As of 12/20/2024   Indus: 42,840 +498.02 +1.2%     Trans: 15,892 +32.54 +0.2%     Utils: 986 +14.76 +1.5%     Nasdaq: 19,573 +199.83 +1.0%     S&P 500: 5,931 +63.77 +1.1%	YTD  +13.7%   0.0%    +11.9%    +30.4%    +24.3%	Targets    Overview: 12/12/2024     44,200 or 41,750 by 01/01/2025   16,100 or 17,700 by 01/01/2025   1,050 or 975 by 01/01/2025   20,500 or 19,300 by 01/01/2025   6,100 or 5,775 by 01/01/2025
Chart Pattern Indicator: on 12/5/24

As of 12/20/2024   Indus: 42,840 +498.02 +1.2%     Trans: 15,892 +32.54 +0.2%     Utils: 986 +14.76 +1.5%     Nasdaq: 19,573 +199.83 +1.0%     S&P 500: 5,931 +63.77 +1.1%	YTD  +13.7%   0.0%    +11.9%    +30.4%    +24.3%
Targets    Overview: 12/12/2024     44,200 or 41,750 by 01/01/2025   16,100 or 17,700 by 01/01/2025   1,050 or 975 by 01/01/2025   20,500 or 19,300 by 01/01/2025   6,100 or 5,775 by 01/01/2025
Chart Pattern Indicator: on 12/5/24

Bulkowski on How to Pick Stocks, Part 1

12/9/2024: I updated the article.

My book, Trading Basics (#ad) is the first book in a series of three called the "Evolution of a Trader." It will teach you about the four styles of trading (buy-and-hold, position, swing, and day trading).

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How to Pick Stocks: Introduction

One of the frequently asked questions is how do I select stocks to trade? This page provides information on building a core group of stocks, ones you will want to hold for the long term. That may mean a year, three years, or longer. Michaels Stores, for example, was a stock bought out in 2006 that I have owned since 1989 (some shares I held for the entire duration, others I bought and sold multiple times). So, yes, you can hold onto a stock for the very long term, and the longer you hold, the more likely it is to double, triple, or perform as well as Michaels. I bought and held shares from 1990 at a split-adjusted price of 88 cents and the buyout was at 44. That is nearly a 5,000% increase, and that is the type of return I seek from my core holdings.

The preferred holdings will be these.

• Beginner: Start by buying exchange traded funds (not mutual funds, because you have to wait for end of day to trade them). Own three ETFs and hold them. See how they do compared to other market indices. By that, I mean compare the performance of the ETF with how other indices and other ETFs. If you buy an ETF that tries to duplicate the Dow industrials, then how does the performance compare with the Nasdaq or S&P 500 indices? After buying and holding onto the three ETFs for a year (or as you acquire money to buy more securities), then look at individual stocks.
• Advanced: Continue to hold the ETFs you already bought, but you can dabble in individual stocks. Think of the ETFs as your basic ingredients and individual stocks as the seasoning you add to your portfolio. Buy one or two issues and see how they do. Continue to add stocks and other ETFs (or add to existing positions) as you make money. Perhaps add some dividend paying stocks (like utilities) and hold them for years. A utility or insurance company with a 4% yield now can grow the yield to 8% or 10% when they increase the dividend. I'm not talking about searching for a utility paying 10%. I'm talking about a company with a stock at $20 paying 20 cents a share per quarter. That's 80 cents (four quarters) or 4% a year. If they raise the dividend to $1.00 a share, the yield on your $20 purchase is now 5%. Maybe the stock has risen to $25, too. Do you see how this works?
• Senior: Because stocks can make dramatic declines on adverse news or missed expectations in one day, you'll want to stop buying individual stock and move back into ETFs. You don't need to own a lot of them because each ETF will own many issues (even non-diversified ETFs will hold 10 or 20 securities). Unless you want to overweight a sector, pick your ETFs so their holdings from fund to fund are different. In other words, if you own three ETFs and each one of them owns Microsoft as one of its top 10 holdings, then your diversification is less than desired (depending on your goal). If Microsoft suffers, then each of the three ETFs will suffer.

How to Pick Stocks: What to Avoid

When starting out searching for stocks to buy, you might listen to advice from others. That advice can come from a broker, a newsletter, television, social media, friends, relatives, and other sources.

Likely, it'll be wrong, or wrong for you. One trader told me that he became profitable when he ignored the advice from his broker, his friends and relatives, and started doing his own research.

Do your own research and don't be swayed by what others tell you. Ignore insider information or hot tips. Market manipulation is still a problem in this country with criminals pumping up share price using social media and selling as the price nears a peak.

How to Pick Stocks: One Approach

One approach is to bottom fish. What does that mean? It means finding quality stocks priced at an unusually low value (below where you think they should trade or below their intrinsic value). Buy low, sell high.

Look at stocks grouped by industry. If you find a stock making a new yearly low, but it is the only one in the industry doing so, then stay away from it. Chances are it is a dog, a stock that may stay down for a long time while the others soar. Clearly, there is something wrong with the stock or else it would not be trading near the yearly low.

Look for entire industries that are weak. Then find a compelling situation within that industry. Take your time before you buy. Weak stocks have a tendency to get weaker and make new lows. When the bottom comes, price often forms an ugly double bottom. The other stocks in the industry will be showing higher lows, too. If so, that might be the time to start nibbling. Price might still collapse, so be careful. Over the long term, a year or two, you will be buying near the bottom and setting yourself up for the double, triple, or better.

It takes time for a company or industry to cure their problems, so have patience.

Buying an industry that is doing poorly takes courage. It is a dangerous play, but one that can lead to large profits over the long term.

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How to Pick Stocks: Approach Two

Have you heard the phrase that bottom fishing is like trying to catch a falling knife? You can get very bloody doing so.

You can try picking stocks and industries that are making new highs. This is called momentum investing or momentum trading. Buy high, sell higher. These strong relative strength stocks and industries tend to remain strong for months or even years.

Buying at or near the yearly high means you don't have to worry about overhead resistance. Let me explain. Novice traders don't sell a stock a $93.29. They sell near $100, so when a stock nears 100, we see it pause or even reverse as the novices sell their stock as a group. That causes resistance. The stock will near 100 and struggle to go higher. Overhead resistance often happens with numbers ending in 0 or double 0, such as 10, 20, or 100.

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How to Pick Stocks: Industry Selection

I use a top-down approach, getting the big picture and drilling down to the individual stocks. I consider demographics, population trends, and other factors when I examine industries I think will do well over the long haul.

Where do you get such information? Visit your local library and ask if they have Value Line.

Value Line is a newsletter, nothing more, so treat it as such. But it does have a good reputation even though I have found their projections wildly optimistic.

At the end of the company index, they show industries ranked in order of timeliness. Timeliness is an industry rank of the stocks in that industry for price performance over the coming 6 to 12 months. I pick from industries I like and think will do well. From those industries I select companies.

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How to Pick Stocks: Company Selection

Let's stay with Value Line. When evaluating a stock, I look for the following on the Value Line pages.

• I read the industry comments at the start of each industry/company list, just to see if I am making a mistake or not. I also look at the relative strength (RS) graph on the industry page. If the industry RS is going down, then I may reconsider buying any company in that industry. I like to see RS trending upward. A falling RS may turn flat for years before beginning a new up trend. Look at several industry RS charts and you will see what I mean.
• Flip to a company page. In the upper left are the rankings. You will want to select stocks ranked 1 or 2 for performance and considered safe. Value Line recommends safety ranks of 1 or 2 for conservative investors or 3 to 5 for aggressive ones willing to assume more risk.
• Immediately below the rank are the 3-5 year price projections. If the stock does not have a good price target years out, then skip it unless you think otherwise. The projections are guesses, so keep that in mind.
• Below the price projections are the record of insider trading. If the company officers are dumping the stock, should you be buying? I like to see knowledgeable people buying the stock.
• On the price chart, I want to see a stock that has a heartbeat -- price looks like waves approaching shore or is trending upward at a good clip. Along the top of the chart are the yearly high and low prices. Look for doubles and triples between the yearly low and high. The company may be a dud but if you can buy near the yearly low and double or triple your money in a year, then that's good. Avoid stocks that are flat (unless they pay big dividends and you are interesting in collecting dividends) or trending downward. Focus on stocks with price trends moving up.
• At the top of the page, it shows the P/E ratio and relative P/E ratio. If you see NMF (not meaningful) in one or both entries, then turn the page (pick another stock) unless you have a strong feeling about the company.
• In the tables, look for higher earnings each year without any or few recent deficit years. As a good rule of thumb, the last 3 years should show higher earnings. If the economy was in a recession or the industry was having problems, then make allowances.

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• Look at the annual sales. You want to find a small company. They are the ones that do well in a growing economy. I use market cap as a measure of company size. The big caps ($5 billion) are good when the economy/stock market tumbles (the stock retains more of its value). Many mid caps stocks ($1 to $5 billion) are good, just not as good as the small caps (below $1 billion). My book, Trading Classic Chart Patterns (#ad), pictured on the right, discusses market caps and invariably, chart patterns in small cap stocks perform best in a bull market.
• On the middle left, where Value Line talks about capital structure, you sometimes find the market cap category. Again, small caps do best, then mid caps and then large caps in a rising stock market. In a falling stock market, the order reverses. Large caps retain most of their value and small caps get slaughtered.
• Look at the long-term debt. As my research on fundamentals shows, companies with long term debt tend to perform better, much to my surprise. Many startup companies have no long term debt and many of them go broke. Debt is fine as long as it is not burdensome. In a recession, no long term debt helps.
• Below the rows of numbers is the Business section. At the end of this section, it shows how much of the company stock the insiders and institutions hold. I like to see insiders holding lots of stock. That way, they feel my pain when the stock tumbles, and I want their blood mixed with mine when it happens.
• In the same section is the company address. I avoid foreign companies. I once received a dividend notice from a company in Canada and my dividend check was kept by the government for taxes. I could ask for a refund by filling out a form and mailing it in, but the cost of doing so was more than the dividend was worth. I skip that hassle and just invest in U.S. companies.
• Dividends. If a company pays a dividend, that is a plus for mature companies but a detriment for young companies. You want to find the fast growers, the ones in which earnings are exploding. If companies pay out their earnings in the form of dividends, then they are not investing as much in the company. Don't misunderstand: I like companies that pay dividends, just not when they are starting out. When growth slows and they start loading up on dividend payments, then send me the check!
• Be sure to read the comments about the company in the lower middle of the page, but recognize that they are just guessing about trends. In my opinion, Value Line reviewers are optimistic, meaning they make statements that do not materialize. Just read some Value Lines that are years old and you will see what I mean.

These are the steps I go through when looking for stocks to add to my portfolio. Whether they will outperform or not is a different question. By 'add to my portfolio,' I mean I may monitor the stock for years and never buy it.

-- Thomas Bulkowski

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See Also

• Here are three lame tips to help you pick stocks.
• Adam and Eve patterns. What are they and how can they help?
• Busted chart patterns. The answer to profits?
• Two candlestick tips could improve profitability.
• Candles near the yearly low perform best.
• Premature buying. Learn how to prevent buying too soon.
• Stocks that double. Discover what attributes they share.
• 12 tips for stock selection.

I may not be right, but I can sure sound like it.