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Should you pick stocks? How do you pick good stocks? These can be burning questions for new investors. Read on to find the right answers for your portfolio.
A lot of Investing advice online focuses on the stock market.
Which makes sense. The stock market is an accessible way for everyone to invest in the market.
You can buy one stock or even partial shares in a company. There are a lot of platforms that cater to smaller investors.
However there are also a large number of investment options available to everyone.
As a beginner investor, even if you have done your homework and decided that investing is the right next move for you and your money. Now you must make a few more decisions. Where exactly in the stock market should you invest? It can get overwhelming!
We often hear about the sexy “investment” opportunities with high upside potential. Options, cryptocurrency, or volatile industries – like technology, marijuana, etc.
These are also stocks that have large downside potential.
Because of the inherently high risk on these stocks, people may choose to sit on the sidelines and forgo potential returns.
In today’s market, there are a lot of opportunities to invest in different securities. These can be done via ETFs, Index Funds or, individual stocks.
For beginners, and risk-averse individuals, ETFs and index funds can be a good starting point for investing money.
Does that mean you should not invest in individual stocks?
That depends. Personally, I do invest in individual stocks because I enjoy the DIY investing approach.
Does that mean it is for everyone?
No.
So I want to discuss all the reasons that stock picking does not work.
But then don’t worry, if you still want to pick a stock, I do have tips to help you pick stocks for your own portfolio!
Why Stock Picking Doesn’t Work?
You don’t have enough money
Market prices are driven by the volume generated by larger institutions. They invest so much more into each trade, that a 1% change in price might actually help them generate a decent return.
If you invest a small amount of money into one stock, that 1% will not result in a lot. And of course, there is no guarantee that the return will be made.
You’re paying retail
There’s no such thing as a free lunch. Even with commission-free trading, your brokerage platform is making money. Here is information about how no-commission platforms like Robinhood make money, from Investopedia.
You can’t react fast enough
By the time you think about making a trade, some trader has already got in and out of that same trade. Professional traders have access to more money, better information, and faster networks.
Retail traders like you and I are no match for larger institutional traders.
The market has already priced in the news
Maybe you see that Apple is about to release a great new product, and want to jump on to the stock.
Remember, that means that others are also working with the same assumption. The stock market is the aggregate of buyers and sellers, driven by supply and demand. The more people who want the stock, the more will have to pay to buy it.
Even if new information were to come to light, there is a good chance that it has already been priced into the stock.
Your emotions will get in the way
Many of us can’t afford to lose a lot of money. Most of us don’t want to lose hard-earned money. And rightly so. We worked hard for it.
Which means we might get emotionally attached to the money we invest. When the market starts to get uncertain, it’s easy to make decisions that are not 100% rational.
No one can predict the future
And if anyone tells you they have a sure fire investment, RUN!
There is never a guaranteed investment. The higher the rate of return, the higher the risk.
Even if you were to argue that you had access to all the information, there is no guarantee that a future event won’t hamper stock returns.
How to Pick Individual Stocks?
If at this point I have not scared you out of picking individual stocks, and it has a spot in your investing strategy, then here are some tips. These tips have helped me become more successful at picking stocks.
I am by no means a professional, these are just some tips I’ve picked up along the way!
Don’t expect all your stock picks to be a success
Not every stock you pick will be a successful trade.
Maybe you bought it when it was trading at its peak. Maybe the next earnings report showed that the company was going to struggle.
Remember everyone has access to the same information as you.
Even after you research the heck out of a stock pick, there’s no guarantee that it will return big.
Diversify: don’t put all your eggs in one basket
When you bet all your money one one stock pick, it is actually gambling.
There are studies that say a fully diversified portfolio, requires about 30 stocks. Others suggest that number is closer to 50 stocks, in order to diversify risk.
Of course, this is an oversimplification and a rule that might not apply to everyone. But it might help you decide if a stock has a spot in your overall portfolio.
Understand the downside
With every stock, there can be significant risk.
The quicker stocks rise, the quicker they fall.
So with every stock, there is a downside risk, especially those that you think have greater potential.
Do your research
Listen to everyone, but with a grain of salt.
Analyst reports can be a great source of information. But again, no one knows the future. Even those who are making a living in predicting the future of companies.
Understand the business/industry
Each stock that you pick, is built on a real company.
Anything that affects that company, will affect the stock, for better or worse.
Decide how long you want to hold the stock
Are you looking to hold for a few days, weeks, months or years?
The company’s track record in the past can be indicative of it’s future success. But it is not a certainty.
If you only intend to hold a stock until they release earnings, stick to your plan and divest.
Don’t get emotionally attached
If a stock has returned well in the past there is no guarantee it will continue to do so in the future, unfortunately.
If a company has a new competitor, or new regulations, this will affect the valuation of the stock in the market.
Be prepared to do the work
I’m not going to sugar coat it. Individual stock picks arguably require more active management. Any bad news (or good news) on a single stock will affect your portfolio more if you hold the single stock than if it were part of a basket (like an ETF).