The best stocks to pick for short term trading are well capitalized stocks that have good trading volume and steady price movements. They are usually part of a well-recognized “group” of stocks (i.e. Banks) and they should trade in correlation to a major stock index. (Dow; Nasdaq)
By far the number one question I get asked by new traders is: how do I find stocks to trade? I usually answer their question with the following question back: “what type of trading are you planning on doing?”. Most of them don’t even have a clue what I am talking about. If you get one thing out of this article, leave with the understanding that you need to definitively decide what your trading style going to be and then work your butt off to get good at it. You cannot figure out how and where to find stocks to trade until you make the decision on your trading style.
Table of contents
- Step by step way to choose stocks for short term trading
- Why growth stocks are not great swing trading stocks
- Why mid to large cap stocks are best for swing trading
- What characteristics a good trading stock should have
- Industry groups you should never trade
- Conclusion
Here is a step by step way to choose stocks for short term trading:
- Decide on the style of trading you will use
- Define what winning looks like
- Define the characteristics of stocks that have the ability to provide those type of returns
- Create a watch list and track those stocks
- Look for established patterns in their stock charts
- Paper trade these stocks until you can identify a few that work well with your type of trading.
Decide on the style of trading you will use
The first step in choosing stocks is to pick your trading style. Are you going to be a day trader or a swing trader? A scalper or a long-term investor? Different types of trading require different types of stocks. You cannot move forward without taking this important step.
What does “winning” look like
As a swing trader, I am looking for positive gains of 5% to 20% in a time frame of two weeks to two months. For you to become a good trader you must be able to accurately describe what you are looking to accomplish from each and every trade so that you can find the appropriate stocks to look for.
What are the characteristics of a good trading stock?
- Stocks with relatively large market capitalization of ($2B+)
- Stocks with sufficient trading volume (Min 1M shares per day)
- Stocks that that are “good paper”. These are stocks of companies with positive earnings and revenues
- Stocks in well-established Industry groups (i.e. Banks; Pharmaceuticals; Semiconductors etc.)
- Stocks whose trading tends to correlate with a major stock index for you to compare and contrast
- Stocks that trade on the NYSE tend to be better short-term trading stocks.
Create a watch list
Once we have successfully identified some good trading stocks, the next step is to put them into a watch list so you can track their performance on a daily and weekly basis. Most good trading simulators give you the ability to set up watch lists. As I have mentioned I like to use Tradingview.com and their free version gives you one watch list. I find one list is more than adequate for beginning traders, but I do see the possibilities of advanced traders using more. Be sure to make note of the date you first added it to this list so you can accurately watch the price action as it develops.
Look for patterns already forming
Once you have your watch list together, it is now time to start studying the charts of these stocks to see if there are any recognized chart patterns already forming. This is especially true for stock channels. Make sure you check all of the time frames to get a handle on the stock both long term and short term. As swing traders we are looking for channels in the 1-month and 3-month time frames.
Paper trade
Once you have your stocks identified and your watch list set, all you need to do then is start paper trading. The second you purchase at least 1 share of a stock (even in simulated trading) you get a new understanding of the stock and its movement. We call this “putting a stake in the ground” and it changes how you see the stock immediately. You become more aware of its movements and whether or not the stock is acting with integrity.
Paper trading is the best way to get good. If you accept the premise that trading is a skill, then the more you practice the better you get. You should do as much paper trading as you can handle. You can literally get years of experience in a very short time without risking your hard-earned capital.
Paper trading is like going to the driving range in golf or the batting cage in baseball. The difference is that paper trading uses the real market. The only thing that is not real is the money. This means that you get to practice on the real playing field during a real game and not have to worry if you screw up.
Why growth stocks are not always great swing trading stocks
In swing trading, you are looking for 5% to 20% wins in a relatively short period of time. It makes no sense to try to find stocks that have the potential to go up hundreds of percent when you are only looking to capture a small piece of it. Growth stocks can be exciting because of the huge upside potential, but they are equally as dangerous on the downside. Beginners often forget what the goal of swing trading is, and they constantly seek out the next best “home run” stocks. Successful swing traders search for stocks that can provide them with singles, doubles and the occasional triple on a consistent basis.
In the middle of a strong bull market, swing trading can work with growth stocks. However, when market conditions deteriorate, they can be dangerous traps and very difficult to trade profitably. It pays for swing traders to seek out larger stocks with lots of shares, so the price movements are slower and more consistent.
Why mid cap and low-end large cap stocks are best for swing trading
Mid cap stocks are stocks with market capitalization of $2B to $10B. Large cap stocks are those with $10 B or more market capitalization. Beginning traders who are swing trading should look for mid-cap and lower end large-cap stocks.
The reason beginning traders and swing traders should focus on these types of stocks are as follows:
- Larger cap stocks have so many shares trading that it takes a lot of buying and selling to move them in either direction. This slower more deliberate or controlled movement makes swing trading easier.
- These stocks tend to have high trading volume and are very liquid. It is easy to exit these positions since they are trading all the time
- These stocks tend to move in tandem with a general market index. This gives you a great benchmark against which you can compare your stock to see if it is acting appropriately.
- These stocks tend to be part of established market “groups” which allows you to compare and contrast your stocks performance against the rest of the group.
Industry groups you should never trade
There are certain industries that just are not good for trading. The immediate one that comes into my mind are bio tech stocks. These stocks typically have little to no earnings and in the beginning, are basically research and development companies. After the Initial Public Offering settles and the hype is over, these stocks tend to only trade when there is news on the company. With biotech’s this news is usually something to do with the drugs in their pipeline and how they are faring in their recent clinical trials on those drugs.
When a negative announcement about a clinical trial occurs, these stocks tank. When they do go well, sometimes the go up dramatically, sometimes they don’t. In between these news events, these stocks tend to have little trading movement and they usually slowly erode in price until the next news cycle.
There are some stocks and groups that just are not good swing trading stocks. I remember trying to trade Travelers Insurance. It is obviously a large cap stock with a lot of volume. However, a lot of the volume in a stock like Travelers is institutional trading that is done in very large transactions. This does not provide a good price flow in which to trade. Needless to say, I didn’t make much money trading Travelers and I moved on to better trading stocks.
We do not have the time to get through every industry group you should avoid in this post. In future posts we will delve deeper into this discussion on groups you should avoid. For now, just know there are some industry groups and sectors that are not good for beginners and swing trading.
Key Takeaways:
- Before you can learn where to look for good stocks to trade, you must be clear on what type of trading you will be doing
- Growth stocks are not good short-term trading stocks. Many of them have small capitalization which can result in dramatic rise and fall in price. This does not work well with swing trading or short-term trading
- Mid-cap and low-end large cap stocks are best for swing trading and short-term trading
- Stocks with heavy trading volume are good candidates for swing trading.
- Your stock should have a close correlation with one of the major market averages
- There are some industry groups, like biotech’s, that you should never try to swing trade.
Conclusion
Short term trading, including swing trading can be very profitable and is the best way for beginners to get into the stock market. New traders should focus on finding stocks that are good vehicles for achieving their short-term trading goals. That is to make between 5% and 20% in a time frame of several weeks to a couple of months.
As a new trader, you should spend a lot of time searching for mid cap stocks in a reasonable price range that trade in correlation of one of the major market indexes. You should also study the industry groups they are part of and get to know the other stocks in those groups.
Always remember that when it comes to short term trading, consistency is more important explosive upward price movements. You must always align your goals as a trader with the types of stocks you are looking to trade.