How to intelligently invest in shares when the stock market is soaring

If you can ably do stock market analysis, direct investments in the stock market can be highly rewarding in the long term provided you understand the risks too.

Many investors with a high-risk appetite love investing in direct equities. The Indian stock market is currently trading close to its all-time highs, but some investors are not sure whether they should stay invested or exit from their current investments in shares. They fear that if the market falls from this level, they may end up losing their wealth. At the same time, they don’t want to give up on possible gains if the market continues to make new highs in the coming days.

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So, what should they do? What should be their investment strategy in shares when the stock market is at an all-time high? I’ve discussed a few useful pointers in this regard.

Consider investing in dividend-paying stocks

Stocks can give you a return on investment in two ways: through capital gains, or dividend income through which companies share their profit with shareholders. If the company you invest is cash-rich, has been generating income regularly, and is low on debt, it is likely to pay dividends. Usually, companies that provide high dividend yields consistently are less prone to market volatility. So, even though the stock market is trading at an all-time high level, you could consider picking such stocks that have strong fundamentals, excellent dividend pay-out history, and a potential to offer dividends consistently in the future.

However, before investing in shares of dividend-paying companies, it’s crucial to understand the tax implications too. Dividend income is taxable at the hand of investors. So, if you receive dividend income, you have to pay tax on such income as per your applicable tax slab rate.

Avoid speculation

Moving in and out of stock investments in a short timeframe to make more money is usually considered speculation. The main difference between investment and speculation is that the former focuses on analysis and risk management towards earning the anticipated rate of return, but the latter doesn’t rely on research – it instead depends on ‘chances’ to earn an income. When the market peaks, you should be ready with all kinds of strategies to mitigate the associated risks. Investing after thorough research can help you avoid unnecessary risks and lower the chances of losses.

Follow strict stop-loss on short-term investments

As the name suggests, ‘stop-loss’ is the threshold level pre-set by the investor beyond which the investment position is exited to reduce further losses. For example, suppose you have invested in 100 shares of ‘XYZ’ at Rs.1,000 per share. The price of ‘XYZ’ shares starts falling after a few days. When it reaches Rs.900, you decide to set the stop-loss at Rs.850. It means you’ll wait till it drops to Rs.850 to exit the investment position. The next day, the stock opened lower at Rs.840 triggering your stop-loss and you existed the investment in ‘XYZ’ at Rs.840 booking a loss of (Rs.1 lakh – Rs.84,000) Rs.16,000. But later, the price of ‘XYZ’ fell to Rs.600. Since you had no position in XYZ share, you avoided a bigger loss, thanks to your stop-loss.

As such, it’s crucial to strictly follow your stop-loss when you invest in shares. It can help in minimising your losses. When the price of your stocks moves up, you should simultaneously shift the stop-loss upward or as per predefined percentage of the stock price to ensure that you can lock the gains. The process of gradually shifting the stop-losses in sync with the movement in the stock price is called trailing stop-loss.

Diversify your investments among fundamentally strong shares

Choosing fundamentally strong shares has several advantages including a quicker recovery after a fall in the stock market. So, while selecting the stocks in your portfolio, focus on fundamentally-strong shares with solid track records, low or zero debt in books, good cash-flow levels, high growth in revenue, attractive profitability, and a promising growth plan. You should aim at adequately diversifying your investments into different sectors and into shares of other companies to minimise risks. Having excess exposure in a single sector and a few companies can increase your risk if that particular sector or the stock underperforms.

Avoid over-investing and use SIP mode if you’re a beginner

You must assess your risk appetite before investing money in the stock market. Always invest as much as you can afford to lose. The stock market is highly volatile, you should invest only if the daily ups and downs don’t impact your daily finances. If you can ably do stock market analysis, direct investments in the stock market can be highly rewarding in the long term provided you understand the risks too. It’s crucial to avoid over-investment, i.e., investing over and above your risk appetite and financial capacity. Over-investment in shares can result in heavy losses if the market condition becomes adverse. For beginners, systematic investment plan (SIP) investments in top-rated equity mutual funds can be a better option to earn good returns in the long term.

(The writer is CEO, BankBazaar.com)