Which Path Do You Take When Picking Stocks?

Benjamin Graham described the traits needed to invest successfully over a lifetime in his classic book,  The Intelligent Investor.  This is but one possible path to take on the road to stock market happiness.  The act of trading stocks has been equally documented and much ballyhooed over the last couple of decades as the popularity of online trading and easy access to brokerage accounts has risen dramatically.  The third path, gambling, is often overlooked as a style of stock picking but I would suggest that many, if not too many stock pickers fall into this category. 

So, what is the difference between the three categories.  Let's take a look:

  1. Investing.  Most would agree that this style of stock picking involves a long-term outlook and a buy-and-hold strategy.  Strong support on fundamental analysis and heavy research into the strength of a company.
  2. Trading.  This style of stock picking places emphasis on  entry and exit points with monitoring of technical analysis and chartology.  the difference between technical and fundamental analysis lies in a chartists belief that a companies fundamentals are priced into the stock price.  No need to review the balance sheet or last quarters income statement as all that information ends up in the stock price moving it up or down based on the mood of the market.  Then, with that in mind, a trader will review the charts with various technical indicators to determine price movement and develop an entry/exit system.
  3. Gambling.  Probably not a title a stock picker would  want to place on him or herself but the reality is that stock gamblers exist at many levels of stock purchasing.  Ever bought a stock on hot 'tip' from a friend?  Didn't do your due diligence on the last stock pick but bought the stock based on a positive news headline?  Ever buy into a stock based on a pop in earnings, after the stock already popped?  Then consider yourself a gambler. 

Now days, it is easy to be inundated with business news, stock advice websites, trading strategies, and generally influencing motives to get you into our out of a stock.  Watch thirty-minutes of a business news channel and you will have a plethora of stock tickers to consider.  Too easy.  Follow that up with a quick internet search on those same promising stock tickers, read a few business articles, maybe check the daily chart on a finance website and your research is over.  Right?

We are all familiar with the age-old stock purchasing tip, buy low  and sell high.  Seems easy enough.  But how easy is it really?  Trading and investing are partly rational and partly emotional.  Acting on impulse will get you into a stock on the high side, and then leave you begging to get rid of the stock on the low side.  Without putting your emotions in check stock picking will leave you on the wrong side of buys and sells every time.  Gambling relies on emotions. 

In reality, stock picking is an extremely disciplined endeavour relying on self-control, thorough fundamental and/or technical analysis, and a sound money management scheme.  Investing or trading without considering these guidelines is flat-out gambling.  Before buying a stock take these points into consideration:

  1. Beware of emotions.  Question why you are considering a purchase of this stock.  Was it because of good news?  What about yesterdays news?  What about last quarters earnings report? 
  2. Take a look at the charts.  Consider the daily and weekly charts and decide on a trend.  Is the trend up, down?  Was the good news you heard contrary to the trend?  Take a look at the financials.  There are many systems out there that give guidance on what financial information to consider when determining the health of a company.  Is the quick ratio greater than one?  Should the goodwill noted in the balance sheet last quarter be considered?
  3. Manage your money.  Lot's of literature will point you towards a 2%-6% rule when trading.  Don't risk more than 2% of your account on any one trade and if you lose more than 6% of your account stop trading for a month or any other specified period.  Protect yourself and your account. 
  4. Get to know the power of the stop-loss.  When considering protection of your account you have to know how to use and put in place a stop for each trade. 

Consider these points before placing your next trade.  it could help lose the title of gambler and help you get into real investing and/or trading.