Stock picking – get started
There are thousands of companies listed on stock markets and picking which stocks to trade can be confusing, especially if you are new to stock trading.
In this module, we will bring together all you have learned in the previous stocks modules and guide you through the share selection process.
This lesson will cover how to start picking companies and the following lessons will show you how to perform the right kind of analysis to suit you.
Start with the time horizon
The longer the period that you want to hold a position, the more detailed the analysis has to be.
This is because when you look at a longer time horizon, you need to make sure that there are solid fundamental reasons why the price of a share will continue rising – or falling, and this requires detailed analysis. For a short-term time horizon, you will only be looking to take advantage of short, quick price movements, and so such a detailed level of analysis is not needed.
Choosing a time horizon can depend on how much time you have. If you have a lot of time to trade and watch price charts, then you can trade on a shorter term time horizon.
If you only have an hour a day, or a week, to dedicate to trading, then you would be more suited to longer term trading.
At the end of this lesson, you will be able to choose which kind of analysis you want do.
Picking your stocks – start simple
If you're new to trading shares, it's best to start simple. Rather than diving straight into riskier, companies that have a small capitalisation, or obscure start-ups, try your hand at trading big, well-known companies.
These stocks are very liquid, meaning it's easy to get in and out of trades at the price you want. They’re always in the news and there’s plenty of research material available.
It may be a good idea to watch their price for a few weeks before committing any real money to the market. A demo account can be great for this.
Go for what you know
Once you're ready to begin stock-picking, start with something you know.
If you've worked in a particular industry, you will have useful background knowledge that will help you understand what issues are important for a company.
Even if you're a regular customer of a company, you might find it easier to understand their business model than a company that you do not know.
Being able to witness first-hand when a company's business is slack, or when its product range seems better than usual, can help you start thinking about whether now could be a good time to trade its shares.
Don't forget about shorting stocks
Remember too that choosing a stock to trade is not only about working out which one you think will rise in value – traders can make just as much profit by shorting a stock – selling it to profit from its anticipated price decline – as they can from buying one.
So if a company strikes you as a disaster waiting to happen, you may have just spotted a trading opportunity.
Pick a sector
Many professional traders decide which stocks they are going to trade through a top-down process of elimination. To start with, pick a sector or an industry that either has good growth opportunities – to buy stocks – or may look like they could be in trouble – to short-sell stocks.
During an economic downturn, for example, retailers, holiday companies and restaurants tend to suffer as consumers are less willing to spend. Consumers may, however, flock to discount retailers, fast-food chains and voucher companies, pushing up their stocks.
There are also certain goods and services that people will need however well off they are. For example, defensive sectors, like pharmaceuticals or waste-collection, will tend to at least hold firm during a downturn.
Weed out the best companies in that sector
Once you have settled on a sector, you need to start looking at many different aspects of the various companies in that industry and find one or two you believe will present the best trading opportunities.
How you do this takes us back to our original point about time frames – the level of analysis you apply will be very different depending on how much time you have and how long you wish to hold the position for.
You can choose your method at the end of this lesson.
Where to find the information you need
There are numerous resources to help you with your research.
For fundamental analysis of a company’s performance and prospects, read its quarterly and annual financial reports.
You can usually find these on the Investor Relations section of a company's website.
There are also regulatory bodies in each country that require public companies to file their financial statements for public viewing.
If a company is listed in the UK, for example, it will file its earnings and other announcements with Companies House, whose website you can search.
For US-listed companies, you can search the Securities and Exchange Commission (SEC) website.
For a mix of fundamental and technical analysis, you can also use a stock screener – a software program or online subscription service that helps you pick stocks based on a range of criteria that you can customise.
Fundamental traders could, for example, customise the program to compare companies based on their sales, profits and any of the other yardsticks listed above.
One example of a free stock screener is YCharts, that is available in English. Alternatively, you can simple enter "free stock screener" into Google.com.
In this lesson you have learned that:
- deciding what time frame you want to trade is an essential first step – it will depend on how much time you have for trading.
- choosing a time frame will determine how you analyse them.
- when you form your first long list of stocks to trade, start simple with big, liquid stocks and use a demo account to try them out before you commit real money to the market.
- move on to what you know – if there’s an industry or company that you're familiar with, you may find it easier to compare one company with its competitors.
- pick a sector that is either struggling or has good growth opportunities – then use a process of elimination to choose two or three stocks that have the best/worst fundamental prospects or the most easily identifiable trends/resistance levels.
- technical traders will rely on price charts for their research, fundamental traders will use company reports – stock screeners can be useful for both.