Stock picking is a very complicated process and investors have different approaches. However, it is wise to follow certain general steps to minimize the risk of the investments. This article will outline these basic steps for picking high performance stocks.
Step 1. Decide on the time frame and the general strategy of the investment. This step is very important because it will dictate the type of stocks you buy.
Suppose
you decide to be a long term investor, you would want to find stocks
that have sustainable competitive advantages along with stable
growth. The key for finding these stocks is by looking at the
historical performance of each stock over the past decades and do a
simple business S.W.O.T. (Strength-weakness-opportunity-threat)
analysis on the company.
If you decide to be a short term
investor, you would like to adhere to one of the following
strategies:
a. Momentum Trading. This strategy is to look for
stocks that increase in both price and volume over the recent past.
Most technical analyses support this trading strategy. My advice on
this strategy is to look for stocks that have demonstrated stable and
smooth rises in their prices. The idea is that when the stocks are
not volatile, you can simply ride the up-trend until the trend
breaks.
b. Contrarian Strategy. This strategy is to look for
over-reactions in the stock market. Research shows that the stock
market is not always efficient, which means prices do not always
accurately represent the values of the stocks. When a company
announces bad news, people panic and price often drops below the
stock's fair value. To decide whether a stock over-reacted to a news
event, you should look at the possibility of recovery from the impact
of the bad news. For example, if the stock drops 20% after the
company loses a legal case that has no permanent damage to the
business's brand and product, you can be confident that the market
over-reacted. My advice on this strategy is to find a list of stocks
that have recent drops in prices, analyze the potential for a
reversal (through candlestick analysis). If the stocks demonstrate
candlestick reversal patterns, I will go through the recent news to
analyze the causes of the recent price drops to determine the
existence of over-sold opportunities.
Step 2. Conduct
research that gives you a selection of stocks that are consistent
with your investment time frame and strategy. There are numerous
stock screeners on the web that can help you find stocks according to
your needs.
Step 3. Once you have a list of stocks to buy,
you need to diversify them in a way that gives the greatest
reward/risk ratio. One way to do this is conduct a Markowitz analysis
for your portfolio. The analysis will give you the proportions of
money 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 in your quest to
consistently make money in the stock market. They will deepen your
knowledge about the financial markets, and will provide a sense of
confidence that helps you to make better trading decisions.
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