How to Pick Stocks

How to pick stocks using an effective trading strategy

Which stocks you trade is going to depend on a number of issues, including your level of experience, how much capital you have available, and what style of trading you are doing (time horizon – day trading, swing trading, position trading, investing). Your criteria for how to pick stocks should be written down as part of a trading plan (see Risk Management for more details on developing a plan). Your trading plan is dynamic, and, thus, will evolve as you continue to learn and uncover your strengths and weaknesses. Also, your personality type will play a part in the types of stock you trade.

For example, if you are 23 years old, grew up on video games, have a fast mind and need to have a lot of action to stay focused, then short-term, aggressive scalping may be right for you. On the other hand, if you are 65 years old, like to think things through before making a decision, and just want to make a little extra spending money each month, then maybe swing trading low volatility stocks might be more appropriate. Whatever decision you make, be sure to think it through. You need to understand that stocks have different levels of volatility and velocity of price movement. By using tools such as Beta, Level I and Level II information, you should be able to see which is the hare and which is the tortoise.

Determine what degree of risk you can live with and afford. Focus on creating a stock picking strategy that is designed to preserve capital and control risk. The most important objective should be to preserve capital. You need to make sure to “stay in the game!” If you do that, making money should take care of itself.

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There is a whole spectrum of stocks to trade, each with different levels of volatility, price, and volume characteristics. Start out by minimizing risk. As your skills, experience and success increase, you can expand risk associated with the stocks you pick to trade.

One of the worse mistakes new traders can make is to “just start trading” and “see how it goes.” This is “gambling” talk. You need to analyze and calculate, not gamble. Just like starting or growing a business, a plan is essential to success.

Keep it simple! Whatever stock picking strategy you decide over the long term, start out by trading just one stock. Watch, study and learn that one stock. Each stock has its own personality and characteristics. You need to understand these “habits” to anticipate the right moves. Study the charts at numerous time frames - intraday, daily and weekly. Over time, begin to add one more stock, and then another, and so forth. While you’re trading one stock, it’s okay to study the behavior of a few other stocks and learn their behavior. Once you’ve moved further along the “learning curve,” begin to trade one of the other stocks you’ve been studying. You will already have an understanding of its behavior since you’ve been watching it.

Focus on stocks that align with your trading plan and allow for consistency!

Do not change your criteria during the trading day – only when market is closed. Stick with your plan. Changing a plan in the middle of trading will allow you to mentally “cheat” on your plan. This leads to a general breakdown of discipline.

Some real life examples are listed below:

Day Trading

  • I will only trade 5 stocks – 1 at a time until comfortable
  • Price between $20 and $40
  • Average 30-day volume of between 1 and 2 million shares
  • Medium degree of volatility
  • No biotech stocks (high intraday volatility)
  • I will study my 5 stocks each night at multiple time frames
  • Perhaps following S&P Futures

Swing Trading (2 days to 3 weeks)

  • I will pick 50 stocks to trade– 1 at a time until comfortable and I understand this may take a lot of research
  • Price above $25
  • Average 30-day volume greater than 500,000 shares a day
  • 25 for Long watch list
    • Strong fundamentally (increasing revenues and earnings, high relative strength, in leading sectors)
    • Above 200 moving average
    • Perhaps following S&P Futures
  • 25 for Short watch list
    • Weak fundamentally (declining revenues and earnings, low relative strength, in weak sectors)
    • Below 200 moving average
    • Perhaps following S&P Futures
  • Stochastics signal
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