How to Select Stock to Trade - dummies

By Michael Griffis, Lita Epstein

After you’ve identified the dominant trend, the leading and lagging sectors, and the current state of the business climate, you will select stocks to trade. Beyond general market conditions, two factors drive a stock’s price higher or lower:

  • The fundamental condition of a company’s business

  • The technical condition of a company’s stock

On the fundamental side, earnings matter more than any other fundamental data. Traders pay particular attention to the rate of earnings growth as characterized by the earnings per share (EPS) growth rate. In general, the bigger the EPS growth rate, the better the stock price, and vice versa. Stocks without earnings often make very dangerous trading candidates for long-side trades.

Although some special situations may merit your consideration, stocks without earnings carry a special risk. Any hint of unfavorable press sends the stock’s price reeling. Besides, the downside risk is simply too great for our taste.

You also need to consider the company’s size when selecting a trading candidate. Although small companies can and sometimes do return outsized trading profits, they also present problems for traders. Stocks of small companies usually are lightly traded, which makes them difficult to buy and even more difficult to sell.

You can afford to be patient when entering a trade but not when exiting a position, especially when the stock hits your stop-loss price. Lightly traded shares make exiting a position difficult, because the price is likely to fall quickly and dramatically when many traders are trying to exit simultaneously. You’re bound to lose more of your precious trading capital (when selling) or spend more of it than you intended.

On the technical side, you want to trade the strongest stocks in the strongest sectors. You want to enter positions in these high relative-strength stocks as they break out of trading ranges or reversal patterns. And you want to hold them as long as they remain relatively strong compared with other stocks.