One of the questions which we hear all the time at TradeSmart is "How do I find a good stock to trade?" Currently there are around 3600 stocks which you could trade in the marketplace which translate to a ton of opportunity: opportunity to make a good trade and unfortunately, opportunity to make a bad trade. It is no wonder want to know how do to find a good stock to trade. There are a few general principles which we tend to follow.
As a trader, you want a stock which is liquid. Liquidity is basically how easy it is to get into or get out of a trade. For example, if you buy a stock, usually they'll let you buy it, but maybe you decide you want to sell it and there's nobody who wants to buy it. That's an issue of liquidity.
As you trade stocks with high liquidity, you trade stocks that a lot of people are trading, but if you're trading stocks that don't have a lot of people trading them, then you may run into this liquidity issue.
General principle, we want a stock with lots of liquidity.
We want to look for a stock which has a lot of price movement. As traders, we need the price to go up or the price to come down. It doesn’t matter which way the price is moving, but to trade the stock, we need it to move.
When considering the liquidity and volatility of stock, there are a few rules which have grown from using these first two points.
Find a stock which has an average daily volume of over two million shares. This number is arbitrary so if you have a little less than two million, that is fine.
The average daily volume tells you how many people are trading the stock. If it drops below two million from time to time, that's fine as we want the average. You can add a fifteen-day moving average on your daily volume, and it'll tell you what the average daily volume is. As long as it hits around two million, you're going to be fine with your liquidity.
At TradeSmart, we do almost all of our trades with options. If we do buy a stock, we turn around and sell options against it. So, we need to make sure any stock which we are trading is going to be optionable.
The general target should be about a thousand open interest for at the money options. Sometimes you may pull up an option chain and the open interest is around 890 which is still okay to trade. However, if it is around 50, this will end up creating problems for you as the chain executes. Make sure you select the option which has a good solid good open interest amount.
Number one reason we recommend staying away from penny stocks is liquidity. Now they'll let you buy them, but then after the price runs up, what happens? You can't get out of the trade, and you end up holding that thing all the way back down to the bottom, and it is a pain. So, if you want the ROI percentages you get with penny stocks, you need to look at a different market, look at trading options, look at trading forex, or something different.
It is also good to know penny stocks are not regulated in the same way as big board stocks; they don't have the same rules governing them. Including the rules of promotion, which means all those newsletters you see, which say this hot penny stock is going to be the big winner. Guess what? They got paid to send that to you, and they have no financial responsibility to tell you the truth at all. They're just simply doing a write up saying, hey, such and such gold company is a great company.
It's a penny stock. It's trading for 14 cents a share, and we believe in the next four weeks it's going to be over $2 a share. You should buy. They can make up whatever they want to make up and there is no regulation about it. Penny stocks are not liquid, and they do not sell based on the truth, and that is a big problem for us.
Initial Public Offerings or IPOs rarely work out the way that you want them to. There have been a handful good ones such as Facebook for example, and even Facebook when it IPO'd, the first thing it did was sold off, and it went down.
Now the first day or two you might see a really big spike. You might see even a 50% or a hundred percent gain, but then it just crashes very quickly, and there's a lot of rules around the IPO. Which is why, we recommend staying away from an IPO until the stock stabilizes and has a little history behind it.
Remember we're technical analysts and we are going to make our trading decisions based on what the stock has done. If it's an IPO, it has no trading history so you can't make a good trading decision which is why we recommend at least one full year of trading history before trading a stock.
TradeSmart has put together a solid watch list of 150 stocks and ETFs that meet our criteria and can provide plenty of trading opportunity. You can download our list from the links below and if you have any questions just let us know. Enjoy!