How often have you bought a stock because someone told you it was a good company to own? It is still amazing to see so many individual investors with such a gamblers mentality when it comes to the stock market. In this article, I will provide you with five simple steps that will help you dramatically improve the odds of making money on every trade or investment that you take. In fact, if the stock you are looking to buy does not comply with any of these steps involved it might be better to simply leave the equity alone. Here is the five step checklist that you should have before buying any stock:
1. What is the current pattern on the chart telling you? The small retail investor has a tendency to buy stocks at extreme highs. Just think about it, why would someone want to own a stock after it has rallied sharply higher for a few weeks or months. I cannot begin to tell you how often the small retail investor has bought a stock at the all time high. For example, in September 2012 Apple Inc (NASDAQ:AAPL) was trading around $700.00 a share which was an all time high. The stock was showing many signs of institutional distribution leading up to that top, but the public was supporting the equity while institutional money was distributing the stock to the public. Do not chase equities after they have made parabolic moves on a stock chart.
2. Anytime a stock receives numerous upgrades by prominent brokerage firms at extreme highs it is often a sign of a top. Apple Inc (AAPL) stock was being upgraded on a daily basis when the stock was nearing the $700.00 level. This is a classic sign of institutional distribution taking place in the equity. In September 2011, J.P. Morgan Chase & Co (NYSE:JPM) upgraded gold to $2500.00 an ounce. Gold topped out a week later at $1923.70 an ounce. In July 2008, Goldman Sachs Group Inc (NYSE:GS) upgraded light sweet crude to $200.00 a barrel. At the time of the upgrade oil was trading around $142.00 a barrel. That same week oil topped out at $147.27 a barrel and declined down to $33.20 a barrel over the next six months. Either these firms are great at calling tops or they simply upgrade these equities so the retail investors can buy what they are selling.
3. Buy stocks that have supporting factors on the chart. Supporting factors will increase the odds of the trade or investment. For example, prior high volume breakout levels will usually be a solid support area on a chart where the institutional money will usually step in and support an equity. Once again, learn to read a chart, it will help you throughout the rest of your trading career.
4. Know the next major resistance point after you buy the equity. It is very important to know where a stock is going to stall out or even pullback once you are in the money. Every stock that is traded will have several major and minor support/resistance levels. It is critical to identify these levels. One little technique that I like to apply is to sell part or half of my position once the stock has reached its first major resistance level. This takes a lot of the pressure off of the individual trader because you now have made some money and can simply protect the remainder of the position with a break-even stop. It is always better when you trade with the houses money.
5. Always have a stop loss on every trade you enter. A stop loss is really the only form of insurance that we have as a trader. Just think about all of the traders in the 1990’s that did not see the 2000 bear market top forming and did not have a stop loss. Believe it or not, there are investors holding stocks from back then because they did not have or use a stop loss. Leading stocks such as Microsoft Corp (NASDAQ:MSFT), Broadcom Corp (NASDAQ:BRCM), and Cisco Systems Inc (NASDAQ:CSCO) are just a few names that are still trading well below their highs made in 2000. The legendary trader Jesse Livermore always stated that everyone should have a hard 10.0 percent stop loss from entry to protect themselves. I personally believe that a solid technical stop loss can work even better, but that is something that you will have to judge for yourself. Either way, a stop loss is critical when trading and investing.