Stock markets are just like any other market where you sell and buy products. In this case, the products are the shares of a company. The difference with other markets is that the stock market is an auction market. There is no fixed price of the listed shares of a company. It depends on demand and supply, which further depends on a company's prospects, profits and many other parameters.

Investing in the stock market can be an enigma for most. But this need not be the case. We will look at some of the basics of stock market investing that readers need to keep in mind when they plan to invest in equity.

What is a stock exchange

A stock exchange is where you can buy or sell shares of a listed company. While there are many small exchanges, almost all the trading in India happens on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).

A share is a part of the company that issues it. It represents your ownership of the company. For example, Infosys has 100 crore shares outstanding in the market. If you own 1 crore Infosys shares, you own 1 per cent of the company. If the company does well, the value of the company goes up and, hence, the share price rises. This appreciation in the share price adds to your wealth because you can now sell the stock at a higher price than you bought it.

Making money

When you buy a share, you own a part of the company. You make money in the stock market in two ways:

• Dividends: When the company pays dividends, you get your share of it. For example, if a company declares Rs 20 dividend per share, you earn Rs 20 for each share you own. If you have bought the shares at Rs 500, you make 4 per cent from the dividend. Usually, dividends are paid annually.

• Price appreciation: When a company does well and increases its profits, this adds to the financial attractiveness of the company. Demand for the shares of the company goes up, which increases the price of shares. This adds to your wealth because the value of your shares also goes up in the market.

In the long term, there are no taxes on profits from shares. The long term is defined as a year or more. Hence, if you buy and sell the shares after a year, there will be no tax on the profit. If you suffer losses, you can use this loss to offset future gains.

How to invest

Stock markets are one of the best ways to put your money to good use as an investment. While there can be significant fluctuation in the prices of shares in the short term, it gives better returns in the long term. The key is to find a good business, invest, and be patient while the business does well. There are many good companies that have given great returns consistently over time. Shares of companies such as HDFC Bank, ITC, Reliance, Infosys and others have done decently in the last 20 years. Let's see how you can take advantage of the stock market.

• To start investing in the stock markets, you need to open a demat account. A demat account can be opened with any of the broking firms such as ICICI Securities, HDFC, Motilal Oswal and others. These broking firms provide you a portal (website) that allows you to buy and sell the shares online.

• Investors can directly invest in shares through their demat accounts. They can buy shares of companies of their choice and sell whenever they want to.

• Investing in shares directly is a high-risk investment. If the company faces adverse market conditions, share prices can drop precipitously. This means the value of your investment can plunge without warning. The positive part is that if the company does well, the prices multiply and you make money.

The key is to find firms that will do well in future. Most investors end up investing in companies based on rumours or hype and lose money. New investors should avoid companies that are unproven. They should rather go for blue-chip companies that are in the market for decades and doing well, such as the 30 companies that make up the Sensex or the 50 companies that make up the Nifty.

Mutual fund route

Mutual funds are an alternative way to invest in the stock market for investors who are not good with company analysis. A mutual fund is a fund that invests in a set of companies. It is always less risky to invest in a set of companies than in one or two companies. These funds are called equity mutual funds.

Equity mutual funds offer different options. Some funds invest in blue-chip companies, a few others in different sectors, while some may invest in small or medium-sized companies. The least risk is in funds that invest in the blue-chips. New investors should invest in blue-chip equity funds to avoid risks in the beginning. Once you have an idea about the fluctuations, price movement and the impact of macroeconomic factors such as government action, interest rates etc, you can diversify into other funds.

Safety with SIPs

Investment in equities can be done through monthly systematic investment plans (SIP) where you can put a certain amount every month in the selected mutual fund. You can authorise the mutual fund company to deduct a certain amount from your account every month and put it into the selected mutual funds. You can also invest a lumpsum amount but that may not be a prudent way of investing. In the case of a sudden adverse movement, your investment value can take a plunge.

In the case of a SIP, when the market goes down, you can buy more units of the fund and build your portfolio. When the market goes up, your existing portfolio makes money. SIP takes care of market fluctuations. You do not need a demat account to invest in mutual funds, but if you have one, it is easier to monitor, track and transact with your funds.

The stock market is the most rewarding for those who are patient and not swayed by short-term changes. However, it can be disastrous for investors who want to make quick money by trading on tips or rumours.

The author is CEO of Bankbazaar.com