6 Steps to Finding Your Next Great Stock Pick
To spot the market's hidden gems, you have to do your homework. Here's my cheat sheet.
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One of the most satisfying aspects of trading is digging through thousands of stocks and uncovering a hidden gem that the market has not yet come to appreciate. The stock market offers us a bounty of opportunities, but we need to do some hard work to find them, and there is always a high risk that our carefully selected stock will turn out to be a flop.
Most investors and traders are not very systematic in their search for great stock picks. Their best investments are often just a function of good luck rather than astute stock selection. Luck will always impact our investing results, but if we approach stock picking in a disciplined and systematic way, then we increase our chances of good luck.
Many folks have no idea how to pick stocks, so they tend to gravitate toward well-known names they see in the media or hear about from friends. Names like Nvidia NVDA , Amazon AMZN , or Apple AAPL can be fantastic investments, but they are not hidden jewels that will quickly double or triple if spotted at the right time. The stocks that produce spectacular gains are not typically household names, and they can be extremely difficult to find.
Even the best stock pickers will make a substantial number of bad choices. That is just the nature of the stock market and is why it is so important to have clear rules for managing risk.
This is my methodology for finding my next great stock pick:
Develop a long list of ideas. Great investors are readers. They read a wide variety of financial publications and websites like Realmoneypro.com. They develop a feel for the overall market and watch for emerging trends and themes.
As I read and study the market, I jot down symbols that I want to research further. I end up with very long lists of symbols. My next step is to group them in various ways, such as by trading approach, sectors, potential catalysts, etc. I might have one sub-list of growth stocks and another that is bottom fishing or value plays.
Another way I develop my list of ideas is to scan through hundreds of charts. I look at stocks that are surging on big volume increases or breaking out of consolidation. Stocks in motion tend to stay in motion, so the ones that are making the biggest moves today are often the best short-term trading opportunities in the weeks ahead. I'll put these on another list and look at them carefully when I'm trying to trade high levels of volatility.
Develop that watch list and identify how those stocks will fit into various trading and investing approaches.
Research fundamentals. Some traders focus purely on the technical action and won't worry about even knowing the name of the stock they are trading. That can work very well if your time frame is extremely short and you are trading volatility, but in most cases, it is helpful to understand something about the company and why it has potential. The more you know about fundamentals, the more insight you will have into why the stock is moving in a certain way.
One of the basic conundrums of trading any stock is determining whether movement is due to something fundamental or is it due to just random volatility. Some of the best opportunities arise when a stock makes a move that has nothing to do with its fundamental conditions, but you have to know something about the stock to make those sorts of judgments.
When you understand valuation, it will give you great confidence in how you trade. Price action will always be the most important issue, but an understanding of valuation adds context that makes for better decisions.
Research Charts. Make sure you are clear about support and resistance levels. At what point do you take a stop? Do you want to average in on weakness or strength? How are overall market conditions impacting the movement of the stock? A great stock pick in a poor market is a very hard way to make money.
Look for potential catalysts. What is going to move this stock that you have identified? Is there potential news that will impact it? News creates volatility, and a "sell the news" reaction can produce opportunities. What will draw more people to buy this stock? Will they start to anticipate events? Will an attractive chart draw them in? Know your catalyst and be ready to react to them.
Develop a strategy. For most investors, their strategy is little more than buying a stock and then hoping that it does well. That can work, but you greatly increase your odds of success if you leverage up when you have a stock that is working and are quick to cut a stock that isn't performing. I hold several stocks that I feel quite optimistic about, and my plan is to watch for the opportunities when I can substantially increase my positions as potential catalysts approach.
Pull the trigger. If you don't take some risks, you will never make money. Do your research, make a plan, and then pull the trigger. Traders are always talking about how they should done this or could have done that. Be selective with the stocks you pick, but don't be so selective that you never do anything. If you aren't taking losses on some bad stock picks, then you aren't trying hard enough.
Stock selection is the most enjoyable aspect of investing, but it shouldn't be a passive activity. Far too many folks will pick a stock and then act like cheerleaders. They never question their selections and will ignore anything negative. Sometimes, that works, but your chances of good luck are much greater if you work harder at managing your stock picks.
(AMZN, AAPL are among the holdings in the Action Alerts PLUS member club. Want to be alerted before AAP buys or sells this stock? Learn more now.)
At the time of publication, DePorre had no position in any security mentioned.
