Stock picking is a very complicated process and investors have different approaches. Greed and fear are the major players in the stock market. These two emotions are the driving force behind almost all market participants – Institutional mangers, stockbrokers, Investors, traders and yourself.
However, it is wise to follow general steps to minimize the risk of the investments. You might be saying to yourself that greed and fear will never get in the way of my trading, but believe it or not they will be.
This article will outline these basic steps for picking high performance stocks.
Step 1. Decide on the time frame and the general strategy of the investment. You have been watching a particular stock for some time now. It has set up perfectly, so you pull the trigger. You bought it at the perfect price and now it is moving higher just as you thought it would.
This step is very important because it will dictate the type of stocks you buy.
Suppose you decide to be a long term investor, you would want to find stocks that have sustainable competitive advantages along with stable growth.
Now greed steps up to the plate and says to you, this is going to be a rocket ship. So you buy some more shares. Or your stock moves a few points and goes passed the price that you decided to get out.
The key for finding these stocks is by looking at the historical performance of each stock over the past decades and do a simple business S.W.O.T. (Strength-weakness-opportunity-threat) analysis on the company.
If you decide to be a short term investor, you would like to adhere to one of the following strategies:
a. Momentum Trading.
b. Contrarian Strategy.
Step 2. Conduct researches that give you a selection of stocks that is consistent to your investment time frame and strategy.
Greed tells you this baby is going higher tomorrow so you hang on.
When stocks make strong moves to the upside greed from all the cumulative market participants joins the move.
There are numerous stock screeners on the web that can help you find stocks according to your needs.
Step 3. Once you have a list of stocks to buy, you would need to diversify them in a way that gives the greatest reward/risk ratio.
Stock prices usually fall faster then they go up, and when this happens, fear now steps up to the plate.
Lets look at the example above, where your stock went through your get out price and you held on because greed was by your side. The next morning the stock price gaps down.
One way to do this is conduct a Markowitz analysis for your portfolio. The analysis will give you the proportions of money you should allocate to each stock. This step is crucial because diversification is one of the free-lunches in the investment world.
Their is heavy selling all morning long. Greed is telling you to hang in there the price will come back. The price keeps going down, now you get a knot in your gut, and your knuckles are turning white. Fear is now by your side, but by now it is to late, your nice profit has turned into a loss.
Everyone goes through this until they have mastered the ugly faces of greed and fear. Master this and you are well on your way to becoming a successful stock trader.
These three steps should get you started in your quest to consistently make money in the stock market.