price falls they will be repurchased and the difference is where the investor profits. Of course, the investor who borrowed the shares carries the risk of not having the price move as anticipated, in which case he may lose money while repurchasing the stocks.

What is a contract note?

It is a statement of confirmation of trade(s) done on a particular day for and on behalf of a client. A contract note is issued in the prescribed format and manner, establishing a legally enforceable relationship between the member and client in respect to the trades stated in that contract note. Contract notes are made in duplicate, where the member and client both keep one copy each.

Stocks often drop excessively on just a little bit of bad news. Why?

If one piece of bad news gets out, investors begin to fear that more bad news is lurking around the corner. Similarly, if one stock in a sector gets into trouble (especially if it is an event that could easily happen to any other company in the same business), there is a suspicion that others, too, will suffer. For instance, investor confidence in Internet companies took a beating after March 2000, when popular Web-based companies in the U.S. faced bankruptcy.

Is it advisable to buy stocks on the basis of information published in newspapers?

You will probably end up being the last in the queue. Everyone reads that news, and the stock price has probably already reflects that news. In fact, stock prices tend to drop on a major news announcements following the old jungle saying: "Buy on rumours, sell on news."

If one invests for the long term, can he/she simply ignore the short term?

If one invests for the long term, can he/she simply ignore the short term? It is true that a ‘buy and hold’ strategy is superior to one that is based on market timing. But, that does not mean you wait for all negative developments to emerge before reacting. Hence, you need to look for positive or negative signals in the short term. If these continue for some time they may have long-term implications. However, avoid the temptation to profit from short-term price swings. It may happen that you decide to sell stock ABC at a price hoping to cover it later at a lower price. But then if the up-move is happening for some sound fundamental reason, you will end up losing. Similarly, it may also happen that you cover up your position at a lower price only to see the stock price falls further as the share may have been downgraded for a genuine reason. It is important that you do not miss the big picture.

How can one take advantage of general fluctuations in stock prices?

If you think the market is ‘too high’, you might give a stop-loss to preserve profits, liquidate some of your positions to capture profits and reduce your exposure or delay any new purchases. If you think the market is ‘too low’, then you might keep some money aside for fresh purchases or cover your position, if you have sold the stock short before.

What are the four things that a trader fears most?

The four fears are:

1. Fear of being wrong
2. Fear of losing money
3. Fear of missing out
4. Fear of leaving money on the table

An opportunity comes every now and then, but these fears do not let us take full advantage of it. For instance, we enter the trade too soon – before the market generates a signal, or too late – long after the market generated the signal.