Picking stocks is not easy. Thousands, if not millions of people are researching various stocks to buy and sell as we speak, and many of them are going to wind up losing money. In order to make money, you have to outsmart some pretty smart people, and that isn’t easy. However, I think that there are things that you can do in order to give yourself an edge in the process. These tips won’t guarantee success, but they will give you an advantage, and perhaps more importantly they will instill a winning mindset that mentally prepares you to make the difficult trades and investments that can make you money.
1. Be a contrarian
This isn’t necessarily a hard and fast rule, but you generally should be a contrarian. Look at what other investors and analysts are saying about the stocks that you like or own. If they all like it and have price target well above the current market price then chances are that they own it, and there are fewer potential buyers of your stock. It also means that the bullish case is already priced in.
As an investor, your job isn’t just to isolate bullish scenarios, but to isolate companies with bullish scenarios that aren’t yet priced in. For instance, take a look at Netflix (NASDAQ:NFLX). I don’t think anybody doubts the company’s ability to execute and the fact that it is in a secular bull market. But this has led investors to bid up the shares to unreasonable levels, and it follows that Netflix is probably a poor investment at current levels. Now when the stock was trading in the double digits and investors were coming out and doubting the company’s ability to execute, there was a buying opportunity, but it is too late, at least for now.
2. Look under the radar
If you are looking at stocks that have large market capitalizations and dozens of analysts covering them, then you are trying to outsmart hundreds, if not thousands of people. One of the things that smart people realize is that out of 1,000 people there are probably some that are even smarter, and this is not a good environment to compete in.
So you should look under the radar. There are thousands of small companies that trade all over the world, and if you pick one that only has coverage from a handful of analysts and which only a few people follow then there is a much better chance that you can have a unique insight into the company, and this is what’s necessary to exploit the valuation disparities that make you money.
So while I don’t completely ignore large companies in my research and in my investing, most of my time and investment dollars go towards much smaller companies.
We are told to diversify our investments. The idea here is that if one sector doesn’t work out then your portfolio isn’t hit so hard.
But while this makes sense to a point there is a downside. The more stocks and sectors you analyze the more difficult it becomes to give yourself an edge. For instance, if you study five sectors how do you have an edge over somebody who spends all of his or her time on just one of these five sectors?
This is a difficult balance, and there are no easy answers. But at the very least if you want to be a successful investor, you need to become fluent in at least one sector. If you do this then you will not only have an advantage over most people who are investing in that sector, but it will give you the confidence to buy stocks that are down and hated, and this is key. If you don’t know a particular stock or sector you will not have the guts to make the contrarian bets that can make you serious money: you will likely assume that because the stock is down that there are people smarter than you who are selling, and that you should simply stay away.