Four Steps To Buying A Stock

As we wind up the year and head into 2009, it’s a good time to step back to consider some of the basics again. If only investors had kept to the fundamentals, there would be far less financial regret over the past 12 months. One of those basics is picking the right investments. In this case, we will examine how to pick a stock.

1) What’s Your Investment Philosophy?

Chances are, if you’re reading this, you are a DIY investor. Instead of throwing money into a mutual fund, you are more interested in getting better returns than an unattended 401k. All the more reason you should seriously consider WHY you buy (and sell) the securities you trade.

Here at Invest With An Edge, we like intermediate-term momentum trades. Without going into too much detail, we believe in picking a mutual fund, ETF, or stock that has been going up and riding it until it stops moving. But here’s the point: you don’t have to follow our philosophy. However, you need to have an investment philosophy before you put on a trade. Determine if you are a growth stock investor, a value stock investor, a mixture of both – and why. Then you’re ready for the next step.

2) Research a Stock That Fits Your Philosophy

After understanding what sort of investor you are, you’re ready for the next phase: research. It’s time to dig deep to see if your next pick will work in your investment scheme. For instance, if you are interested in value stock – stocks with a low P/E ratio and are seen to be undervalued by many value investors – then it probably would not make sense to buy Apple (AAPL) or PepsiCo (PEP). These stocks don’t fit the profile of an undervalued company by most value investors.

Bill Singer recently wrote at Forbes.com on the nature of this critical phase of investing:

“As I have so often lamented during my career, public investors will spend hours online searching for a model of a car to buy, will compare hundreds of prices, will visit many dealers and then browbeat the car salesperson into chopping away at the minimum sticker price; but, that same consumer will buy some unknown stock from an unseen stockbroker from an unheard of brokerage firm, and all too often do so based upon a television commercial or a glitzy Web site.”

3) Determine Your Entry AND Your Exit

After picking your investment philosophy, and researching a stock, you should determine when you’ll get in and when you’ll get out. Oftentimes, investors will simply buy at the market price. That may be the perfect option at times, but now always. In your research phase you may find out that the stock you like often trades in a daily range. Placing a limit order towards the bottom of that range is a smarter way to buy that stock than getting it at the market price.

Secondly, determine your exit before you enter the trade. Yes, I know, this one’s going to the moon and you’ll never look back. Unfortunately, not all of our stock picks will be winners. That’s why you should at least have mental stop-loss orders in place. If, after you buy a company, it falls to a certain pre-determined level, you should offload the position for a loss.

In the same way, you should consider profit-targets at appropriate levels. One of Jim Cramer’s favorite sayings is “Pigs get slaughtered.” Don’t be a greedy pig – take some money off the table on a winning trade.

4) Execute Your Trade

Some new investors are interested in everything being right before making a trade. I’m not saying you invest unaware, but don’t stay on the sidelines forever. The most well-researched stock pick is worthless without execution. I’m sure you’ve heard the phrase “you have to be in it to win it.” The same can be said for investing. You’ll never catch the next Google (GOOG) without clicking ‘BUY’.

In the New Year, find out why you’re still investing, look up some stocks that fit your reasons, figure out where you want to buy and sell, then do it. It may be harder than this, but you have to start somewhere. All the best on your next big winner!