INVESTING TRHOUGH MUTUAL FUNDS IS AN EASY WAY TO ENTER IN THE VOLATILE MARKET

Investing through Mutual Funds
for several reasons, first-time investors should enter the equity markets via mutual funds. It is true that equities are necessary in a portfolio to meet long-term financial goals, jumping straight into the equity markets without knowledge and expertise may not be a prudent decision. Investors should utilize the mutual fund route to derive the benefits of professional management, diversification and flexibility at a low cost.
First-time investors will be better off entering the equity markets via exchange traded funds (ETF) and index funds. These are low-cost funds that allow investing in a basket of stocks belonging to one of the major indices, such as the Nifty, Sensex, Nifty Junior, S&P 500, and so on. Investors don't have to worry about choosing the best fund or fund manager when they invest in these passive funds. Once they have lived with these passive funds for a couple of years, tested the ability to hold on to equities in declining markets, and educated themselves about how to choose the right funds, they may graduate to investing in active funds.  The bulk of the equity corpus should be invested in mutual funds. Only a small amount of money, ring-fenced from the rest of the corpus, should be invested in the equity markets directly.
Start small initially, bet only the money that you can afford to lose entirely. It will take about 2-3 years of regular work for a few hours every week to get an idea of how to invest in stocks. This process cannot be hastened. Any losses incurred during this period should be treated as the cost of learning.
Stick to large-caps first Segment of stocks in which you invest is also important. First-time entrants in the equity markets will be better off sticking to large-cap stocks for two reasons. One, the volatility in large-caps is much more palatable than in mid- and small-cap stocks. Two, a lot more information is available on large-cap stocks. Since they are intensively tracked by both the analysts and media, more is known about their business and management. This minimizes the probability of unpleasant surprises. The chances of falling prey to issues like aggressive accounting and cooked books are also lower among these stocks. 

Develop an exit strategy Develop a clearly defined sell strategy even before you enter the markets. Once you are in the game, taking the right decisions becomes difficult unless you have a strong decision framework in place. This decision framework should be based on a mix of fundamentals and valuation. If a stock's fundamentals remain sound but its price has fallen, you should buy more. If the fundamentals have declined while the valuation has run up, you should sell. If the fundamentals remain sound but its price has fallen, you should buy more. If the fundamentals have declined while the valuation has run up, you should sell. If the fundamentals remain sound but the valuation has run up, you may perhaps book partial profits, and so on. 

Stick to your circle of competence Gain a sound understanding of a company's business model before investing in it. Unless you do so, you will not know whether to hold on to its stock or sell it whenever the stock price tanks. Stick to simple businesses whose functioning you can understand easily. The business should also ideally have a consistent operating history. Its 10-year historic revenue and profits should show a smooth and gradual increase. Beginners should avoid stocks with volatile track records of financial performance. It is also best to stick to unchanging businesses. 
Buy-and-hold type investors should select companies that enjoy sustainable competitive advantages. It is intrinsic to capitalism that if a company enjoys outsized profits, a number of competitors enter the field and drive down profits. However, some companies manage to remain highly profitable for a long time. These are the ones that possess an economic moat. They have one or more of the following characteristics: a strong brand, a low cost advantage, high entry barriers for rivals, and high switching costs for customers wanting to move to rivals.

Opt for quality management Watch out for management that doesn't act in the best interests of minority shareholders. Check the announcements made three-four years earlier by the management to see whether it has managed to bring those plans to fruition. This will give you an idea of its execution skills. You should look up Sebi's website and trawl the Internet for bad news on promoters. Avoid companies where the promoter holding is less than 30%.

Don't invest in high-debt companies When the economy is expanding, many companies tend to overstretch themselves. Some take on more projects than they can handle. Others undertake costly acquisitions funded by debt. If the economy turns, the company's revenue may plummet, but the interest on debt will still have to be paid. This can severely dent the company's bottom line. The debt equity ratio and the interest coverage ratio are two parameters that tell you about a company's degree of leverage. 

Buy at the right valuation usually retail investors enter the markets when they are at a high and valuations have already become stretched. Remember that the higher a stock's valuation, the lower the prospective returns from it. Study the stocks and build a list of the ones which would like to buy. Work out the price points at which you would like to buy those stocks. Then wait patiently for prices to reach those levels. Bear in mind that the stock that is cheap is not necessarily valuable. It is better to pay a reasonable price for a quality business than a low price for a poor-quality business.

Measure your returns Be diligent about benchmarking your performance either against a broad market index or the category average returns of mutual funds. If after a year or two, you find that your direct stock portfolio has failed to match these yardsticks, you would be better off taking the fund route. Use portfolio trackers available on Indian financial websites. 

No quick gains At the very outset, investors must accept that the equity markets are not a route to quick riches. All direct investments in equities should be made with a time horizon of at least 3-5 years. If you ignore this tenet and adopt a high-churn strategy, you will soon come to grief.You may get lucky on your first punt and make some quick money. Then, inevitably, you will buy something that will keep sinking. If the markets tank and the uneducated investor is left holding stocks of suspect quality, his corpus value erodes rapidly and does not recover for a long time, if ever. Many investors get so badly singed by their first such brush with the equity markets that they decide to stay away from stocks forever. 

Educate yourself regularly Before you start investing directly in equities, make the effort to educate yourself. If you won't invest time in educating yourself, then direct stock investing is not for you. Learn the ropes of investing from an unbiased source with no conflict of interest. Many brokerage houses today run short-term learning programmes on equity investing. Brokerages earn more when you transact more. Hence, they have a vested interest in teaching you investment strategies that involve a high churn.
Collect information from a host of publicly available, often free, sources like:

§  Annual reports, especially the management discussions and analyses.

§  Company's presentation to analysts, available on company's website.

§   Business magazines, trade journals, equity databases.

§   Speak to industry sources, if you know any.

§   Reports from brokerages (for information on company, not for earnings estimates). 

From my view, the approach with which you stand the best chance of making money is one based on fundamental analysis and buy-and-hold. Also, by reading investment classics, you may have the best chance of developing an approach that is time-tested.

What you should avoid 

Novices should steer clear of some of the common pitfalls of equity investing if they don't want their first foray into the equity markets to end badly. Avoid investing in futures and options. These are highly leveraged bets that can result in steep losses.
Trading on margins—funds borrowed from your broker—is another high-risk strategy that should be avoided. Do your own homework and ignore tips. Day trading should also be eschewed.  Investors make money, not traders.
Finally, if the current bullishness in the markets continues, a large number of initial public offers (IPOs) will be launched. First time investors should avoid them for the simple reason that less information is available about these companies than about players which have been listed on the bourses for over 5-10 years. Besides, when the sentiment on the street is upbeat, promoters tend to price their IPOs expensively.  Chosen well, stocks can be a rewarding investment. Observe the comprehensive list of dos and don'ts listed above and your foray into the stock markets should be both safe and profitable. 

5 Most common Errors of Investors 

Here are some of the most common ones that investors should avoid.
Representative Thinking When a certain sector does well, investors tend to think that all stocks within that sector will do well. So, when in 2007 the infrastructure sector was doing well, valuations of many infrastructure stocks with very poor earnings track records had also shot up. When the inevitable downturn came, the investors who had put their money in such stocks lost heavily.

Regency Effect  Investors tend to look at recent data and project it into the future. For instance, if a stock has posted strong earnings growth in the past three years, many investors tend to believe that this will continue in the future as well. They do not take into account the impact of business cycles and that of competitive forces.

Short cut availability Investor's tendency is to rely overwhelmingly on information that is easily available, rather than dig deeper. For instance, the PE ratio is the most commonly used valuation ratio. It is easily found in investment magazines and websites. Therefore, most investors tend to use it for determining the valuation of a company. While the PE ratio has its merits, it has its flaws too, which investors tend to overlook.

Heard Mentality Human beings are social creatures. They have a strong need for peer approval, which makes it difficult for them to go against the crowd. That is why a large number of investors enters the markets after they have risen and desert them after they have fallen. Very few have the emotional strength required for contrarian investing.

Loss Aversion The pain of loss is felt much more acutely than the joy of gain. When a stock's price has fallen, an investor should ideally examine its fundamentals. If they have deteriorated, he should sell the stock and cut his losses. Instead, investors find it difficult to admit to their error of judgment and hold on to the stock, hoping that it will turn around in due course.