Why is picking stocks for trading so crucial?
Let’s say, you have got everything right – you have the capital, you understand the stock market, you know how to trade and make money. But when you pick the wrong stock, all the right things go wrong!
That’s precisely why you need to pause for a moment and consider how to pick stocks for trading.
There are many criteria and it could be quite puzzling.
Here’s what you need to know for stock picking for trading:
Trade what you know
- Let’s say you like Sun Pharma because it makes huge moves every day. Should you trade it?
- From the point of view of how much money you can make, it seems like a compelling decision. The question is not about how much it moves or how much money you can make. That could be true about Sun Pharma, Reliance or Tata Steel.
- You should trade in stocks which you know and understand. Do you understand pharma sector and the place of Sun Pharma in such a sector? If yes, you should trade or else you should avoid it.
- The real strategy for stock picking is starting with what you know. You should focus on a sector that you know and understand. It could be healthcare, entertainment, IT, auto, banking or any other sector. Start with the sector you understand and then look for a stock that is good for trading.
- Let’s say you like and understand banking. Should you trade in HDFC Bank or Axis? HDFC Bank is unsuitable for trading. Do you know the reason why? The simple reason is that it is in a clear-cut uptrend. You can enter and exit once, then what?
- For trading, you need a stock that is in a clear cut range rather than strong uptrend. So Axis Bank is good for trading. You can keep buying low and selling high. You can keep doing it because it keeps going up and down without going anywhere above or below a particular level in a trading range.
- Trade in a stock that you understand in so far as the sector is concerned. If you look at sugar stocks and if you understand them, you are in a much better position to trade or avoid them. At a time when Rupee is close to 70, IT stocks are a better bet. So if you understand IT, trade IT stocks.
- Don’t trade in stocks about which you have no or little understanding. Such stocks can reverse and move quickly before you can exit them. Worse, they will be stuck well below your buy levels and you would end up waiting for them to make an upward movement.
- Don’t be carried away price surges and the potential for money making. Avoid greed at all costs because your greed can trap you in stocks which you don’t know or understand.
Avoid the stocks with a hype
- When you want to pick stocks for trading, don’t buy or sell based on hype. Trading is not a competition as to who buys first and makes money. Don’t follow the crowd.
- In fact, people who make money are those who find their own picks for trading, away from the crowd. They go away from the general perception and pick stocks that may or not may have the kind of limelight in the market.
- For instance, stay away from PNB, Geetanjali Gems, Jet Airways or any other stocks for trading because there is enough limelight on these stocks.
- You should pick stocks which don’t have any hype around them. Look for stocks which are stable, liquid and good for up and down movement suitable for trading. Unnecessary limelight will only make the stock more volatile and wild swings which will drive you crazy as a trader. It will trigger your stoploss and create actual losses.
- You should look for stocks which are away from any kind of unnecessary limelight or hype and trade them consistently.
Consider price and valuation
- You should carefully consider price and valuation of a stock when you think of buying or selling it. You should not look at just the name of the company, or a particular piece of news to trade in a stock.
- Don’t get attached to companies. “I always trade in Reliance” Is a bad reason for selecting a stock. Simply because you traded Sun Pharma last year does not mean you should trade Sun Pharma this year and next. Simply because you like the way a stock moves does not mean you should keep trading the same stock even after it stops moving. There are stocks which have become completely inactive. So stop picking the same stocks year after year. Always look for new stocks to trade.
- You should see how it is close or away from 52-week high or low. It will give you an idea regarding whether this is a good price to buy or not. If it is at 52-week high and you don’t know, you can end up buying at high and then if there is a correction, you would end up selling it way lower. It will results in massive losses.
- If it is at 52-week low, it is just the same case for avoiding the stock. You should avoid buying stocks which are at or close to 52-week low because it is a clear indication of what the market thinks about the stock. The price is telling you that the market does not want this stock to go up. It means that you should avoid it too.
- If the valuations are too high, as it is the case right now, you are likely to enter at a time when correction is due. So you buy and then there is correction, you are staring at a loss. So SBI is at 320. It has come up from 250 sort of levels. If you buy at 320 and if it declines, back to 260 or 270, your trade goes terribly wrong.
- A word of caution though regarding higher valuation- don’t think that the valuations are too high so the stock will come down and you should sell it. If HDFC Bank is at 2100, it doesn’t mean it will come down. So don’t start shorting stocks trading at higher levels.
- So consider price and valuation before buying or selling a stock.
Cheap isn’t always good and expensive isn’t always bad
- The other side of the coin of looking at price is that you should not consider only price. You should not look for stocks which are at ridiculous prices and then hope that they will go up overnight.
- The whole idea of spotting and chasing multi-baggers is against the basic market wisdom of making small but consistent returns for wealth creation. Simply because RCom is at 20 Rupees, it does not mean that you should trade it. It is never going to be the multi-bagger.
- Simply because HDFC Bank is at 2100 does not make it an unworthy stock for trading if it is in a trading range. The reason that it is apparently expensive should not discourage you.
- Expensive stocks could be good for trading too. There are a lot of traders who make money trading Maruti as a stock. It would be trading at 9000+ on any given day.
- To think that Rcom or Suzlon will make more money because it is cheap and Maruti will make more money because it is expensive make no trading sense.
- It is not about cheap or expensive but whether the stock will move enough for you to make money. Once you can see that a stock will move enough for you to make money, its cheap or expensive price does not matter.
What’s good for investment may not good for trading
- There are many people who confuse investment with trading. There may be quality stocks in Nifty which would be good for investment but may not be good for trading.
- The reason is simple- a stock suitable for trading should give you multiple, frequent opportunities for entry and exit at the same or similar levels. By this logic, HDFC Bank does not qualify for trading because it has been going up and up without any correction or decline.
- On the other hand, Tata Steel perfectly fits this description. It keeps going up and down so it allows you to enter and exit a number of times. This is what trading means. You buy and sell the same stocks many times a month, or year at around similar price points.
- So Bajaj Auto is a good stock for trading but Bajaj Finance is not because Bajaj Auto is in a trading range but Bajaj Finance is in an unquestionable uptrend. Tata Steel is a good stock for trading but Tata Motors is not because it has been beaten down. It has broken down on the downside and hence it is not fit for trading.
- Dabur may be good for trading but Avenues Supermarket is not. The reason is that market thinks that Avenues Supermarket is a stock fit for long-term investment. We need to respect what the market thinks and leave it alone.
- BPCL may be good for trading; Reliance is not because market now thinks that Reliance is good for long-term growth. So the breakouts and upward trajectory makes it impossible to trade Reliance frequently now. Stick to BPCL and you will be able to make money.
- HCL Tech may be good for trading; TCS is not because market has a huge respect for TCS. Market considers TCS as an iconic stock made for wealth creation over a period of time. So stay away from trying to time the market as far as TCS is considered. Be content with trading HCL Tech.
- In all, recognize the way a stock fits for investment and avoid trying to trade such stocks no matter how good they may be. This saves you from the painful experience of waiting for it to come down so that you can buy low and then sell high. TCS, HDFC Bank or Avenues Supermarket may not give you that opportunity easily.
What not to do:
Don’t trade in penny stocks
- Don’t trade in stocks which are small in price or total share quantity.
- The reason why some traders like penny stocks because they go up 5% or 10% in a day. Considering the small price, you might think of how much money you can make.
- But make sure that you understand that it can also fall 5% or 10% in a day and 30% in a week.
- While stocks falling massively is hardly the issue. The real issue is that it may never come back to the price that you have purchased at. That’s the problem with penny stocks. You buy them at 20 and then they fall and start trading below 10. You will have to wait for months before you see them anywhere close to 15.
- They may not even come back above 10 or 15.
Don’t trade on price alone
- Price is important but price is not the only important criterion for selection of stock. Don’t just look at the price and buy or sell.
- Don’t think that because it has gone up 10% so it’s time to buy it. Don’t buy because it has fallen 20% or 30% assuming it will go back up.
- Don’t think that it is worth buying because it’s at a particular price point. It can further go down or up from here.
- Don’t think that it is worth selling because it’s at a particular high and now it cannot go up from here. Don’t try to predict or pre-empt its fall. It may not fall. It may keep going up and your short trade will go terribly wrong.
- Price is a great indicator but when you isolate it and trade based entirely on price, you are making a grave error for which there is a ‘price’ to be paid!
Don’t rely on easy and readymade tips and recommendations
- One very good way to save your money is to not pay attention to analysts on TV. Don’t listen to too many analysts on TV telling you how a particular stock is going to go up and go down. If they knew, they would stop talking to you and place their own trade in that stock. In that way, they will make more money.
- Apart from the TV analysts, there are brokerage houses which provide recommendations. Don’t fall for it either. Brokerage houses may or may not be able to accurately predict the market. If they could, they would first tell their clients secretly rather than advertising on TV. So stay away from this as well.
- Don’t believe in any tips or recommendations you receive in an SMS or email. These are hoax calls. Stay away from it.
- If you have a friend who is doing the same, stay away from him as well. Don’t trust somebody for financial decisions because someone is your friend. You will regret later.
Don’t buy/sell on news/rumour
- We live in the golden age of information and misinformation. It is difficult to separate the two.
- There is so much that goes around as news and rumour, it is difficult to call which is which.
- So absolutely avoid news and rumour as the basis of your trading decision.
- You should trade when there is no news about the stock because the stock would be stable at such a time. When there is any news, the stock is going to be volatile.
- Even if the news is correct, it will be difficult to time the market because the stock would go up before the news is out. There is no way the stock is going to wait for you to buy it before it goes up or down.
- Most of the time, it is fake and unreliable information. So don’t fall for it.
Don’t mix Fundamental and Technical Analysis
- As a trader, you have to take a side. You cannot have the best of both worlds- fundamental and technical analysis.
- You need to choose which one suits you as a trader. If you like analyzing EPS, revenues, quarterly earnings etc., stick to it for your trading decisions. Don’t add the charts and candle sticks to the analysis of fundamental nature.
- On the other hand, if you relish chart patterns and candle sticks, don’t add a flavor of fundamental analysis to it. Stick to the charts and technical analysis for your trading decisions.
- The reason for separating the two is that they both may not agree. They may give you different pictures altogether. For instance, from a fundamental point of view, certain stocks should go up but they don’t. Charts may suggest even a downtrend in these stocks.
- So fundamental and technical analysis may have a different prediction for the markets. It’s better to stick to any one of the two.
Don’t stick to any one stock forever
- Those who had the opportunity to trade before and around 2008, Reliance Industries was like a symbol for Nifty. If you are trading in Nifty, it means you would be trading in Reliance. Everyone had some or the other kind of exposure to Reliance at that time.
- If Reliance went up, markets would go up and if Reliance went down, markets would go down.
- It is no longer the same in 2018. Ten years later, markets have found new stocks as their leader for the new bull market. You should also do the same.
- Don’t get stuck with Reliance or any other stock because you traded them in 2008 or whatever.
- Reliance is only symbolic of what traders do in terms of stock picking. It could be Sun Pharma, SBI, Tata Motors or any other stock which was once a market leader or sector leader and good for trading.
- Now it may not be so. So get over your favorite stock and find a new one.
It should be evident that trading requires a cold and calculated approach. There is no room for emotions.
If you can remain detached and assess stocks on merit, you can select the right kind of stocks.
If you allow your emotions and ideas to dominate the stock picking, you will end up selecting stocks which may not eventually earn the kind of results you have in mind.
Everything else may be correct but if your selection of stocks is not correct, you would not achieve your goals that you have set for yourself.
Therefore, it is necessary to set aside all your prior opinions and views about the markets and stocks and objectively look at the data and see which stocks deserve your attention.
Don’t be obsessed with particular stocks. Be open to a change of opinion in spite of your liking for a stock when you see that the charts don’t support your decision.
Find out ways to assess a stock that take away the emotion, the personal bias and the personal approach to trading.
As long as you use some other and different ways to select stocks, you will be able to make the right selection of the stock.
When you select the right stocks for trading, half the battle is won. Don’t forget, battles are won and lost in the minds.
Win the battle in your mind regarding stock selection and you have earned your right to the wealth that markets promise.
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