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How to choose stocks
SaxoInvestor
Saxo Group
Investing in individual stocks can be more complex and time-consuming than investing in ETFs or mutual funds. If you decide to invest in stocks, it’s important to follow a structured approach and have a clear understanding of what you’re doing to avoid common pitfalls and unnecessary mistakes. This approach is essential for making informed decisions and managing risks effectively.
- Consider the market: How is the overall state of the economy, what about economic factors such as interest rates, inflation and geopolitical situation. How is the stock market performing and how is it valued?
- Identify a sector: When identifying the sector you want to invest in, be aware that there are defensive and cyclical sectors. Defensive sectors, such as utilities, consumer staples, and healthcare, are known for their resilience. These sectors tend to be less risky and withstand financial downturns better than their cyclical counterparts. Examples of cyclical sectors include automobiles, construction, travel and luxury goods. Those sectors tend to suffer more in time of crisis. Why is this important? Because selecting the appropriate sector will determine the risk of your entire portfolio. Of course, personal preferences also play a significant role when selecting sectors.
- Use a stock screener: The next step—once you know which sectors you are interested in—is to use a tool known as a stock screener which is available on most brokers’ platforms nowadays. A screener enables you to filter stocks based on specific criteria, reducing the vast universe of stocks to a more manageable list that meets your investment requirements. This tool helps you quickly identify potential investment opportunities by focusing only on stocks that align with your predefined parameters. Note screened list of stocks is not a buy list but rather a list of potential options.
- Do your research: This step is crucial and we cannot emphasize this enough: you must do your research before hitting the buy button. This entails understanding the company’s business, its competitive position and the industry trends. A review of the company’s financial statements will allow you to assess whether the company is financially healthy, profitable and growing. Take a look the company’s financial information and ratios such as its assets, liabilities, debt, revenue, profit margins and cash flows. Look at the company’s PE ratio to determine if the stock is fairly valued, overvalued or undervalued and compare the PE ratio to industry peers ratios. A thorough research will help you make better informed decisions, which can lead to more successful investment outcomes.
- Look at the stock’s trend line: Once you have determined the stocks you are interested in buying, you can have a look at the charts. You know what you want to buy, and the chart can help you determine when to buy it. If you do this, you will have combined fundamental analysis with technical analysis. This does not mean that you will only buy winners; there will be stocks in your portfolio that will behave differently than you expected. This underlines the importance of risk management. If you are bullish on a stock and you buy it, how comfortable (or uncomfortable) are you with being wrong? Will you take your loss at minus 10%? Minus 20%? Make sure you answer these questions upfront and use stop-loss orders to protect your capital.
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