The basics of stock selection
E*TRADE from Morgan Stanley
To choose specific stocks and ETFs that may be right for you, we suggest following three basic principles. 1. Look for stocks that fit your strategy. 2. Start with broad categories, then narrow down. 3. Use analytical tools to zero in on specific securities.
How to find stocks that might be right for you
One of the first challenges that investors face is sifting through the thousands of stocks and ETFs on the market to find the ones that are right for them. Here are a few key guidelines that can help you take a systematic approach:
- Be disciplined about picking stocks that fit your investing strategy and objectives
- Start with broad categories, then drill down from there
- Use analytical tools and techniques to make precise stock and ETF selections
1. Look for stocks that fit your strategy, not vice versa
Some traders and investors make the mistake of trying to force a stock they're watching into their favorite strategy, even if it's not a good fit. To help stay focused on appropriate investments:
- Be clear about your opinion on the market. Consistently timing the market isn't practical but having an opinion about the direction of the market can help you decide when you might want to be a buyer (or sometimes even when to be a seller).
- Use the advanced screening tools available to you. You'll find a range of tools on the E*TRADE from Morgan Stanley website and in E*TRADE trading software that let you efficiently sift through the huge number of available securities.
2. Start with broad categories, then narrow down your search
- You might begin by selecting a particular sector or industry, like technology, consumer staples, healthcare, or energy. Just add a simple filter to one of the E*TRADE screeners to find stocks in those industries or others.
- Another broad filter is market capitalization, or market cap. This is the number of shares outstanding multiplied by the price per share, and it's a common way to gauge the scale of a company. Screeners can help you find small cap, mid cap, or large cap stocks.
3. Use the tools of fundamental analysis and technical analysis to refine even further
- Fundamental analysis helps you judge the value of a company, and the outlook for its stock, by analyzing the company's financial performance—its fundamentals—as shown in its balance sheet, income statement, and cash flow report. The figures that are in these reports or derived from them can be used to easily compare one company to another.
A commonly used fundamental analysis figure is the price to earnings ratio, or P/E ratio. This is the company's stock price divided by its earnings per share. It tells you how much investors are paying for a company's stock in relation to its profits.
Other fundamental factors like revenue and profit margins may also be useful indicators. You can look at how a particular company ranks by these measures compared to similar companies. Depending on your strategy, you may be interested in stocks that rank high or ones that rank low.
- Technical analysis is used to evaluate stocks by analyzing trends and movements of the stock's price. In other words, you're looking at the stock's price chart rather than the company's financial reports.
Price trends are a key idea in technical analysis. You can set up a screener to view a stock's price relative to its high or low over a given time period. If the price is trending towards new highs, you might want to be a buyer. On the other hand, short sellers who aim to profit from a stock's decline would screen for stocks trending towards new lows.
Moving average is another important figure. If it's trending up, that means that the stock price is also trending up.
- News is another factor that can affect stock prices, especially earnings reports or legal news related to stocks you own or might want to buy. Be aware of upcoming scheduled news events.
With these three principles in mind, you'll have a solid start on selecting stocks. Explore the E*TRADE Education Center for much more on stocks and ETFs, as well as a wide range of other investing and trading topics.