What Makes a Good Stock Pick?
Matching stocks to strategies is the key
Successful day traders share a number of key traits, including exercising discipline in their decisions, having a good plan in place and trading a proven approach with stocks best suited to that strategy. The challenge each day is determining which stocks enable them to most fully leverage and profit from their chosen strategy.
No matter the trading strategy used, there are minimum requirements each trader must apply to any stock before it can be considered as a trade candidate.
Those requirements are based on the individual's personality, risk profile and amount of capital they have to trade with. Charles Schwab offers a good resource on risk profiles and how to create them. Common minimum requirements include:
- Average Daily Volume - Thinly traded stocks (light daily volume - hundreds to tens of thousands) can often be difficult to get in and out of, while those averaging much higher daily volume are easier to enter and exit.
- Share Price - Lower-priced stocks generally equate to greater risk, as they tend to be less known within the market and often lack analytical coverage. Penny stocks are a good example and not appropriate for the average trader, due to their inherently high risk. Stocks priced too high also present issues, as they can tie up an inordinate percentage of capital in one position and are generally not practical for the typical trader with relatively limited trade capital.
- Shares Outstanding and Institutional Ownership - Companies with relatively small trading floats (the number of share issued by the company and available to trade in the marketplace) tend to be illiquid and present a higher level of risk than comparable stocks with a greater number of shares outstanding. Same holds true for companies with little institutional ownership (e.g. mutual funds) of their outstanding shares, as they can be more easily manipulated than stocks widely-owned by institutional investors.
A trader's minimum requirements should act as the initial stock screen for all stocks available. Simply stated, if the stock doesn't clear these hurdles, it doesn't get considered.
The key question to be answered before entering any trade is whether the stock considered fits the profile (characteristics) best suited to the trade strategy that will be utilized. A trader needs to define those characteristics, such as a dramatic increase in average daily volume or a stock trading to a new 52-week or all-time high. Candidates failing to meet those criteria should be passed up, while those that conform must be more fully investigated to determine if they make sense for a trade.
Beyond fitting the desired profile for a specific strategy, candidates should have a compelling element that will serve to create increased interest among market participants, and in turn ramp up momentum - the fuel necessary to drive share prices sharply upward over a short time-frame. News, events, expected announcements and upcoming earnings are some of the most common elements favored by seasoned traders.
While far from an exact science, some stocks trade in a predictable fashion in a given scenario and others don't.
A good example is an earnings run, where traders attempt to take advantage of increased momentum and resulting price appreciation in anticipation of a positive upcoming earnings announcement. Some stocks consistently run up appreciably in such instances and others languish. Past performance is no guarantee, but it can provide an indication of how a stock might act in certain situations - an edge a good day trader always seeks to leverage.
Need to Know
There's no need to be an expert on a company when day trading the stock, given the relatively short time-frame traders hold positions, but there are some key things traders need to be aware of regarding any stock they trade, including the following:
- Scheduled earnings date for the company and key industry competitors.
- Expected news or announcements (e.g. product release) for the company and competitors.
- Dates of important industry conferences or events related to the company and competitors.
Awareness of such issues going into a trade reduces the likelihood of unexpected developments and decreases a trader's risk in the trade.