Saturday, March 29, 2008

Finding a Stock

Perhaps the question I am asked most often is how do I find what stock to trade. Quite honestly, I don't think that is the most important question a successful trader can ask, but it is clearly one that is on the minds of many retail traders. First, I should say that there are many ways to find trading candidates and that the specific methodology should be chosen by each trader individually and become a part of his or her business plan. In my book, "Trade Your Way to Wealth," I set out, in detail a way to construct a business plan and I sincerely believe that having such a plan is much more important than the specific method a trader may chose to select a particular candidate to trade.

That having been said, there are a few basics that may be helpful in narrowing the search for candidates to trade. Narrowing, after all, is a key ingredient to ultimate selection of the specific trading vehicle. Do you want to trade a whole market, for example, or are you interested in finding a specific stock or option to trade? Trading the whole market can be accomplished with various Exchange Traded Funds (ETFs) and removes some of the risk inherent in trading a single stock. Generally speaking, trading the whole market may also level off volatility, but will result in a trade-off as does almost every decision one will make when trading. A single stock may offer greater volatility or movement than a market and, therefore, may have a greater potential for a higher reward, but, at the same time may provide higher risk as well. It is unlikely that a market will go to zero but many stocks have done exactly that or at least lost an enormous percentage of their value. The recent troubles of Bear Stearns bear witness to that phenomenon.

Clearly, it is important to know what the market is doing even if one is going to search for a specific stock. A trader is really playing against the odds if he is buying stock in a continuing bear market. Fact is, a bear market is a bear market because most stocks are going down. A bullish play in a bear market is contrarian and while contrarian plays certainly can do very well, picking a bottom can be very hard to do. A bullish play in a bearish market may succeed, but it is less likely to do so than in a bull market. If the overall market is bearish, why not look for bearish candidates. If the trader does not like to short stocks or employ other bearish strategies, why not stand aside until the bull returns? Bearish plays (and I discuss a bunch in "Trade Your Way to Wealth") can be very profitable and sometimes very quickly, but they are not for everyone. Some people will not make a bearish trade because their overall philosophy is bullish; others avoid the bear plays because they do not know how to profit from a bear move. Any reason an individual may have to avoid bearish plays in a bearish market can be fine, but that does not mean it is necessarily a good idea to try the bullish plays in a falling market. Waiting for the upturn is perfectly acceptable.

I prefer to make bullish plays in bullish markets and bearish plays in bearish markets. If I am going to make a bullish play in a bearish market, I would at least like the stock I am buying to be in a bullish sector even if the market is bearish. It is quite rare for all sectors to be bearish even in a bear market so if one is bound and determined to make a bullish play in a bearish market, why not look for stocks in sectors that are bullish. Obviously, the reverse holds true as well. If one likes bearish trades better than bullish trades and the market is bullish, how about looking at a bearish sector to find a candidate for a bearish trade.

The fact is that it is impossible to be right all the time in the markets. Almost everyone who trades will have losing trades. The successful traders are the ones who give themselves an edge, who take what the market will give them rather than try to fight the markets, who know how to manage risk, and who continue to educate themselves. Over the years, I have coached some traders and still do on rare occasion. One of the things I have noticed in my own trading and in my coaching experience is that those who can exercise discipline and trade in the present rather than worrying about the past or trying to predict the future are the ones who are most likely to be successful. Learning ways to give yourself an edge, even a slight edge, is key. Just look at the casinos in Vegas. They don't make money because they are right on every bet; they make money because they make sure the odds, however slight, are in their favor.

by Bill Kraft, Editor
Copyright 2008, Makin' Hay, Inc.
All Rights Reserved

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Anonymous said...

Dear Bill Kraft,

Although your lenghty answer to "Finding a Stock" is appreciated I think that you missed the point. Maybe the individual who ask this question should have said "How do I find stocks." In other words how do you screen 5000 stocks to get a good one to play options. Do you have a good stock screener for us new options trader. I know how to do a Bear Call, Bull Put or Iron Condor. I just don't know how to find the worthy stocks that qualify. How do you select the stock/s that you think will go your direction long enough to make you money?

Bill Kraft, said...

Robert, it is less important to "find a stock" than it is to find a situation. The situation is one where an entry can be made in such a fashion that the loss is limited if the stock goes the wrong way. Since I probably haven't convinced you of that so far, if you want to find a stock, first determine what the market is doing. If bullish, find a bullish sector, then find a bullish stock in a bullish sector. If the market is bearish, find a bearish sector and then choose a bearish stock in the bearish sector. I don't think I missed the point; my point is that I disagree with the idea that finding the stock should be the emphasis. Finding the situation is what works for me and I can often use many different stocks to achieve my goals.
Bill Kraft