How to Pick Stocks the Right Way

Choosing the right stocks to invest in is an essential skill for the success of every trader and investor. But with thousands of stocks available on exchanges, it can be hard to decide which ones you should choose. And the dizzying amount of data points for each stock doesn’t make things easier. If that’s something that you find challenging, good news: you’ve landed on the right place. In this blog post, you are going to learn how to pick stocks the right way, whether you are an active trader, or a medium to long-term investor. Follow the steps we explain below and you’ll find it much easier to spot profitable opportunities.

Without further ado, let’s get started.

Determine Your Goals

Before you start searching for stocks to invest in, first you need to think about your goals. Do you want to make money in the short term, or do you prefer to hold a position with the expectation of medium or long-term growth?

To give you a few examples, traders are typically looking to generate a consistent income within a short-term horizon ranging from hours to days, months, and up to five years. Medium-term investors (5 to 10 years) invest to prepare for future expenses, like school fees for their children or rainy days. Long-term investors (10+ years) are often investing for retirement. So you want to be clear on your time horizon.

Your financial goals will guide your investment plan and risk management strategy. So take the time to think them over and write them down in detail.

Choose a sector and industry

Next, you want to determine which sector of the economy you want to invest in. Is it technology? Real estate? Industrials? Energy? Depending on the current state of the economy, some sectors might be performing better than others.

To illustrate, the top-performing S&P sector in 2022 was by far energy (+52.6), while other sectors like real estate and communication services underperformed.

Also, according to Insider Monkey, the most promising sectors in 2023 include biotechnology, semiconductors, and computer software.

So once you make your choice, it’s time to hone in on a specific industry within that sector. This could be an industry in which you are a consumer, or an industry where you have worked before. You can also simply choose an industry you are interested in or even passionate about, like automobile. If you’re not sure what to choose, take a look at financial news found on online brokerage sites, stock exchanges, blogs, newspapers, and other similar sources.

Be sure to check recent news and events as well as expert opinions to stay abreast of the latest changes in the sector/industry you chose.

Find and Research Companies

After choosing a sector and industry, next you want to find companies that present good opportunities. When you spot an interesting company, you need to know exactly how it makes money and how it plans to grow in the future. As Warren Buffet famously said:

“Never invest in a business you cannot understand.”

So how do you find companies that are worth investigating? Simple: you use a stock screener and do your research.

Use a stock screener

To narrow down your scope of research from thousands of stocks to just a few, you need to use a stock screener. Take the time to determine the criteria of your research and design a screen that fits your goal. By this point, you already know which industry to focus on. So now you need to determine more specific metrics and criteria. Here are some examples:

• Undervalued large-cap stocks

• A price-to-earnings ratio that doesn’t exceed 20

• A debt-to-equity ratio lower than 1

• Dividend yield that is higher the industry average yield

• Etc.

After you create a set of filters, your screener will come up with a list of stocks that match your criteria.

That being said, you shouldn’t rely solely on screeners to pick stocks. You should do your own research on financial publications, news sites, blogs, your trading tools, and other sources of information to find companies that could be worth investing in.

For long-term investing, focus on companies with a moat

For long-term investments, you want to bet on companies with a moat, the competitive advantage that allows it to maintain long-term profits. Naturally, no one wants to invest their money in a company that is likely to be outperformed by competitors in the future.

The five main types of moats are cost advantage, high switching costs, network effects, intangible assets, and efficient scale.

So when picking a stock for long-term investing, it’s necessary that you conduct due diligence and identify the moats of the companies you’re considering.

Make sure to also research the following elements:

• Key indicators from financial statements (gross profit margin, ROE, ROA, current ratio, etc.)

• The history of the stock’s price

• The performance of competitors

• Industry trends and prospects

• Management and leadership

• Growth potential

After your screener generates a list of stocks that match your criteria, it’s time to do some fundamental analysis (if you’re a long-term investor), or technical analysis (if you’re a short-term trader), or even both if you’re picking stocks for different goals.

Suggested reading: Technical Analysis vs Fundamental Analysis: Top Screeners

How to Pick Stocks with Fundamental Analysis

Fundamental analysis aims to determine a stock’s fair price as opposed to its market price, which could be either overvalued or undervalued.

After your stock screener comes up with a list of stocks, choose the most interesting companies and start evaluating them.

Essentially, you want to assess the current performance of a company and its growth potential. How did it fare this year? Is it expected to do well or bad in the years to come? Did anything happen recently that could move the stock’s price higher or lower? This could be anything from a new product launch to a controversy surrounding the CEO.

So you’re going to analyze quantitative and qualitative factors:

• Quantitative: indicators and ratios found in balance sheets, income statements, cash flow statements, dividends, etc. Popular indicators include the EPS, P/E, ROE, PEG, FCF, and the D/E. Don’t hesitate to review other metrics that you deem relevant.

• Qualitative: review the macroeconomy, industry trends and events, company news, competitors, management, sector prospects, and other factors that may impact a company’s financial and economical performance.

You can find information for fundamental analysis in financial statements, annual and quarterly reports, market reports, government agency reports, newspapers, online publications, opinion pieces, websites, etc.

If you are looking for a stock screener that is built for fundamental analysts, give WallStreetZen a try. In addition to typical filters like sector and price, WallStreetZen lets you add filters that focus on fundamentals, like valuation, forecast, dividends, etc. For each stock that you find, you can review an overview of that company’s performance along with many indicators and concise due diligence comments.

Disclaimer: This blog post includes affiliate links. We may receive compensation for clicks that result in a purchase, at no extra cost to you.

How to Pick Stocks with Technical Analysis

If you prefer to focus on short-term trading, you need to analyze the price movement of stocks. So here is how to pick stocks with technical analysis.

In a nutshell, you build your screen with the filters that you previously selected. Once your stock screener produces a list of stocks that pass your filters, it’s time to study charts and patterns. For each stock, try to find if there are past trends that may reoccur, what the support and resistance levels are, the price’s momentum, possible breakouts or reversals, etc. Analyzing these elements will reveal the most likely scenarios in the future and inform your trading decisions.

Suggested reading: 5 Day Trading Patterns You Should Track in Tradervue

Some of the most commonly used indicators used in technical analysis include:

• Moving Average (MA)

• Moving Average Convergence Divergence (MACD)

• Relative Strength Index (RSI)

• Stochastic Oscillator

• Bollinger Bands

• Fibonacci retracement

• Etc.

To conduct technical analysis, you want to use a stock screener that gives you plenty of charting tools and technical indicators.

One such screener is Finviz, a popular option among intraday and swing traders. Finviz lets you screen for stocks easily with real-time stock prices and an extensive array of filters. And once you get a list of stocks that match your criteria, you can review charts and data points to identify trading opportunities.

Disclaimer: This blog post includes affiliate links. We may receive compensation for clicks that result in a purchase, at no extra cost to you.

4 Best Practices to Follow

Alright, so now you know how to pick stocks. Great! Just make sure to apply the following best practices before and after you buy stocks, especially if you’re trading in the short term.

Always follow your trading plan

Before you make your move, you must have a clear trading plan in place. Your plan encompasses a lot more than your trading strategy. It gives you total clarity on your goals, motivation for setting those goals, time frame, target profits, entry and exit criteria, risk and reward, how you are going to manage risk, your psychology, and more.

We always hear traders and mentors talk about the importance of sticking to your plan for a good reason. Your plan guides your decision-making and pushes you to stay disciplined when you’re tempted by emotions. It doesn’t guarantee your success; in fact, you’ll have to revise and improve your plan continually. But trading without a plan is a straight path to failure.

Manage your emotions

Emotion management is one of the most important skills to develop in trading. As humans, traders experience a wide range of feelings, most notably fear, hope, greed, frustration, and FOMO. But without control over these feelings, you will trade outside your plan and make more mistakes than you recover from.

So it’s important to study trading psychology and understand how you feel when trading. Knowing what feelings drove you to make a mistake helps you avoid repeating them. Some of the most common pitfalls include revenge trading, buying a stock just because others are flocking to it, and failing to take your profit and exit a position before the price plummets.

Manage risk

Risk is inherent to every investing decision, so your ability to manage risk invariably impacts your results.

First of all, you should be clear on your level of risk tolerance because it determines which stocks you will invest in. Are you aggressive, moderate, or conservative? Knowing which of these types describes you helps you plan your portfolios and avoid buying stocks that will make you feel too stressed.

Next, you need to set clear limits for how much money you are willing to risk. More specifically, be sure to track those risk metrics:

• Profit target

• Stop loss

• Risk per trade

• Daily loss limit

• Maximum drawdown

Whenever you break the limits you have set for yourself, it’s time to stop trading and reassess what went south. At the end of the day, losing is part of the game, so take it as an opportunity to learn and grow.

For medium and long-term investments, the rule of thumb is to diversify your portfolio and keep an eye on news and events that could affect your portfolio. To measure risk here, investors typically use the Sharpe ratio, the R-Squared, and the Value at Risk to mention a few metrics.

Keep a trading journal

Last but not least, you should always keep a detailed record of your activity and results. Track your trades and write down notes on the market conditions, your reasoning for entering a trade, which setups lead to your biggest winners and which ones cause the biggest losses, and basically anything noteworthy that you do as a trader. You will thank yourself later for the invaluable insight you will have gathered.

Reviewing your journal will show you what you did right and what you did wrong, as well as what you could have done to get a better result. You understand your emotions, develop a stronger mindset, and identify your trading edge.

Luckily, online journals like Tradervue make it incredibly easy to track all your trades and analyze them to uncover patterns and insights. Organizing your notes in a trading journal template and reviewing them is also far easier than using the traditional paper journal.

In Summary

Knowing how to pick stocks is crucial to making sound trading and investing decisions. Before you buy a stock, you should follow this tried-and-true process:

1. Determine your goals

2. Choose a sector and industry

3. Find stocks with screeners like Finviz and WallStreetZen

4. Research companies that pique your interest

5. Conduct fundamental and/or technical analysis

6. Follow best practices: follow your plan, manage emotions, manage risk, keep a journal

Like everything else in trading and investing, Choosing the right stocks is a skill that you develop over time. Naturally, you will make some mistakes along the way. But having a clear process in mind will help you navigate the markets and reach your goals.

To document how you pick stocks and where you should improve, use Tradervue as your trading journal. With Tradervue, you can import your trades in seconds and start analyzing them right away. Tradervue is also perfect for in-depth journaling and comparing notes with other traders. Start a free account today and take your journaling to the next level.