It’s rarely a good idea to make a snap decision when trading stocks. Relying on instinct may feel like the right way to go sometimes, but more often than not, it ends in a loss. Research and careful risk management is definitely a better strategy. There are several factors to consider when you’re deciding whether or not a particular stock is a good buy.
This is more of a general factor that will often dictate whether or not you research a given stock at all, so whether or not the stock meshes with your investment goals is your first consideration. For instance, if you’re interested in making long-term investments for retirement, choosing stocks that pay dividends is a good bet, as this makes it easy to compound your earnings by reinvesting the dividends.
According to Warren Buffet, it’s never a good idea to invest in something you don’t understand. That means that researching a company—understanding what it does and how well it does it—is your first order of business when you’re seriously considering a stock purchase.
How well any given stock performs is highly dependent on the company, of course, but the overall market and economic climate also plays a role.
When you’re researching the stock itself—versus researching the company, the numbers you’re looking for are the price/earnings ratio, the beta, and the stock value over time, represented by the chart.
Investment charts are easy to learn and hard to master. The basic message of an investment chart is that if the general trend shows the stock going up, then it’s worth considering further. If it’s going down, stay away.
Price/earnings ratio measures the price of a stock against the company’s earnings. To reach this figure, divide the per-share stock price by the company’s most recent 12-month earnings per share figure.
The beta measures the volatility of a given stock, typically over a 5-year period. In general, the higher the beta value of a stock, the more volatile it is, and the higher the risk you take on when you invest. A value over 1 is considered high-risk, and a value under 1 is considered low-risk.
All of the above factors combined help to determine what level of risk a particular investment represents. All investments entail a certain amount of risk, and it’s up to the individual to decide what level of risk they’re comfortable taking on. Whether you’re comfortable with high-risk investments, or you prefer to stick to low-risk trading, the key is making sure that your risk versus reward ratio is good enough to make it worthwhile.
