Trading strategies: how to pick stocks
With thousands of stocks out there for you to invest your cash in, finding the best stocks to invest in is all part of successful investing and trading strategies. But where to begin? Here’s how to choose stocks for your portfolio.
Picking the best stocks to invest in
How to start choosing stocks
Let’s be clear: there is no right or wrong way when it comes to picking the best companies to invest in. Adding stocks to your portfolio really boils down to personal preference. But we can give you some key guidelines on how to get started.
- Research – It’s an obvious one, but make sure you do your research first. Have a look at company performance, or the general sector performance. There’s a couple of ways you can do this, which we’ll have a look at in more detail later.
- Make your portfolio diverse – You don’t have to just invest in stocks. There are other options out there. You might consider foreign currency (forex), commodities, or invest in exchange traded funds (ETFs). The idea behind creating a diverse portfolio is to cast a wide net so you’re minimising risk. You can lose money when investing or trading. It’s inherently risky.
- Cut out the emotion – Use your head, not your heart. Just because there is hype around a particular stock or asset does not mean it is suitable for you. Do not rush into buying or selling decisions. It’s important to remember trading and investing is risky so try and keep a clear head.
What do you want to get out of investing?
The most effective investing and trading strategies are based on achieving well-defined goals. That also feeds into finding the best companies to invest in for your personal preferences.
Obviously, everyone invests to make money, but there are different reasons for doing so. You may be looking to put away a nest egg for retirement, for instance, or you might just be looking to preserve your existing wealth. You might also just be wanting to build your wealth.
Think about this deeply before you commit any capital.
Doing your research: fundamental analysis
Let’s look at research. Picking the best stocks to invest in revolves around research. Generally, successful investors use quantitative and qualitative analysis to help them select equities. It’s an investing fundamental.
Fundamental analysis is based on estimating a stock’s intrinsic value, i.e. how it is worth. This is where we measure qualitative and quantitative factors relating to the economy, industries, and companies. Understanding these factors might give you an idea of the best companies to invest in for your individual goals.
Qualitative factors are things like company news, personnel changes within businesses or major financial events. Think the Covid-10 pandemic. All of them factor into share price movements. For instance, many companies, like cinema chains or cruise liners, have struggled in the pandemic, thus their share prices have dropped. That’s an example of how qualitative factors should be considered before investing.
Quantitative factors help investors pick stocks by looking at aspects of a business that are quantifiable. Earnings releases are important here. Publicly traded companies release quarterly financial reports detailing their earnings for the last quarter. If a company’s earnings drop and the share price does not move in line with the new earnings level, then the stock price might not reflect true value.
Likewise, balance sheets are important too. These list a company’s liabilities and assets. Generally, a stronger balance sheet means a strong stock price, because it reflects a company’s earnings potential.
Then there are dividends, which we’ll go into in a bit more detail later on.
Doing your research: using technical analysis to choose equities
Technical analysis looks at stock price data and movements. It includes analysing patterns and trends that may show future market movements. There are a lot of indicators to be aware of if you’re taking a technical approach to selecting stocks, such as moving average, morning average, and so on. If you’re a beginner, have a look into these if you’d like to take a more technical stock selection approach.
What makes stocks valuable?
A stock’s value comes from the principles of supply and demand. High demand usually means a higher price; low demand usually means a lower price. Another factor that gives a stock value is the ROI it can give to investors and traders.
Investors might look at stocks with strong fundamentals. Other this smaller, under-appreciated businesses are the best companies to invest in, as they might have great growth potential. What you choose is up to you, but a blend of technical and fundamental analysis will give you a clearer view of the markets and help inform your choices.
There are some methods you can use to find out a stock’s valuation and whether it has been under or overvalued.
How to tell if a stock is over or undervalued
It’s important to note that when analysing stocks in this way you’re not looking for cheap or expensive stocks.
You should be trying to find quality stocks that are priced below or above their fair valuations. Assuming market prices correct themselves over time to reflect stocks’ true values could potentially make you a profit. You might work on this assumption by taking a long position on an undervalued stock, or by going short on an overvalued one.
Stocks may also be over or undervalued if market conditions change due to shifting dynamics, news, cyclical fluctuations, or misjudged results.
Let’s talk about dividends
Dividend stocks are often found in a long-term investor’s portfolios. A dividend is a portion of a company’s profits it can choose to return to shareholders. Investors can either take those dividends for themselves, but many choose to reinvest the dividend payment, which in turn can lead to higher gains down the line.
Not all companies pay dividends, but those that tend to be popular stock picks. You might consider them if you’re going for a long-term investment strategy. They may be some of the best shares to invest.
Investing & risk
Investing is inherently risky. You can make money, but you can also lose it if stocks turn against you. Only invest if you can afford any potential losses. Make sure to diversify your portfolio too, so you’re more protected against risk.