Learning how to pick the best stocks to buy can be a daunting process even for those who have been trading for some time, but this need not be the case. The first question we need to ask ourselves is “why are we buying” which is an obvious question but one which many traders and investors do not ask. For example a long term buy and hold investor would have a very different buying criteria to a short term day trader or an equity option writer, so before rushing in to buy our stocks, we need to have a very clear idea of our goals and objectives for the stocks we are proposing to buy. This article looks at the steps needed to select stocks for a long term buy and hold strategy for investment.
There are, of course, many “black box” solutions and get rich quick schemes claiming to give precise buy and sell signals. Whilst these systems may work some of the time, over longer periods they eventually fail, as the markets are essentially driven by factors other than statistical analysis of historic data. The fact that something has occurred in a particular way in the past, is no guarantee that it will behave that way in the future – it this were the case there would be many rich investors around the world!
From my own experience I have found over the years that the simpler the system for selecting stocks the better and the good news is that virtually all the information you need is now freely available on the internet. All that is required is some effort, hard work and lots of practice. The process I use to identify good stocks to buy is largely a technical approach, but also includes elements of fundamental analysis at the macro level. The process is fully explained on my site, but the principles are as follows.
The first step is to consider the economy of the country where you are investing, as some stocks and sectors perform better in recession than in expansion, and vice versa. For example, utility stocks generally perform well in early recession as the professional money is looking for guaranteed income streams. At the moment the gold price is rising as frightened investors look for a safe haven.
The first step is to look at the main indices to establish a longer term view from the charts. In the US this would be the Dow 30 and the S&P500. In the UK it would be the FTSE 100, 250 or 350.
The next stage is to establish the sectors which make up the indices and find the ones that are performing well, and those that are doing badly – clearly we want to find the best stocks in those sectors that are doing well and in a long term uptrend.
Now we start to look at the individual stock charts and at this stage the only technical indicators I use are volume, simple moving averages combined with support and resistance levels. Having identified some possible prospects the stocks are then placed on a watch list and monitored for a daily 2% increase in price.
How long they remain on the watch list will depend on the chart but, assuming an individual stock looks like a possible buy, there is still some more work to do. It is important to look up dividend and earnings dates as well as director dealings as these may give us clues or warning signals as to whether this is in fact the best time to buy.
Finally when placing the buy order we always have a stop loss in place in case the price trend suddenly reverses. Overall we are looking to have a balanced portfolio of stocks in a variety of sectors – we don’t want all our eggs in one basket!!
The only software that I use for the above analysis is a simple end of day data charting package – this allows me to run the required filters (either by sector or by price movements) and to do all the analysis of support and resistance and moving averages that I require.
In essence the process starts with the macro and moves down to the micro in a series of stages, using both technical and fundamental data. Although not easy it is a simple process which I have used for many years with great success. For new traders I would also suggest practising either by paper trading or using a free online stock trading game, as it allows new traders to try out strategies, understand the various markets, learn how to place orders, and to become comfortable with all the terminology of stock trading.
To be a successful stock trader you need to know the best stocks to buy – success lies in the effort you put in at the start – I hope the above helps a little!