Stock selection is a very complicated process and investors have different approaches. However, it is wise to follow general steps to minimize investment risk. This article describes these basic steps for picking high-performing stocks.
Step 1. Decide on a time frame and general investment strategy. This step is very important as it will determine the type of stock you are buying.
Let's say you decide to be a long-term investor, you'd want to find stocks that have sustainable competitive advantages along with steady growth. The key to finding these stocks is to look at each stock's historical performance over the past decade and do a simple trading S.W.O.T. (Strength-weakness-opportunity-threat) analysis of the company.
If you choose to be a short-term investor, you should stick to one of the following strategies:
A. Momentum Trading. This strategy consists of looking for stocks whose price and volume have increased in the recent past. Most technical analysis supports this trading strategy. My advice for this strategy is to look for stocks that have shown steady and smooth growth in their prices. The idea is that when the stock is not volatile, you can simply ride the uptrend until the trend breaks.
b. Counter strategy. This strategy consists of looking for overreactions in the stock market. Research shows that the stock market is not always efficient, meaning that prices do not always accurately represent stock values. When a company announces bad news, people panic and the price often falls below the fair value of the stock. To decide whether a stock has overreacted to the news, you should look at the possibility of a recovery from the impact of bad news. For example, if a stock drops 20% after a company loses a lawsuit that has no lasting damage to the brand and product, you can be sure that the market has overreacted. My advice for this strategy is to find a list of stocks that have seen a recent decline in price, analyze the potential for a reversal (using candlestick analysis). If the stock is demonstrating candlestick reversal patterns, I will review recent news to analyze the causes of recent price declines to determine the existence of oversold opportunities.
Step 2. Conduct research to provide you with stock picks that align with your investment time frame and strategy. There are many stock sorters on the web to help you find the stock that suits your needs.
Step 3. Once you have a list of stocks to buy, you will need to diversify them in a way that provides the greatest reward/risk ratio. One way to do this is to perform a Markowitz analysis of your portfolio. The analysis will give you the money ratios you should allocate to each stock. This step is crucial because diversification is one of the free lunches in the investment world.
These three steps should get you started on your quest to consistently make money in the stock market. It will deepen your knowledge of the financial markets and give you a sense of confidence that will help you make better trading decisions
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