What is insider trading?
Insider trading is when someone buys or sells stocks based on non-public information about the company. This information is not available to the general public and can give the person an unfair advantage in the market.
Example:
- Suppose you are an executive at a company, and you know that the company is about to announce a major deal or product launch that will significantly raise its stock price. If you buy the company’s stock before the public announcement, that’s insider trading.
Why It’s Illegal:
- Unfair Advantage: It gives people with insider knowledge an unfair advantage over regular investors who don’t have access to that information.
- Market Integrity: Insider trading can harm trust in the stock market, as regular investors might feel they can’t compete with those who have secret knowledge.
Penalties: Insider trading is illegal and can result in heavy fines or even jail time if someone is caught and convicted. In India, the Securities and Exchange Board of India (SEBI) regulates and enforces laws against insider trading.
What is the Securities and Exchange Commission (SEC)?
The Securities and Exchange Commission (SEC) is a U.S. government agency that regulates the stock market to protect investors and ensure fair trading.
Key Functions:
- Regulates Markets: Ensures stock exchanges operate fairly.
- Protects Investors: Prevents fraud and insider trading.
- Requires Transparency: Forces companies to disclose important financial information.
- Enforces Laws: Takes action against rule-breakers.
For example, if a company plans to issue new stock, it must file detailed reports with the SEC to inform investors. The SEC helps keep markets fair and honest.
What is the SEBI (Securities and Exchange Board of India)?
SEBI (Securities and Exchange Board of India) is the regulatory body in India that oversees and regulates the securities market to protect investors and ensure fair trading practices.
Key Functions of SEBI:
- Regulates Markets: Ensures fair and efficient functioning of stock exchanges.
- Protects Investors: Prevents fraud, insider trading, and manipulative practices.
- Promotes Transparency: Requires companies to disclose accurate financial information.
- Enforces Rules: Takes action against violators of securities laws.
For example, SEBI ensures that companies provide all the necessary information when issuing new stocks, so investors can make informed decisions.
What are the rules for short selling?
Short selling is when an investor borrows shares of a stock, sells them at the current price, and hopes to buy them back later at a lower price to make a profit.
In India, short selling is regulated by SEBI (Securities and Exchange Board of India), and there are specific rules:
Key Rules for Short Selling:
- Borrowing Shares: To short sell, the investor must borrow shares from a broker or another investor before selling them.
- Margin Requirement: Investors must maintain a margin (a certain amount of money) with the broker as collateral to cover potential losses.
- Timing: Short selling can only be done on the stock exchanges that allow it, and it’s typically done through margin trading or futures and options.
- Settlement: If the stock price falls, the investor buys back the shares at a lower price and returns them to the lender, pocketing the difference.
- Restrictions on Certain Stocks: SEBI may impose restrictions on short selling for certain stocks, especially if they are highly volatile or there is a risk of market manipulation.
- Naked Short Selling Prohibited: Investors must borrow the shares before selling them. “Naked short selling,” where investors sell without borrowing, is not allowed.
Example:
- You borrow 100 shares of Stock XYZ at ₹500 each and sell them for ₹50,000.
- Later, the price of Stock XYZ drops to ₹400, so you buy back the 100 shares for ₹40,000 and return them to the lender.
- Your profit is ₹10,000 (₹50,000 – ₹40,000).
Short selling carries a high risk because if the stock price rises instead of falling, you could face unlimited losses.
What is a margin account?
A margin account in India allows you to borrow money from your broker to buy more stocks than you can with just your own money. This helps you make bigger investments with less capital upfront.
Example: If you have ₹50,000, but want to buy ₹1,00,000 worth of shares, a margin account lets you borrow ₹50,000 from your broker. However, if the stock price falls, you still need to repay the borrowed money, plus interest.
What is the difference between long and short positions?
- Long Position: When you buy a stock with the expectation that its price will go up. You make a profit if the stock’s price increases.
Example:
You buy 100 shares of a company at ₹500 each, hoping the price will rise. If the price goes up to ₹600, you can sell them for a profit. - Short Position: When you borrow a stock from a broker and sell it, hoping the price will fall. You plan to buy it back at a lower price to return to the broker and make a profit.
Example:
You borrow 100 shares and sell them at ₹500 each. If the price drops to ₹400, you buy them back for ₹400, return them to the broker, and keep the ₹100 profit per share.
What is dollar-cost averaging?
Dollar-cost averaging is a strategy where you invest a fixed amount of money in a particular stock or mutual fund at regular intervals, no matter the price. This helps reduce the impact of price swings over time.
Example: Instead of investing ₹10,000 all at once, you invest ₹1,000 every month. If the stock price is high one month and low the next, you buy fewer shares when the price is high and more shares when it’s low, balancing out the cost.
What is rupee-cost averaging?
Rupee-cost averaging is a strategy similar to dollar-cost averaging, but in the Indian context. It means investing a fixed amount of money regularly (like every month) in stocks or mutual funds, regardless of the market price. This helps you avoid the risk of investing all your money when prices are high.
Example:
If you invest ₹5,000 every month in a mutual fund, sometimes you’ll buy more units when prices are low and fewer units when prices are high. Over time, this averages out your cost per unit.
How often should I review my portfolio?
You should review your investment portfolio at least once every 3 to 6 months. This helps you check if your investments are on track to meet your goals and if any changes are needed.
Example: If you’ve invested in a mix of stocks and mutual funds, reviewing every few months lets you see if certain investments need to be adjusted based on market changes or if your goals have shifted.
What are the signs of a good investment?
A good investment should have the potential to grow over time and fit your financial goals. Here are some signs:
- Strong Track Record: The investment has performed well in the past and shows steady growth.
- Solid Fundamentals: The company or asset is financially stable, with good earnings, low debt, and a clear business plan.
- Reasonable Price: It’s priced fairly compared to its future potential, not too expensive.
- Long-Term Potential: It has growth potential over the years, not just quick profits.
Example: If you’re investing in stocks, a company with consistent profits, a strong brand, and room for growth (like a tech company) is a good sign of a potentially good investment.
