Education Articles
How to Research a Stock |
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When making the decision to start investing in the stock market, there are a number of steps every investor needs to take. Picking a broker, setting up a brokerage account, and deciding what kind of investor you want to be are all critical first steps. Once those are in place, it’s time to start making the really tough choices: which stocks to invest in. Even if you have a broker who recommends stocks for your portfolio, it is often wise to do
your own research rather than buy on a hot tip. While your broker is supposed to be looking out for your best financial interest,
in the end it is still your money, and you should always know where your money is going.
Depending on the type of investing technique you choose, fundamental analysis vs. technical analysis, your research process will
vary greatly. Check out some important research tips below for each type of investor so you can find the best stocks at the best
price.
Fundamental analysis looks at the company as a whole, not just the stock. Fundamental investors look at how the company
is doing financially, and follow the news watching for any external factors and forces that could impact the company’s performance.
Before you get started picking stocks, you need clearly defined investment objectives and goals: short term goals like buying a
car, mid-term goals such as buying a house, or long term goals like retirement. Also, how much of your income/savings can you afford
to invest? Once you have your goals in mind, you can start your research.
Start by looking at companies in sectors that interest you. Do your homework. Take a look at industry publications and keep an eye
on the news. Once you’ve identified a handful of companies that interest you, the fun can begin!
One good way of selecting the best stocks is to set up a stock screen, essentially a standard you set for any stock you even consider
purchasing. Your stock screen should have tolerance levels for a number of criteria. Here are a few factors to consider before purchasing
a stock:
- Earnings Growth
- Price/Earnings Ratio
- Debt/Cash
- Dividends
- Market Cap or Size
- Industry and Relative Strength (advantage over competitors? Position in the market?)
- Corporate News
- World News
And of course, you have to take price into consideration relative to all of the factors that you have now researched. A value
investor will look to see if a stock’s value reflects the full value of the company’s assets, or if a stock is
undervalued with a potential to grow as the company becomes stronger and gains market share. A growth investor looks at
the history of a company to see how quickly they have grown (in terms of sales and earnings). Then they look at the price of the
stock and make a decision: does this price reflect the growth potential of the company? Will I be rewarded if I get in now before
this companies booms?
All of this research can be overwhelming, but the SEC has put together a database of all financial filings for companies required
to report earnings in the US. The Electronic Data Gathering, Analysis, and Retrieval (EDGAR) (http://www.sec.gov/edgar.shtml)
is a great place to start your stock research. All information is available to the public and can be downloaded free directly from
the website.
Technical analysis, on the other hand, is all about the stock and its patterns. Technical traders don’t care
if the Fed cuts rates, or the housing market tanks or what the latest unemployment numbers are. They look at the patterns to
find stocks that are about to move, and then use the charts to figure out which way the stock is headed, how fast it is going to
go up or down, and how far it is going to go.
Technical analysis is looking at the past prices and trading volume of a stock or other security to uncover patterns and determine
when to buy or sell. Unlike fundamental analysts, who like to see a company's balance sheet and earnings reports to see if it would
make a good buy at current prices, technical analysts just want to profit from moves in price, regardless of the fundamentals.
There are really three things you need to consider when research a stock through technical analysis—direction, speed and
distance. Simply put, direction is which way the price is going—up or down. If it's going up, it's described as "bullish," and
if it's going down, it's described as "bearish." Speed is how fast the price is moving. Sometimes a price makes a big
move in one trading day. Other times it could take 10, 20, or 100 trading days. Distance is how far the price will go, regardless
of whether it's moving up or down. You could measure it in dollars, but it's usually more useful to measure it in percentages—10%,
15%, 30%.
To make it technical analysis a little easier to understand, let’s break it down into these components.
We’ll start with direction. It's easy to see trends once they're over, but the only way you can profit is to identify
the direction of the trend before it has run its course. That's why traders look for 1-2-3 Bullish Trend Reversals and 1-2-3 Bearish
Trend Reversals. As the names imply, a bullish trend reversal signals an uptrend, and a bearish trend reversal signals a downtrend.
The rule of thumb is to go long on a bullish uptrend, and either go short or close your position on a downtrend.
The three things look for when identifying a 1-2-3 Trend Reversal of either type are the Aroon
indicator, Williams %R, and the PPO. (Click on any
of the chart names for an audio tutorial on how to use them.)
Next, a technical analyst looks at speed. Speed is determined by looking at Elliott
Waves. Elliott Waves indicate two basic types of waves: motive and corrective. The motive waves occur in groups of 5 waves
labeled 1, 2, 3, 4, and 5, and corrective waves occurred in groups of 3 waves labeled A, B, and C.
A motive wave is an impulse that moves, or impels, prices in the direction of the underlying trend. You know you're in a motive
wave when waves 1 and 4 do not overlap—that is, the prices in wave 4 do not retrace any of the prices in wave 1. Typically,
wave 3 of a motive wave is the fastest of all the waves.
A corrective wave, on the other hand, occurs when prices move against the underlying trend. The result is that wave 4 will overlap
wave 1—or in other words, retrace some of the prices in wave 1.
It's very important to identify waves correctly, or you'll end up losing a lot of money.
Now let’s consider distance. Distance is measured by chart patterns. Chart patterns were identified decades ago in
the form of geometrical shapes such as triangles. The shapes are plotted with the highest and lowest points of five wave structures
in the chart. Two examples would be an expanding triangle, which originates at a point and makes higher highs and lower lows, and
a contracting triangle, which makes lower highs and higher lows and eventually comes to a point.
Click on any of the following chart patterns to learn how they show you distance: ascending
triangle, diamond bottom, and
head and shoulders top.
For more pattern descriptions and help, check out the “Free Education” resources at Trending123.com.
It doesn't matter whether it's a stock, an index, an ETF, or a commodity. Patterns are patterns. All they do is measure distance.
The success and failure of them all depend on what the primary trend is. If you're trying to play a bullish pattern in a bearish
market the chance of that playing out successfully significantly decreases
So what now?
In the end, it is up to you to decide what type of trader you are, fundamental or technical. Both methods have yielded incredible
success to those who do their homework. One great resource for all traders is PortfolioGrader
Pro, a free online tool which ranks over 5,000 stocks and is update weekly.
Don’t forget: even if you work with a broker who provides stock recommendations, you would be wise to do your own research
before issuing the buy order. A smart investor knows what they are buying and why they are buying it.
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