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The first key to selecting a good stock to buy (or sell) is to narrow your selection down from the thousands of individual stocks that are available for trading. A great place to start screening can be found here. Thomson Investor's advanced stock screener has parameters where you can choose stocks from any industry (chemical, utilities, internet, all, etc.) and traded on any or all of the major exchanges. You can also choose from stock, valuation, and fundamental screens.
Screening stock parameters involves the price of the stock, market capitalization, shares outstanding, volume, moving average breakouts, relative performance as well as over a dozen other selections. It’s important when screening stock parameters to make sure you consider the price of a stock (stocks that trade under $5 are usually riskier) and it’s market capitalization (small cap, mid cap, large cap) in relation to your investing needs and risk tolerance.
You can choose valuation parameters ranging from price to earning ratios (P/E), price to sales, current ratio, and company growth. Good, solid stocks have high growth rates compared to other companies in the same industry and the S&P. Another key is the price to earnings ratio. Some high flying stocks can have P/E ratios that are over 100 while other more conservative stocks are below 10. P/E growth is a positive sign no matter where the current P/E stands.
The final parameters to choose from are the fundamental parameters. These include earnings per share (EPS), cash flow, dividends, sales and turnover parameters. Good fundamentals include growing sales, high return on equity and assets, and growing EPS. This is also a good place to find quality stocks that pay a healthy dividend if you are looking for income generating stocks.
In all you’ll want to select between 15-30 different parameters with some from each category. You want your screen to be robust yet not too constricting. Usually if you run several different screens you will start to see the same stocks on your results list (choose from 10 up to 150).
Chart Analysis
Once you’ve run some screens and have found some stocks the next step is to analyze each individual stock's chart. A good place to analyze stock charts can be found here. Simply type in the symbol of your stock from your screened list and its chart will pop up. For the overall picture it’s good to view a stock from a few different time periods. We also recommend looking at logarithmic chart styles for a better picture of a stocks trend.
The first thing to look for is a stocks overall trend. Has it been steadily increasing, decreasing or trading within a range? Does it trade smoothly or does it slam up and down? You’ll want to look for stocks that have either consolidated into a base and could be in for a breakout to stocks that have already established an uptrend and are looking to go higher.
Just as important to a stocks price action is the volume action that accompanies it. Certain combinations of price/volume action can alert you to whether a stock is poised for a breakout or is ready to collapse. A strong stock in an uptrend will typically have gains on stronger volume and fallbacks on lower volume. A stock on a breakout will have a large move up on very high volume on its breakout day and should follow through with more days up on high volume. Pay attention to action whenever a stock approaches or crosses any support or resistance.
Another thing to look at is a stocks price in relation to its moving average (MA). A stock on the rise will be above its 10 day MA. Some stocks will trade between MA ranges, finding support at its 200 MA and resistance along its 50 MA. Pay particular attention whenever a stock approaches a moving average. It can signal the change of a trend if it crosses its MA or a sign of support if it tests it and bounces back.
Most stocks from your screen list will not chart well. An inconclusive or hard to read chart usually mean that a stock is not worth pursuing. Stick with stocks that have shown proper chart formations and appear ready for a breakout or have broken out already and are in an uptrend.
What Next?
What you are left with represents stocks that have satisfied all your screening parameters and chart well. You have statistically improved your chances of picking stocks that will outperform the market.
Even as important as the stocks you pick is employing money management discipline. Not every stock you buy is going to increase in value. What you want to avoid is losing a large percentage (over 15-20%) on a single stock. You also don’t want to sell at the first sign of a price move against you and get “shaken out” of a good stock. It’s not unusual for a stock to have a broad trading range within any given day. You also don’t want to place all your money in one stock, it’s best to have 10 to 20 stocks in your trading portfolio.
A good way to trade is with the use of stop loss orders. These orders will trigger a sell if your stock crosses through the pre-determined price you select. If your stock moves down you will be “stopped out” and incur no more losses. On the other hand, if your stock is moving up in value, you might want to consider sliding up your stop loss in step with the appreciation in your stocks value.
In the universe of stocks you’ve chosen, your small winners and losers should cancel each other out. The real money you make will most likely come from the few stocks that have a fat distribution tail, i.e. the home runs. These are stocks that keep riding their trend for a while. It’s not unusual for these stocks to go up many times in relation to the overall market. It’s very important that you stay in a stock until you are either stopped out or there is a definite trend change, otherwise you will miss out on these home run stocks.
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