High Risk, Low Research
Benjamin Graham's seminal book, The Intelligent Investor, describes investment risk as relative to the amount of research performed prior to purchase of an investment vehicle. This means that your risk level is completely up to you and absolutely equal to the amount of work you care to put into researching a stock before purchase. Want to buy a stock on a hunch or news headline? That's high risk, low research.
When trading stocks, as opposed to investing and regardless of timeline, the concept of high risk-low research still applies. Now, this is all relative to your level of experience. I'm targeting the novice traders. Anyone who could be new to trading or have a few years of technical analysis under their belt. Lets begin by considering which stocks to trade and how to set up an entry point:
- Take a look at a sector or index. I suggest perusing a finance website and visiting a sector summary page. You'll see performance summary's of Basic Materials, Capital Goods, and Transportation, etc. Each individual stock, or company, belongs to a) a sector and b) an industry and possibly a sub-industry. For example, Liquidity Services, Inc. (picked randomly, this article is not an endorsement of any stock or company) with ticker LQDT belongs to Services sector, and the Retail industry with a sub-category of Catalog and Mail Order.
- Decide which sector to follow based on recent performance or reputation. Transportation is known as a good overall market indicator and is followed quite closely for this reason.
- Start following no more than 12 stocks. Create a watch list. Any finance website will assist with this.
- Consider two criteria: liquidity and volatility. Liquidity refers to how easy it is to get in and out of the stock (average daily volume should be high) while volatility is the movement of the stock price. The more movement, the better vehicle for trading opportunities.
We could consider the NASDAQ 100 composite Index and follow these steps:
- Sort list by volume and look for volume moving between 15-20 million.
- Look for a large daily trading range. Take the difference between the high and low of the previous day. Look for a range of $3-$6 but $2-$3 is ok.
- Make your list and follow.
Once you have your watch list of twelve or less stocks established then keep a close eye on the list. From here you can begin your technical and/or fundamental analysis and paper trading. Paper trading, or back testing, is crucial when analyzing watch lists. You can test entry/exit strategies, set targets, stops, work support and resistance levels and manipulate all the technical indicators you wish to develop.
The idea here is to develop a system and work it down to being tradeable. Nothing in this article is meant to endorse any particular stock or investment product but only to provide an idea of where to begin researching a trading strategy. Research is key in understanding your risk with any stock pick.