We give you the essential filters for stock picking
Stocks are the preferred instrument type for many traders, attracting attention with their new products and services, especially if it’s something that touches our everyday lives. Here we give you the most important filters for choosing among the wide variety of companies out there.
1. Start with companies you know – everyone has heard the names of Apple, Google, Facebook and Mercedes-Benz. Why not trade their stocks? You can also initially start with companies from your own country, taking advantage of any knowledge that helps with placing their activities in context.
2. Decide if the trade you’re planning is short or long term – this will be your main internal filter for the information and data you find while researching the companies. Short term trades can be based on news or on technical indicators, while longer plays can be founded on fundamentals alone.
3. Perform thorough fundamental and/or technical analysis – these are the building blocks of any research into a company, beside the general news and its look and feel. Of course you can go without them and trade based on instinct, but that would be like going to an exam and filling-in answers based on your wits.
4. Don’t bet on one horse – trading, like everything involving risk, has to involve risk management and the best way to reduce it with picking stocks is to spread it around. Identifying the best choice among companies is possible, but unlikely, as the number of variables influencing their performance is quite big (this is why hedge funds use supercomputers). Instead, make several picks and do your homework on them to limit the chances of getting it wrong multiple times.
5. Select your risk tolerance – deciding what you’re going for in terms of profit is another filter that helps you focus on what’s important in the selection process. Some stocks have more volatility and are more prone to sharp moves, while others can remain “dormant” in ranges for days, weeks and months (which can also be traded on). Checking this and previous price movements will help you place your Take Profit and Stop Loss levels either wider or tighter around the entry point.
6. Don’t forget that you can both buy and sell – seems kind of obvious, but many people forget this while deciding if they like a company or not. But analysis works both ways – if you decide the background check shows it isn’t worthwhile buying the stock, then you might consider selling it.
7. Pick the best AND the worst – Don’t only go for prominent stocks, as this limits your statistical chances of winning trades. Opportunities lie in both spectrums and companies perform badly all the time, providing ample opportunity to profit from their downfall. Fundamental and technical analysis can give you hints.
8. Always check the most important measurable data about companies – these come from quarterly reports issued by companies and provide a look inside. The price to earnings ratio (low is usually good), the amount of cash the company has on its books (the more, the better), dividends and the future guidance are all to be considered. (We will be taking a closer look at them in subsequent articles.)