Once you have identified which market sectors you want to take positions in, and of course, whether you want to be long or short in those sectors, then you are primed to pick specific stocks to trade. Profit to earnings ratios have been rigorously scrutinized by investors for decades, and so it’s unlikely you will find a company with an amazing P/E ratio that isn’t already fairly priced. In the past it was possible to identify these companies and make substantial returns on them, but in todays digital trading arena there are scanners which can search just about every company on the stock market and with a simple algorithm, extract any which appear undervalued (those wretched computer-bots again!). If you want to make huge returns for taking risk in the markets then you will need to be a lot smarter than this.
Your primary aim should be to populate your portfolio with stocks which have potential, this doesn’t mean the company has to be new, it just needs to have great potential for profits at some point in the future. That may be through a merger, when two companies join together (ie. eBay and PayPal), or through an acquisition (ie. Coca Cola buying out Costa Coffee), or it may just be that a company is growing and looks dominant within its sector.
A good way to help visualize this is to create specific case studies and play them out in full to see what happens (a type of role play, if you will); the reason why many individuals trading stocks don’t make money is quite simply, they don’t think things through. The basic rule is that if you want to invest in an area of the stock market then you need to have a thoroughly sound understanding of it, an understanding to a level that would, for instance, make it possible to create a strong and convincing argument on that topic.
If you take a commodity such as electricity; do you anticipate seeing a big increase in the price you pay for this in the future, or will more homes install solar panels and create their own electricity reserves? If you believe this then perhaps you can look further into the solar area and invest in a company there. To explore further, you could find out if there are any government caps or limitations on the prices electricity providers can charge. If there are, it means it’s unlikely there will be any steep profit curves, and it’s more likely that these companies will experience steady and consistent growth on a relatively shallow upward curve (still not a bad investment).
Once you have made a decision to invest in an area it is useful to find out who the major providers are and which one is most likely to dominate long-term, and why. It may be that they have more capital and potential to expand, they might have a member of their board with an outstanding track-record for increasing company profits, or they could have major development plans lined up for the future. When you take some time to research a little about what each company is doing, you will naturally pick up on what is going on within the industry and become much more knowledgeable than the average person with regard to this subject matter. Which is all good news in terms of taking money out of the pockets of traders you are competing against, and into your own.
"Professional traders form a conclusion on the balance of probability that the price of a stock will go either up or down, and you must do exactly the same."
To be a great investor you need to have a passion for research and enjoy finding out about what goes on behind the scenes at a company, and what plans they might have for the future. You then need to frame the research you carry out in order to make an educated guess as to what that company's stock price will do, and why. If you can write down a list of reasons as to why you feel a company’s share value will increase and feel conviction in that argument, then that might be a good enough reason to buy some stock.
Investing in brands which you are a customer of certainly adds an advantageous edge as opposed to any other business you might choose to buy shares in. Having a vested interest, or even an emotional attachment to a company means you are far more likely to pay closer attention to their business activities. Any type of edge that you can gain over other traders in the market should always be explored and used to its full potential, so this is certainly worth considering when building your portfolio.
The term investing is usually defined by the fact that positions are held for the medium to long-term but that is not to say you can be anymore careless with regard to your entry when purchasing a stock, than if you were planning to trade the company intraday. Ensuring you can take a position which offers a high risk to reward ratio from the moment you buy into it is equally as crucial as the work you do researching the stock. You must be equally adept at reading price action and understanding market cycles as what you are at the research work you carried out to determine which stock to invest in, in the first place.
For a company to warrant your investment it has to be somewhat of a golden egg and that means you feel there is something rather special about the business that justifies your involvement, because after all, you are buying into that company, quite literally. If you can start thinking about the stocks which you invest in, in this way, alongside carrying out due diligence in your research then you will be in a much stronger position to profit. By turning yourself into an expert in various business sectors, with bona fide arguments as to whether you see individual businesses growing or declining, you will, by default, become a professional trader with conviction in your positions.