What Makes a Good Stock Pick?
Matching stocks to strategies is key
Successful day traders share a number of key traits. They exercise discipline in their decisions, they have a good plan in place, and they trade 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 strategies.
Each trader must apply minimum requirements to any stock before it can be considered a trade candidate. These requirements are based on the individual's personality, risk profile, and the amount of capital he has 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 because 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 because they can tie up an inordinate percentage of capital in one position and they're 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 shares issued by the company and available to trade in the marketplace—tend to be illiquid and present more risk than comparable stocks with a greater number of shares outstanding. The same holds true for companies with little institutional ownership of their outstanding shares, such as mutual funds. 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. 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 being considered fits the profile and characteristics that are 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 by, while those that conform must be more fully investigated to determine if they make sense for a trade.
A Compelling Element
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. This in turn should ramp up momentum—the fuel necessary to drive share prices sharply upward over a short timeframe.
News, events, expected announcements, and upcoming earnings are some of the most common elements favored by seasoned traders.
While it's far from an exact science, some stocks trade in a predictable fashion in a given scenario while others do not. 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 circumstances, but others languish. Past performance is no guarantee, but it can provide an indication of how a stock might act in certain situations—an edge that every good day trader always seeks to leverage.
Other Key Points
You don't have to be an expert on a company when day trading the stock given the relatively short timeframes for which traders hold positions. But traders should be aware of some key points regarding any stock they trade:
- The scheduled earnings date for the company and key industry competitors
- Expected news or announcements for the company and competitors, such as product releases.
- Dates of important industry conferences or events related to the company and competitors
Awareness of such issues when you're going into a trade reduces the likelihood of unexpected developments and decreases a trader's risk.