Lesson 9: Picking Stocks & Analyzing Economic Data When it comes to personal finance and the accumulation of wealth, few subjects are more talked about than stocks. It's easy to understand why: playing the stock market is thrilling. But on this financial roller-coaster ride, we all want to experience the ups without the downs. There are nearly 6,000 publicly traded companies in the U.S. While this represents a 37% decline in the number of U.S.-listed companies since its 1997 high, it’s still a lot of companies. How’s an investor to choose? In this tutorial, we examine some of the most popular time-tested strategies for finding good stocks (or at least avoiding bad ones). In other words, we'll explore the art of stock-picking – selecting stocks based on a certain set of criteria, with the aim of achieving a rate of return that is greater than the market's overall average. #Intra-day Trading Intraday trading involves buying and selling of stocks within the same trading day. Here stocks are purchased, not with an intention to invest, but for the purpose of earning profits by harnessing the movement of stock indices. Thus, the fluctuations in the prices of the stocks are harnessed to earn profits from the trading of stocks. An online trading account is used for the purpose of intraday trading. While doing intraday trading, you need to specify that the orders are specific to intraday trading. As the orders are squared off before the end of the trading day, it is also called as Intraday Trading. Intraday trading deals with buying and selling of stocks on the same day, during the trading hours that are stipulated by the exchange. Stocks are bought and sold in large numbers strategically with the intention of booking profits in a day. Let’s explain Intraday trading with an example: Suppose that you have bought 100 stocks of ABC limited during the open market hours, then you have to sell the same no. of stocks of ABC limited before market closure. Same is the case if you have sold the stocks, you have to buy the same quantity of the stock you have sold earlier. Advantage of intra-day trading 1. No overnight risk The greatest benefit of day trading is that you have zero overnight risk. You close your position prior to the end of trading day because of which your profitability is not affected by good or bad news and events that happens during the non-trading hours. A positional traders profit can disappear overnight because of any bad overnight event. No overnight crises or tragedies of local or global markets can affect your income for that day.
2. Day traders can make profit in any direction Day traders can take benefit of both rising and falling market. This is not the case with long term investors who hold their stocks for long duration to make profit from bull run. Day traders can do short selling to make profit from falling stocks. Positional traders can do short selling only in futures which requires high margin. 3. Increased Leverage more buying power Day trading requires low margin and provides greater leverage on your trading capital. Most brokers provide up to 100% leverage. That means you can trade with more amount than you actually have in your account. If you have 1 lakh in your account then you can trade with up to 2 lakh in a intraday (this varies from broker to broker) This increased leverage can multiply your profits. Positional traders don’t have this advantage and they have to have high level of investment to make substantial profit. 4. High Returns If proper day trading strategy is implemented with discipline good profit can be made. To get good returns you have to learn to handle the intraday fluctuations of the market to keep up. 5. Low brokerage commission Brokerage commissions are 1/10th for day trading comparing to that of taking the delivery of stocks. Other charges like service tax, stamp charges, stock transaction tax etc. are applied over brokerage only, therefore for day trading you have to pay very less commission. Taking delivery of stocks involves extra procedure of transferring stock from company to your demat account which increases the cost that you pay through brokerage. With day trading you can trade with more amount by paying the least commission which is not possible with positional and long-term trading. 6. You are in cash at the beginning and end of day In intraday you square off all your position before the close of market. You start your day with cash and end it with same cash (adjusting profit/loss) It’s easy to sleep well at night when you’re in 100% cash. There is also a big advantage of this and that is you can withdraw your cash any time in case of any emergency. Positional traders don’t have this advantage they can’t withdraw their money immediately. They have to sell the stocks first and then only can cash it. 7. Less Risky As you are not vulnerable to overnight risk, with proper money management and discipline you are less exposed to risk comparing to other form of trading. Loses can be too much in positional trading as anything can happen overnight and your stock can crash next morning on the opening of market. You may not even get suitable exit levels. Imagine you are holding a fundamentally sound company stocks. After the close of market CBI raids company office and arrests in CEO. The next morning the
stock will plunge down and you may not even get opportunity to exit. Your loses are limited in day trading. 8. You can do more trades Day trading gives you more opportunities. In positional trade you have to wait for days, weeks or months for your targets or stop loss levels to trigger so that you can make exit. But in day trading you have more leverage and can do more trades. You can make quick exit on profit or loss in case of stop outs and can take entry into another good stock. You have more buying power in day trade and can use more opportunities than positional or long-term trade. 9. Better learning opportunities Intraday trading gives you more opportunity to learn, test and apply various trading techniques in the relatively short time span. You can test yourself which strategies works good for you, which chart patterns gives better results. This can make you more efficient and profitable. 10. Don’t have to do much study If you prefer to buy stocks for short or long-time period you have to do more study to select the right stock. You have to study its fundamentals and technical thoroughly. You don’t have to do too much serious study of stocks in case of day trade. Most of the traders only trade in few selected high-volume stocks every day and make good profit without doing any intense technical or fundamental study of that stock. #Full time trading Both day trading and more conventional career paths have their benefits. A conventional job guarantees you a salary (and, sometimes, benefits), whereas day trading has higher theoretical scalability and allows you to be your own boss. For most full-time day-traders, the biggest benefit is that you get to do what you love at a job that consistently challenges you. Sound appealing? Take the following into account: As a full-time day-trader, you will have less stability, especially as you start out. You will have good months, bad months, great months, and mentally exhausting months. While this roller coaster of emotions is part of what makes day trading exciting, it can also be stressful if approached improperly. There are plenty of day traders and swing traders out there, many of them engaging in the stock market at different levels. Some people utilize day trading for a living, while others just trade for a few hours a day to bring in some extra income. One of the questions I get asked a lot is, “when is the right time to make the leap to full-time day trading?” Of course, there is no universal answer to this question, however there are a few considerations that come into play. It should be noted that day trading is not as
glamorous as it is often portrayed to be. Trading stocks is not about “making bank” or living an exotic lifestyle. For full-time day-traders, trading stocks is a career. This means it requires work – work that entails sitting by the computer for hours a day staring at screens. You are not guaranteed to make millions of dollars. Heck, you’re not even guaranteed to get paid. Day trading is one of the few career choices where you are not guaranteed a paycheck, and you may even lose money after investing hours of your time. Discouraged yet? Don’t be. This is not intended to critique day trading as a career. I trade every day and I love it. This post is intended to be a reality check that allows you to set realistic expectations that will help you take the necessary steps to achieve your goals. It’s also important to note that this post is targeted towards people who want to know how to start day trading full-time (meaning you are leaving your other job to pursue day trading full-time). Some of these points will not be relevant to those who trade as an extracurricular activity. Training – Before you even consider taking the leap towards becoming a full-time stock trader, you should make sure you are properly equipped. You wouldn’t quit your job to become an engineer without any proper training, right? What are your chances of succeeding? The same logic applies to trading. Start developing the proper expertise before even considering a career in day trading. We have a variety of free and paid resources to get you started on your journey. Experience – You can read 1000 books on trading theory and still get crushed by the markets. Theory and practice are two different skill sets. Most traders need to spend some time actually trading before they can get a real feel for the markets. Consistency – If you are even considering becoming a full-time trader, make sure you are trading consistently. This will allow you to set realistic expectations for the future. Consistency is proof that you have actually developed an applicable skillset. For a new trader, there’s more long-term value in making $5,000/month for 12 months than making $200,000 your first month and $0 the rest of the year. Sure, one provides a higher short-term monetary value, however, it is less sustainable in the long run. #Identifying Stocks In order to identify trading opportunities, we need to filter stocks for suitability define the criteria and identify trading ideas for long and short trades. A few caveats before we get started: Many investors new to the stock-picking scene believe that there is some infallible strategy that, once followed, will guarantee success. There is no foolproof system for picking stocks! This doesn't mean you can't expand your wealth through the stock market. It's just better to think of stock-picking as an art rather than a science. There are a few reasons for this: 1. So many factors affect a company's health that it is nearly impossible to construct a formula that will predict success. It is one thing to assemble data that you can work with, but quite another to determine which numbers are relevant.
2. A lot of information is intangible and cannot be measured. The quantifiable aspects of a company, such as profits, are easy enough to find. But how do you measure the qualitative factors, such as the company's staff, its competitive advantages, its reputation and so on? This combination of tangible and intangible aspects makes picking stocks a highly subjective, even intuitive process. 3. Because of the human (often irrational) element inherent in the forces that move the stock market, stocks do not always do what you anticipate they'll do. Emotions can change quickly and unpredictably. And unfortunately, when confidence turns into fear, the stock market can be a dangerous place. 4. his should go without saying, but too many investors buy shares of companies without really knowing how they make their money or having a grasp on the overall business dynamics of the industry. As a rule, when searching for undervalued companies, I highly recommend narrowing your search for undervalued stocks to the types of businesses you understand. For example, I have a strong understanding of the banking industry, as well as real estate, energy, and consumer goods, so stocks in those industries make up the majority of my portfolio. On the other hand, I really don't have a good grasp on the biotech industry so I simply won't invest in it. Don't get me wrong -- I'm sure there are a lot of great companies in biotech, and many could indeed be undervalued right now, but it's just not my area of expertise. 5. Know the metrics. There are dozens of metrics you can use to evaluate a stock, but the following are some of the best for locating undervalued stocks: Price-to-earnings (P/E) ratio: By dividing a stock's current share price by its annual earnings, you can calculate this metric, which is useful for comparing companies in the same business. A lower P/E means a stock is "cheaper," but this is just one variable to consider. Price-to-book (P/B) ratio: Calculated by dividing a stock's price by its equity per share. A book value of less than one implies that the stock is trading for less than the value of a business's assets. Value investors use P/B multiples to find stocks with a margin of safety. Price-to-earnings to growth (PEG): Found by dividing a stock's P/E ratio by its projected earnings growth rate over a certain time period -- typically the next five years. This can be effective for assessing the valuation of a company with a seemingly high P/E, but whose earnings are growing rapidly. Return on equity (ROE): A company's annualized net income as a percentage of shareholders' equity. This is a measure of how efficiently a company is using invested capital to generate profits. Debt-to-equity ratio: As the name implies, this is calculated by dividing a company's total debt by its shareholders' equity.
Current ratio: A liquidity metric calculated by dividing a company's current assets by its current liabilities. This tells investors how easily a company can pay its short-term obligations. Once you start evaluating stocks and getting a feel for these metrics, it's a good idea to develop your own criteria for identifying a stock as undervalued. For example, when I'm hunting for a good value, I like to see a below-average P/E for the stock's peer group, a debt-to-equity ratio of 0.5 or less, and ROE of 15% or higher. Note that these aren't set-in-stone guidelines. Rather, they are one piece of the puzzle that should be taken into consideration. The bottom line is that there is no one way to pick stocks. Better to think of every stock strategy as nothing more than an application of a theory – a "best guess" of how to invest. And sometimes two seemingly opposed theories can be successful at the same time. Perhaps just as important as considering theory, is determining how well an investment strategy fits your personal outlook, time frame, risk tolerance and the amount of time you want to devote to investing and picking stocks. At this point, you may be asking yourself why stock-picking is so important. Why spend hours doing it? The answer is simple: wealth. If you become a good stock-picker, you can increase your personal wealth exponentially. Take Microsoft, for example. Had you invested in Bill Gates' brainchild at its IPO back in 1986 and simply held that investment, your return would have been somewhere in the neighborhood of 35,000% by spring of 2004. In other words, over an 18-year period, a $10,000 investment would have turned itself into a cool $3.5 million! (In fact, had you had this foresight in the bull market of the late '90s, your return could have been even greater.) With returns like this, it's no wonder that investors continue to hunt for "the next Microsoft". Let's start by delving into one of the most basic and crucial aspects of stock-picking: fundamental analysis, the theory that underlies all of the strategies we explore in this tutorial (with the exception of the last section on technical analysis). Although there are many differences among strategies, they all come down to finding the worth of a company. Keep this in mind as we move forward. The following can help in identifying stocks: Stock Screener -Finviz and another, different site, maybe google finance, yahoo finance. #Stock Market Announcements Stock market announcement is an official public statement of a company's profitability for a specific time period, typically a quarter or a year. Stock market announcement typically occurs on a specific date during earnings season and is preceded by earnings estimates that equity analysts issue. If a company has been profitable leading up to the announcement, its share price will usually increase up to and slightly after the information is released. Because stock market announcement is the official statement of a company's profitability, the days leading up to the announcement are often filled with speculation among investors. Analyst estimates can be notoriously off-the-mark and can rapidly
adjust up or down in the days leading up to the announcement, artificially inflating the share price alongside speculative trading. Earnings Announcement and Analyst Estimates For analysts valuing a firm future earnings per share (EPS) estimates are arguably the most important input. Analysts use forecasting models, management guidance and other fundamental information on the company to derive an EPS estimate. For example, they might use a discounted cash flows model or DCF. DCF analyses use future free cash flow projections and discount them. This is done using a required annual rate to arrive at present value estimates, which in turn is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity could be a good one. Calculated as: DCF = [CF1/(1+r)1] + [CF2/(1+r)2] + ... + [CFn/(1+r)n] CF = Cash Flow r= discount rate (WACC) Analysts may also rely on fundamental factors outlined in the management discussion and analysis (MD&A) section of a company’s financial reports. This section provides an overview of the previous year or quarter’s operations and how the company performed financially. It digs into the reasons behind certain aspects of growth or decline on the company’s income statement, balance sheet, and statement of cash flows. It discusses growth drivers, risks, even pending litigation. Management also often uses this section to discusses the upcoming year by outlining future goals and approaches to new projects, along with any changes in the executive suite and/or key hires. Finally, analysts may take into account external factors, such as industry trends (e.g. large mergers, acquisitions, bankruptcies, etc.), the macro economic climate, pending U.S Federal Reserve meetings and potential interest rate hikes. Stock market announcement can be obtained from the following: - Market Announcements - Company Announcements - Economic News and Market Announcements - Economic News - Company Releases - Interest Rate Announcement - Employment - Consumer Confidence