Whether you consider yourself a day trader or long-term investor, novice or experienced, choosing the right stocks for your portfolio and the timing of when you buy and sell are critical.
There are many individual stocks to choose from, as well as mutual funds, exchange-traded funds (ETFs), and other means of diversification. Picking the best stocks may seem like a simple task, but you’ll need a trading strategy, solid investment advice, and a bit of risk tolerance to be successful.
Which stocks should you add to your investment portfolio? That’s the question of the hour! Unfortunately, there isn’t a published book that can reveal the ultimate investment decision. There are simply too many variables.
However, there are tricks of the trade and strategies that traders can apply to predict stock price movements. These tips are an excellent starting point for a competitive advantage in day trading, value investing, and other stock market activities.
Let’s dive into them now so you can be more confident about the next buy or sell decision you make as you trade stocks.
What Types of Analysis Are Used To Pick Stocks?
There are two commonly used types:
- Fundamental Analysis
- Technical Analysis
Which one you decide to apply to your strategy is up to you. They each speak to unique personalities and are used by traders to classify stocks in different buckets to choose from at the end.
What Is Fundamental Analysis?
Let’s consider a stock’s intrinsic value for a moment. What makes it tick? An individual company’s financial position is one component, and economic factors are another. Plenty of different factors can contribute to a stock’s volatility and overall valuation during a certain time frame.
Fundamental analysis uses macro and micro factors to determine whether or not a stock’s value is priced accurately. For example, an undervalued stock could potentially be worth a profit. If so, traders want to take advantage of this to grow their investment.
What Are Micro and Macro Factors?
Micro and macro factors affect business operations indirectly. Let’s take a look at the differences between the two.
Micro factors are made up of:
There are many more micro factors that influence the day-to-day business operations and impact the company’s bottom line. Some of these factors are more applicable for major corporations like Apple or Amazon, but others apply to virtually any company past its IPO.
Let’s take suppliers as an example. A supplier to a grocery store provides the perishable and non-perishable items. If the supplier is unable to produce or deliver an item in high demand, the store will showcase an empty space on the shelf.
As an effect, customers may be turned away from this store, giving their business to a competitor and causing the percentage of sales to decrease.
Macro factors are more or less out of the company’s control. These are external influences which include:
- Legal matters
- Technology advances
- Economic factors
Think of macro factors as those that impact the globe, region, or nation versus micro factors that are more internal and industry-specific.
Who Uses Fundamental Analysis?
Anyone can use this type of analysis; however, it is more often used by long-term traders or passive investors.
Using Fundamental Analysis To Pick Stocks
There are several metrics available to investors that allow them to have an inside look at a company’s well-being and performance. That is, as long as you know how to interpret them.
Here are several of the metrics used by investors and what they mean:
Investing Metrics: A Guide
- Earnings Per Share (EPS) - The formula is: Net Income - Dividends / Outstanding Shares. EPS tells you how much of a company’s profit is embedded in each stock share.
- Price To Earnings Ratio (P/E) - The formula is: Share Price / Earnings Per Share. This ratio tells investors about the value of a company. The higher the ratio, the greater growth a company’s stocks have (growth stocks). The lower the ratio, the more value stocks hold (value stocks).
- Projected Earnings Growth (PEG) - The formula is: (Share Price/EPS) / EPS Growth Rate. This ratio is used in conjunction with the P/E ratio to adjust the ratio for growth.
- Price to Sales Ratio (P/S) - The formula is: Share Price / Total Sales. This ratio measures the overall value that traders place on the company and compares it to its bottom line, their profit or loss.
- Price to Book Ratio (P/B) - Does the market value of a company tie to its book value, or are there variations?
- Dividend Yield - If you have a value stock, you are likely getting dividends. This ratio measures cash flow and is represented as a percentage.
- Dividend Payout Ratio (DPR) - How much is paid to shareholders in dividends compared to the company’s net profit based on past performance.
- Debt To Equity Ratio (D/E) - It’s always wise to check the liabilities of a company, and the Debt to Equity ratio can help. A high D/E ratio is best, showing that a company can settle its debt obligations timely.
- Return on Equity (ROE) - The formula is: Net Income / Shareholder’s Equity. It measures the profitability of a company.
Don’t worry: You don’t have to pull the data and calculate these metrics on your own. They are made available to you for informational purposes when reviewing stock information on different companies.
What Is Technical Analysis?
Ever wonder what the ever-moving line chart signifies when it is applied to stocks? It’s not a heart monitor, though it may feel that way when the stocks take a sudden increase or decrease in value.
Technical analysis focuses on understanding the movement, or statistical patterns, using stock screeners and charts to predict the future value of stocks.
Who Uses Technical Analysis?
We find that day traders and short-term investors lean on technical analysis more than they do fundamental analysis. Remember, though: It boils down to personal preference and choice.
Using Technical Analysis To Screen Stocks
There are tools readily available to get you started with the screenings process.
Consider using a stock screener to guide your decision. A stock screener is a valuable tool that sorts stocks based on criteria selected by the trader.
Here are examples of criteria you can screen by:
- Price and market capitalization - This is the best criteria to start with because you can narrow down the price, excluding stocks that you cannot afford or are valued higher than your target market.
- Sectors and industries - Do you have one in mind? If so, sort the criteria and remove the noise from sectors and industries you aren’t interested in. Perhaps you’ve heard that a particular stock is at an all-time low but learned that the value is anticipated to rise.
- Momentum - Look at the levels of support and resistance. Is the market bearish or bullish?
How many stocks should you break your criteria down to? Generally, you want to narrow it down, so you have 20 to 25 stocks on your list.
Next, it’s off to the charts.
20 to 25 stocks are still an overwhelming number. The goal in technical analysis is to have your top three or four to select from, and chart scanning gets you there.
Do you know what to look for? Breaks and pullbacks.
Anytime you notice a stock has a sharp, upward movement in price, it is experiencing a break. If you find that a stock is trending in one direction long-term, then begins to move in the opposite direction, you have a pullback.
Identifying the Entry Point With Breaks
As a stock moves away from a position and lands on its first or second high, it may be good to buy. This works in either direction, whether you are investing long-term or looking for a short sale.
Identifying the Entry Point With Pullbacks
Watch the stock carefully, monitoring its behavior. Once it heads in the opposite direction and holds that movement for a few days, you can consider making the purchase.
Making Your Stock Selections
If the analysis and active management are too overwhelming for you right now, try taking a passive approach.
One method is by investing in index funds. Index funds act as an anchor or a foundation to a portfolio. For a hands-off experience, robo-advisors are the path to take. Otherwise, online brokers are an option if you want to select your own.
Beyond index funds, take advantage of diversifying your portfolio. This means that it is not heavily weighted in one company, industry, sector, or security. Add some flavor with international stocks, commodities, real estate, and more.
Most importantly, monitor it frequently and make consistent contributions with whichever investment strategy you decide on. Keep your stock selections and portfolio aligned with your short-term or long-term investment goals at all times.
The Bottom Line
Before buying any type of stock and risking your hard-earned money on the market, investigate the company that you are about to invest in. Consider your financial health. Is it in growth mode? How do the metrics align with other companies in the same industry?
What we want to convey to you is that research makes a difference. Don’t skip this part. If you want to invest your money, take the time and invest in the stock and stock market knowledge.
How is your portfolio diversified? In addition to stocks, investing in physical assets like gold can be a profitable choice.
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