Hunting for your next great stock pick is one of the most rewarding and entertaining aspects of trading and investing. It is very satisfying to discover what looks like a great opportunity and watch as it blossoms into a significant winner.
Most market players approach stock picking randomly. They discover a pick by reading an article, hearing about it on TV, or social media. Sometimes those picks work well, but often they don’t.
Like most aspects of trading, you will increase your chances of successful stock picking if you have a clear strategy and apply it systematically. Here is my stock-picking process:
Identify Your Goal. The first step to great stock picking is to be clear about what you want to achieve. Are you seeking a long-term buy-and-hold investment or a day trade that you might hold for a few minutes? A great short-term pick is often a terrible long-term pick, and vice versa.
It is also essential to understand the context of the overall market when you start your hunt. Is this a bull market with strong positive trends that favor momentum, or a bear market where you are looking for counter-trend moves and great values that are finding support?
Have a clear goal in mind, and that will narrow your focus as you dig deeper.
Read. The best way to find ideas is to read everything you can, but that is just a starting point. The information out there can be overwhelming, and it can be challenging to separate the quality information from the sensationalistic that is just trying to seek attention and clicks.
Sites like RealMoney.com and Sharkinesting.com will provide you with new stock ideas daily, but that is just a starting point. It is up to you to determine if these stocks meet your needs, and you have to develop your strategy for trading them. Don’t expect someone else to make very important decisions for you. Identifying an exciting stock is just a starting point.
Follow the Charts. One of the best ways to find great stock ideas is to look at hundreds of charts regularly. Price action tells you more about a stock than anything else. I look daily at stocks that are making sizable moves on increased volume and then study the charts and try to discern why they are moving. Some of them may be great short-term trades, and a small number may be great long-term plays that are just starting to develop.
Scan, Scan, Scan. Most professional investors use scanning programs that allow them to enter various technical and fundamental criteria that will narrow down the selection process. MarketSmith, which Investors Business Daily produces, is favored by momentum and growth investors looking for stocks with strong relative strength and earnings. The stock-picking process is much easier to apply using the MarkSmith scanner.
Finviz.com offers a simple and very effective scanner. It allows you to enter technical and fundamental criteria and scan the entire market to find stocks that meet your standards.
The trick to using scanners is to develop search criteria that are broad enough so that you don’t miss great opportunities but narrow enough so that you are not overwhelmed by the number of stocks.
Research. Once you have narrowed down your stock selection, the hard work of research begins. Review the charts carefully and identify the time frames most relevant to your trading. If your time frames are short, you will likely focus primarily on chart patterns and immediate catalysts for movement, such as news events and macro data. If you have a longer-term time frame, it is much more important to understand fundamentals and to have a thesis for what will drive the stock higher over time.
Prepare Your Watchlist. Many of the stocks you find may look very interesting but are not ready for entry. Put those stocks on a list and watch them closely. Learn their personalities and how they move so you can execute when the time is right.
Finally, Execute. After you’ve completed your work and identified what looks like an outstanding stock, execute and implement your strategy. Often the best approach is to start with a small initial position and then add to it as it develops.
I will discuss trading strategy extensively in future columns, but the most important thing to remember is that if you have found a good stock and it is working well, then it is time to press and try to maximize gains. If it doesn’t work, then cut your losses and move on. You will have many failed picks along your journey to find the next great stock pick.
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