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Brain, Meet Brawn: How to Pick a Stock

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October 15, 2014

How do you find a good stock to trade? I get that question from two types of traders. The first type is someone who’s just starting out, who’s learned a few strategies but doesn’t quite know in what stocks to employ them. The second is someone who’s been trading for a while and who may feel like she’s in a trading rut with her current stocks or indices, or overall she just isn’t finding enough opportunities.

Mastering the Universe

Naturally we strive to be democratic in life. But to most traders, stocks, ETFs, and indices are not created equally. Among the thousands of choices, some underlying products might present better opportunities or benefits than others, and deserve more of our attention. The trick is honing in on a ”custom” short list that you will trade. Finding good trading spots takes time. But focusing on a subset of symbols—what I like to call a “trading universe”—is a way of streamlining and managing the process so it’s less overwhelming. Instead of waking up every morning and looking at thousands of symbols, look first to the symbols in your own trading universe—think home planet vs. galaxy.

The idea is to create a list of trading symbols you can monitor without having to continuously search for new ones. If you’re new, maybe your universe will have 20 symbols. A veteran trader might have 200. Having a consistent set of symbols you observe day after day will also help you build greater knowledge of your preferred stocks and indices, how they move in relation to each other or the market as a whole, whether they’re more or less volatile than other stocks, or react more or less to news events or government data. Consider a few tips on building your own universe using the Market Watch tools on TD Ameritrade’s thinkorswim® platform.

Trading broad indices and sectors. When creating your own universe, you might look first in index products and related ETFs. This can be especially useful for new traders, though this may appear counterintuitive because indices sound big and volatile. But indices, particularly diversified ones like the S&P 500, Nasdaq 100, Russell 2000, and the Dow Jones Industrial Average are often less volatile than individual stocks because they have less unsystematic risk.

In finance, broadly, there are two types of risk—systematic, the risk inherent to all stocks and which diversification can’t reduce; and unsystematic risk, the risk particular to an individual stock and which diversification can help reduce. Also, some index ETFs have some of the most liquid and actively traded options, as well as single points between strikes. This can help you uncover defined-risk strategies that have relatively little risk. How do you find these potential opportunities?

  1. Refer to Figure 1. Go to the Market Watch page and the Quotes sub-tab.
  2. Click the dot next to the word Symbol in the upper-left-hand corner, and select Public from the drop-down menu. This opens up a list of commonly used symbol watch lists.
  3. Click Indices to see symbols for index products, and All ETFs to see their symbols.
  4. If you’re looking at an ETFs list, click on the dot to the left of the word Symbol again, and choose Customize.
  5. Select Volume from the list of available column headings, and click the Add Item button to have it displayed on the symbols list. You can click on the Volume column heading to sort the symbols by volume. That will let you see the most actively traded ETFs. There isn’t any volume for indices, though. 

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FIGURE 1:

Scan for your universe of stocks using the Quotes page under the MarketWatch tab of thinkorswim. Clicking the dot to the left of the word “Symbol” gives you access to all the public lists as well as lets you customize the different columns to the right of each symbol. For illustrative purposes only.

Trade what you know. The next stock set you might consider for your personal universe are those issued by companies whose products and services you know and like. Consider the things you buy everyday—from breakfast cereal to gas to jeans to staplers. You may have encountered this approach from famous investors like Peter Lynch or Warren Buffet. But there’s another important step: make sure the stock and its options are actively traded. No matter how well you understand a company, trading its stock and options is harder if those products are not liquid.

So what do you do if a stock you like isn’t liquid? Find a correlated liquid alternative—that is, they often move up and down at the same time. Many stocks share an industry group with others, and with which they may be correlated. If you’re bullish on one stock in a sector, you may likely be bullish on another. So given a choice of a more or less liquid stock in the same sector, it might make sense to choose the more liquid one. How do you find them?

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FIGURE 2:

Finding Generals Amongst Soldiers. By customizing columns in thinkorswim, you can find other correlating stocks in the same sector that might be more liquid. For illustrative purposes only. 

To find other stocks in the same industry as the company you’re considering, go to the Market Watch page and the Quotes sub-tab.

  1. Type in the stock symbol on a watch list.
  2. Click the dot to the left of the word Symbol in the upper-left-hand corner, and select Customize.
  3. Add the Industry Division, Industry Group, and Industry Sector columns. That will show you the industry classification and sector for your stock. Then click Add Item(s), then OK.
  4. To see other sector stocks, click on the dot to the left of the word Symbol again and click on Industry in the drop-down menu.
  5. Find the industry sectors in which your stock appears and click on the final choice. This will show you the other sector stocks.

Trade what’s hot. To round out your custom universe, how about the stocks on everyone’s lips? If you pay close attention to market news, you’ll have a good idea of which stocks are “Wall Street darlings” in any given year. (For example, 2013 was the year of electric cars, a solar redux, social media, and products that start with “i” in the name.)

“Hot” stocks can present interesting opportunities, though they can cool off just as fast. Hot stocks may not always be solid long-term investment prospects, and may be suited to shorter-term swing trades that try to capture event-driven price changes. Liquidity is just as important with popular stocks. But there might not always be a correlated sector alternative. Misleading star power? What makes a given stock newsworthy can also make it act less like the other stocks in the sector.

Aside from watching financial news, under the Market Watch tab you can find stocks getting some attention.

Top 10. Under the Quotes sub-tab, click the dot next to the word Symbol in the upper-left-hand corner and select Top 10 from the drop-down menu. Here you’ll find some of the most actively traded stocks, or those with some of the largest daily gains or losses.

Sizzle Index. You can also look at the Top 10 Sizzling Stocks. The “Sizzle Index” compares a given day’s total option-trading volume to the previous five days’ daily average. A high Sizzle Index means a lot of trading that day in the option, which can signal public and institutional interest.

Trade Flash. Finally, there’s the Trade Flash gadget to see market events as they happen in real time. Stocks connected to third-party analyst upgrades or downgrades, to news or corporate events, or to large trades pop up in Trade Flash. Click on the Plus icon in the panel’s lower-left corner on the platform’s left side and select Trade Flash from the menu.

High Vol for the Pro

A final stock category that can fit a custom universe may be more appealing to veteran traders. Stocks whose options have higher implied volatility can present opportunities to traders knowledgeable about strategies that benefit from higher vol—such as short puts, short verticals, short straddles, or iron condors. These strategies offer different risk-and-reward levels and capital requirements, which is where experience and knowledge kick in. In fact, your ability to apply these strategies to options can be more important than the actual stock. Liquidity is still paramount even with these stocks, particularly when you’re using sophisticated option strategies. But what the company itself does, or your bullish or bearish stock bias, becomes secondary to your skill at applying the strategies.

Sometimes a stock has higher implied vol because its price has been beaten down. And maybe that’s an opportunity to buy on the dip. Or maybe that’s a chance to sell on momentum. Either way, higher volatility can be fleeting, and these stocks may rotate in and out of your universe on a weekly or monthly basis.

To find these stocks in the Quotes page under the MarketWatch tab, add the Vol Index column as you did previously. (Click dot to the left of Symbol > Customize > select Vol Index > Add Item(s) > OK.) This shows a stock option’s overall implied volatility. If you load a Watch List like the Dow Jones Industrial Average you can sort by the Vol Index column to see which of the Dow stocks have options with the highest implied volatility. You might add those to your universe so you can easily scan them as needed.

Now go out there and build a custom trading universe of symbols. Run your tools once a week to keep your universe fresh. Finding stocks with the methods described here does not guarantee success. But a good personal stock universe lets you quickly scan the market, evaluate trading opportunities more easily, and potentially save a lot of time.

What’s That Symbol Again?

If you don’t know the ticker symbol for a publicly traded company, here’s a quick shortcut in thinkorswim.

  1.  Type a “?” in the symbol field in the upper left-hand corner of the Trade page. That opens the Symbol Table. 
  2.  Click on the Lookup sub-tab in the Symbol Table. 
  3.  Type in the company name in the field at the top. 

You’ll then see a list of companies that have that name along with their stock symbols.

Carefully consider the investment objectives, risks, charges, and expenses of an exchange traded fund before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.

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