When it comes to making important investment decisions, you want to make sure you’ve done your research before handing over your money. Following are the seven things you should know before buying a stock:
1. Which way is the market moving?
Before you do anything, you’ll need to know what the market is doing. If the market has a strong upward movement, it’s possible to make major profits in short bursts of time. On the other hand, when the market is declining, investors need to be highly selective, identifying stocks in industries that are gaining strength counter to the downward market trend. By knowing which way the market is moving, you can adopt the appropriate investment strategy and set your expectations accordingly.
2. Which direction is the industry or sector heading in?
We often say, “Stocks travel in packs, like wolves.” So when an industry (either alone or with its entire sector) is moving in a particular direction, the odds are good that your stock will follow suit. And while it is certainly possible for individual stocks to gain in value while the rest of their industry is on a downward trend (or vice versa), these “lone wolf” stocks are the exception rather than the rule. To fully understand the risk involved in purchasing a stock, be sure you know which direction the industry and sector are moving in.
3. How does the stock perform relative to others in industry / sector?
When you identify a stock that you’d like to add to your investment portfolio, be sure you look at how that company’s doing relative to other stocks within its particular industry and sector. Good stock tracking software will help you sort this out. This helps you put the company’s performance into context so that you can see whether you’re choosing the pick of the litter or just a mediocre performer in its area. When doing this, pay particular attention to stock fundamentals such as Earnings Rank, Relative Strength Rank and Industry Group rank. These will help you really focus on the key indicators of future stock performance.
4. When are earnings coming due?
We always recommend that individual investors avoid purchasing a stock when quarterly earnings are about to come due. This is advisable because as soon as the earnings report is released, the market will react within a matter of seconds. This can leave individual investors in the lurch, holding a stock which is no longer worth what you just paid for it, due to the nearly instantaneous reaction of institutional investors and their sophisticated trading tools.
5. What is my capital preservation strategy?
When it comes to stocks, making money is the name of the game. So, you’ll want to have a plan in place to prevent steep or sudden losses from putting a huge dent in your wallet. This means having a capital preservation strategy – putting stops in place to automatically sell the stock when the price dips to a particular level. Many investors have learned the hard way how one deep loss in a portfolio can have a big impact on your overall rate of return.
6. Will I still be properly diversified?
When you’re looking for new stocks to invest in, take care not to unbalance your portfolio. A diversified portfolio mitigates risk, so beware of any type of imbalance you may be creating with your new purchase. You may notice, for example, that your purchase will result in having too many stocks within a particular industry, too many growth stocks, too few safe stocks (i.e. “mattress stuffers”), etc. As every intelligent investor knows, keeping your portfolio properly diversified helps protect you from large losses resulting from any one shift in the market.
7. Are my emotions coming into play?
Emotions can wreak havoc with an investor’s decision-making process. For example, impatience can cause an investor to buy before it’s time. Or, fear of being wrong can cause an investor to not buy when they should. And, before you purchase a stock, take a cold hard (unemotional) look at whether your decision to purchase is based on fact or emotion. Once you can conclude that the stock meets your objective criteria and the planned course of action is not skewed by your emotions, you can execute your plan with confidence.
By going through the above checklist, you can spot potential problems and avoid making unwise investment decisions. Over time, factoring in these considerations will become second nature to you as you become an increasingly savvy stock market investor.
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