- 1). Research at least some fundamental and technical data about the stock. On one hand, a stock represents company ownership. There's no sense in buying a product you know nothing about. Then again, stock price movement is not always a reflection of company prospects, especially in shorter time frames. Stock price is "pulled" by overall market sentiment to irrational highs and lows.
- 2). Look at price-to-earnings (P/E) and price-to-earnings-to-growth (PEG) financial ratios. Price-to-earnings values slightly below 10 (6 to 9 range) combined with PEG values below 1 typically indicate a very good (but never certain) prospect. For instance, price/earnings value of 8 means that for every dollar the company generates (earnings), it costs $8 to buy the stock. Note that this doesn't mean a share of stock is worth $8. If the company expects to generate 10 percent more earnings next year, then forward-annual PEG is 0.8 (8/10). If the company expects to grow by only 2 percent next year, PEG = 8/2 = 4.
- 3). Use a stock screener. Stock screeners are online search filters that sift through a stock database and display only those stocks that meet certain parameters. Stock parameters are set by the user. These parameters can include company debt, trading volume, P/E range, highs/lows for the past year and other variables. Clever filter settings can display stocks that are more likely to give excellent returns.
- 4). Select "momentum" stocks. Momentum refers to an overall (with oscillations) price increase or decrease. This method relies on technical analysis to identify when to buy or sell certain stocks. False signals and time frame are important. Short-term price irregularities can spook an investor into "cutting his losses" when, had he stayed invested, he would have made substantial profits. Momentum trading helps to identify when to shrug off stock price irregularities and when to "really" exit a trade.
- 5). "Buy what you know." So says Warren Buffett, the most famous--and richest--investor in the U.S. Companies that have complicated business plans and risky technologies have an uncertainty that simpler companies do not. Prospects of, for example, restaurant, retail and roof repair companies are (relatively) simple. This simplicity gives insight into how likely, and by what amount, an investment would grow.
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