3 Things To Do Before You Invest In A Stock

David Goodboy's picture

Monday, June 19, 2017 - 2:30pm

by David Goodboy

Have you ever wondered why some stock market investors seem to be consistently profitable while others struggle to just keep from losing their money? 

While many investors wrongly attribute the reason to luck or inside connections, the fact is that the primary thing that differentiates winning stock market investors from the masses of mediocre and downright losing market participants is having a particular system or process for choosing winning stocks. In other words, you need to know the right steps to take before buying a stock. 

A defined stock picking process separates truly successful investors from those who only buy stocks based on rumors, what is featured on the news, or just by making a guess. 
These steps can be easily repeated, so they can be applied in a systematic process to every stock in your portfolio. 

Why Having A System Is Important Right Now
It's unbelievable how high the stock market is climbing. Just a few short years ago, bulls calling for Dow 20,000 were dismissed as crazy fanatics. But what was once only fantasy has become a reality, with Dow 20,000 in our rearview mirror. 

Now, with the Dow currently trading around 21,000, many market experts believe the time is getting short for the bull market, now in its eighth straight year. Remember, bull markets are defined by a continuous upward trend without a 20% or greater price drop in the major indexes. Only four small corrections have marred this nearly decade-long bullish advance.

The market could, in theory, keep pushing higher for an indefinite amount of time. However, history tells us that the bull market may soon crumble into a bearish phase. Rising interest rates and political confusion combined with toppy looking technical patterns confirm the widely held bearish sentiment among professional traders. 

It's in these potential last days of the bull market that knowing what things to do before you invest in a stock become the most critical.

Here Are Three Things To Do Before You Invest In A Stock
Skilled stock pickers do not care what happens to the overall market. Although they are fewer and further between during bear phases, there are always stocks providing outperformance. Here's how you can set yourself up for success.

1. Know When To Pull The Plug
I would venture that knowing when to sell is the number one thing to know before you buy a stock. Having a specific price goal in mind for every stock allows you to operate your investment portfolio like a professional. 

While some investors prefer a particular percentage gain or loss to trigger exit orders, I think flexibility is the key here. Every stock is different, so your exit price needs to be customized for each one. Using technical support and resistance levels on the daily price chart is a time-proven method of determining where to set stop losses and profit taking stop orders.

There is some controversy among investors on the viability of pre-set, profit-taking stop orders. Some believe that closing a winning trade only prevents further gains. Others firmly believe that knowing beforehand what they will accept as a profit is the best way to proceed.

I have found that using trailing stops, once profits are created in the trade, is the best of both worlds. A trailing stop follows price and is only triggered if the shares start to drop lower. 

2. Use Both Technical And Fundamental Analysis
While the two major types of asset analysis are often treated as two opposing methodologies, both the fundamental facts and the technical picture of the shares are needed to fully assess a stock's potential. 

First, use technical analysis to locate stocks breaking out of a trading channel or pulling back during a longer term upward price trend on the chart. Narrow that down to five to ten stocks exhibiting bullish technical price behavior. 

Next, check the news on each of the stocks. Is there a credible reason for the upward move? Is the pullback from the longer-term upward price trend caused by a onetime event? If the answer is yes to one or both of these questions, keep the stock on the list.

Lastly, look closely at the fundamentals of the company. Are the fundamentals solid, do they support the share price? Are the shares trading below their intrinsic fundamental value? If so, the stock may be a great candidate for your portfolio. 

3. Diversify Properly
A critical yet neglected thing to do before you invest in a stock is to figure out how it complements the rest of your portfolio. Proper diversification means not risking too much in any single stock. Beginning investors often make the mistake of going all in on a single stock and hoping for the best. While this can work, it is hazardous and can lead to a disaster. It's best to spread the risk across multiple stocks when investing.

Risks To Consider: The stock market can be very volatile. Even if you religiously apply these rules, you can lose your shirt. Always use stop-loss orders and position size properly when investing.

Action To Take: Try to get in the habit of never investing without applying these three simple rules.

Editor's Note: From proven blue-chips to breakthrough players, these 10 top stocks are rock solid "must-have" material for any portfolio. To find out how you can accelerate your retirement schedule by up to a decade, check out the report here...

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.