The 3 key steps to profitable stock picking

Investors have different approaches to stock picking, which has proved to be a very complicated process. To minimise the risk in investment, it is advisable to follow the basic general steps in this process. These are discussed herein in this article.

stockpicking

Step 1

First, the general strategy of the investment and the time frame has to be decided on very carefully. The fact that this step dictates the type of stock you buy makes it very vital. You can decide to be either a long term investor or a short term investor.

For long term investment, you should find stocks that have sustainable competitive advantages and stable growth. SWOT analysis (strength-weakness-opportunity-threat) on the company will help you look at the historical performance of each stock over the past decades, and this becomes one of the key methods to find this stock with sustainable competitive advantages and stable growth.

For short term investors on the other hand, you should look into either momentum trading or contrarian strategy.

  1. Contrarian strategy

Here, over reactions in the stock market are looking into. It has been evident from researchers that prices do not always accurately represent the value of stock. That is the stock market is not always efficient. Upon a company’s announcement of bad news, it is often that people panic and price drop below the stock’s fair value. Possibility of recovery of stock from the impact of the bad news is used to evaluate whether the stock over-reacted to this news.

For instance, the stock can drop by 25% after the company loses a legal case that has no permanent damage to the business’s brand and product. That, definitely, is an over-reaction of the market. Here, probably you could ask yourself, “What should I do?” You should find a list of sock with recent price drops, use candlestick analysis to analyse the potential of a reversal. If candlestick reversal patterns are demonstrated, you should go through the recent news to analyse the existence of oversold opportunities through analysing the causes of the recent price drops.

  1. Momentum trading.

This strategy is based on looking for stocks that increase in both volume and price over the recent past. Here, it is advisable that you look for stocks that have demonstrated smooth rises in their prices. You can then simply ride the uptrend when stocks are not erratic, until the breaking of the trend.

Step 2.

The second step in this approach is conducting researches that give you a selection of stocks consistent with your strategy and time frame. The web is a good place for research and you can get numerous stock screeners to help you find stocks in relation to your need.

Step 3.

This step involves diversification of stock in a way that will give you the highest reward/risk ratio. This is after you have a list of stocks to buy. Conducting a Markowitz analysis for your portfolio is one way to do this. The Amount of money to be allocated to each stock is gotten by this analysis. Diversification is one of the free-lunches in the investment world, making this step very crucial.

In conclusion, if you want to quench your thirst to consistently make money in the stock market, these three steps should get you started right away. They will provide a sense of confidence that helps you make better trading decisions and deepen your knowledge about financial markets.