In this article, I share 5 tips for stock picking success. It’s very basic advice to help you implement a simple active investing strategy.
Stock picking – also called active investing – is the art of buying and selling individual stocks.
In theory, it’s very easy.
In practice, it’s extremely difficult.
That’s right: picking stocks that regularly outperform the market is very tough.
Even investment professionals struggle to consistently beat market returns.
What makes you think you can do better than them?
Actually, plenty of individual investors manage to beat the market and the professionals. However, they follow a few simple rules to ensure they stay disciplined and avoid beginner mistakes.
Stock picking is a risky activity that can lead to the loss of part or all of your capital. If you want to partake in stock picking, you should not commit more than 20% of your capital to this activity. Invest at least 80% of your capital in index funds and other low risk investments. You should not invest any money you’ll be needing in the next 5 years.
That being said, here are 5 tips for stock picking success.
1. Don’t invest emotionally
The first of the 5 tips for stock picking success concerns intelligence.
Contrary to popular belief, I.Q. has nothing to do with stock picking success or successful active investing strategies.
In fact, legendary investor Warren Buffet even claims that “Success in investing doesn’t correlate with I.Q.” and claims that psychology plays a much more important role in an investor’s success.
Who are we to doubt the Oracle of Omaha’s wisdom?
Seasoned investors will confirm that letting your emotions get the best of you will insatiably lead to underperformance.
Don’t let this happen.
Avoid making impulsive decisions and try to remain rational at all times.
If this means disconnecting your internet or turning off Jim Cramer’s Mad Money (why are you watching it in the first place?) in times of doubt and uncertainty – do it. Sometimes, being overexposed to outside sources ad conflicting opinions leads to irrational decision making.
Don’t get emotional. That’s tip number 1.
The 4 tips that follow will help you cultivate long term success.
2. Remember that you are a shareholder – not a speculator!
Novice investors often forget that behind each ticker is an real company run by real people.
Stock picking is not an abstract concept.
When you buy a stock, you become a shareholder of the company proportionally to your investment amount, no matter how small it is.
I repeat: when you buy company’s stock, you become a part owner and have a vested interest to see that company succeed.
Always remember this fact.
Thus, before you buy a stock, ask yourself the following questions: what is the company’s business model? Is it well diversified? Who are the competitors? What is the expected growth 5-year growth rate of its industry? Is the company’s product pipeline innovative? How healthy is the Balance Sheet?
And so on and so forth.
Try to evaluate whether the company’s business model is sustainable and capable of generating rising profits over the long term.
3. Have a strategy
Strategy is everything.
The problem is we often make impulsive decisions that lead to buying high and selling low – thus going against our initial strategy!
Going against your strategy is a monumental error that you should avoid at all cost.
One trick that may help you stay consistent is keeping a journal where you write why you’re investing in a particular stock and the reasons that would make you sell.
- Why am I buying? Write the reasons why you are buying the stock and your investment horizon. What are your expectations and how will you evaluate the company’s success?
- What would make me sell? There are plenty of valid reasons to sell a stock. Price fluctuations alone are not one of them. The only reason why you should sell is a change in the company’s fundamentals: the loss of important clients; poor strategic decisions by the CEO; the emergence of serious competitors; or your investment thesis is not panning out as expected.
Elaborate a strategy and stick to it.
4. Take your time
We can’t say it enough: time in the market beats timing the market!
Your greatest ally is patience.
Warren Buffet (him again!) famously said that “the stock market is a mechanism which transfers money from the impatient to the patient“.
His approach has enabled him to become one of the world’s wealthiest men. Perhaps we should heed his warning.
Stay calm and don’t panic. Over the long term, your patience will be rewarded.
Thus, you should take your time to build your portfolio.
Here are 3 strategies which can help you reduce your exposure to short term volatility:
- Dollar-Cost Averaging (DCA): DCA consists of allocating a fixed amount of capital to buy a particular asset at regular intervals, for example every week or every month. This fixed amount allows you to buy more of this asset when the price decreases and less when the price increases. Over the long term, your average buy in price will average out.
- Buying in thirds: This strategy consists of taking the amount you want to invest in a stock and dividing it by three. Then, you pick three different times to inject this money into the stock. This allows you to buy in at different times, for example once every month/quarter or after specific dates such as earnings publications or important events.
- Buy the “basket”: Buying the basket means you’re buying all the companies of a given sector rather than just one. This allows you to own the entire industry and not miss out on one company’s explosion. This also allows you to identify the top performers and allocate more capital to the winners.
5. Don’t trade too much!
The last of the 5 tips for stock picking success is to not trade too much.
These days, easy internet access means we’re all addicted to our screens.
The advantage is that we can see our portfolio’s performance in real time.
The disadvantage is that we have a tendency to react impulsively to short term events and focus too much on price rather than on value.
Thus, we become euphoric when prices rise – and we buy out of FOMO – and we panic when prices fall – and sell to cut our losses.
We must break out of this negative spiral because it leads to horrible returns.
So what can we do?
Simple: do not consult your portfolio every day.
Logging in once every week or once every month is more than enough to track your performance and rebalance your assets if necessary.
If the price of an assets falls, don’t panic. Ask yourself these two simple questions:
- Is the price falling because the market as a whole is falling?
- Are the fundamentals of the company changing?
Short term noise such as sensational headlines and analyst opinions are rarely useful to help you make rational decisions. Furthermore, this noise often has little to no impact on the long term performance of a given stock.
So why bother giving the noise so much credit?
You need to cut out the noise and focus on what matters: the fundamentals and your investment thesis.
These are the 5 tips for stock picking success.
I hope they will help you become a better investor and maximize your long term returns.
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DISCLAIMER: This article is the fruit of my personal research and should not be viewed as financial advice. I enjoy analyzing stocks and providing investment ideas but I highly encourage you to conduct your own research before investing in any asset. NEVER invest without having done proper due diligence and NEVER invest out of the Fear Of Missing Out (FOMO). Also, NEVER invest because some internet message boards are hyping up a high-flying stock. As a rule of thumb, the number of rockets included in a tweet are inversely proportional to the quality of the advice given.