Stock picking is a very complex process and investors have different perspectives. However, it is wise to follow general steps to reduce investment risk. This article will outline these basic steps for choosing high-performing stocks. Step 1. Decide on the investment time frame and general strategy. This step is very important as it will determine the type of stock you want to buy. Let's say you decide to become a long-term investor, you will want to find stocks that have stable growth as well as sustainable competitive advantages. The key to finding these stocks is by looking at the historical performance of each stock over the past decades and doing a simple business S.W.O.T. (Strength-Weakness-Opportunity-Threat) Analysis on the company. If you decide to become a short-term investor, you will want to follow one of the following strategies: A. Momentum Trading. The strategy is to look for stocks that have increased in both price and volume in the recent past. Most technical analysis supports this trading strategy. My advice regarding this strategy is to look for stocks that have demonstrated a steady and smooth growth in their prices. The idea is that when stocks are not volatile, you can simply ride the up-trend until the trend breaks. b. Contradictory strategy. This strategy is to watch for over-reactions in the stock market. Research suggests that the stock market is not always efficient, meaning that prices do not always accurately represent the values of stocks. When a company announces bad news, people panic and the price often drops below the fair value of the stock. To determine whether a stock has overreacted to a piece of news, you should look at the likelihood of it recovering from the effects of bad news. For example, if the stock falls 20% after the company loses its legal case, causing no lasting damage to the business's brand and product, you can rest assured that the market has overreacted. My advice to this strategy is to find a list of stocks that have recently declined in price, analyze the reversal potential (via candlestick analysis). If the stock exhibits a candlestick reversal pattern, I would go through the recent news to analyze the reasons for the recent price drop to determine the existence of overbought opportunities. Step 2. Conduct research that gives you a selection of stocks that suit your investment time frame and strategy. There are many stock screeners on the web that can help you find stocks as per your needs. Step 3. Once you have a list of stocks to buy, you will need to diversify them in a way that gives the greatest reward/risk ratio. One way to do this is to do a Markowitz analysis for your portfolio. The analysis will give you the proportion of funds allocated for each stock. This step is important because diversification is one of the free lunches in the investing world, There just may not be a method to actually decipher the true value of a share of common stock. Is market price a function of company fundamentals, artificial demand for “derivative” securities, or various forms of Institutional Window Dressing? But this is a condition that can be used to great financial advantage. With security prices less closely related to those old-fashioned fundamental issues such as dividends, projected profits, and unfunded pension liabilities and perhaps more closely related to artificial demand factors, the only operational alternative appears to be trading! Buy the downtrodden (but still fundamentally investment grade) issues and take your profits on those that have risen to inappropriately high levels based on basic measures of quality… and try to get it done before the big players do. To over simplify, a recipe for success would involve shopping for investment grade stocks at bargain prices, allowing them to simmer until a reasonable, pre-defined, profit target is reached, and seasoning the portfolio brew with the discipline to actually implement the profit taking plan.
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