How to Pick Stocks Using the Power of Probabilities

As you know, a probability is the likelihood of a particular thing to occur. If you want to buy a stock that will likely rise or decline (for shorting), you need to understand what makes that probable and line up as many probabilities in a stock candidate’s favor as you can without over complicating the strategy.

Stock trading probabilities then become additional stock trading parameters. to use when looking for stocks to trade. When you set up a scan for potential stock market picks, there are basic parameters like volume or price and then there is criteria based on probabilities.

Let’s take a look at what kind of probabilities you could be adding to your list for how to pick stocks. Some are pretty basic and some are based on price patterns and technical setups that have been observed of strongly tending stocks. The categories of probability factors are news, market trend, fundamental analysis and technical indicators.

News

News would include company-based information including earnings, new products or services or management-related changes. It could also be economic or political news. The probability of a stock going up on good news may be higher than not, but that factor alone is not enough.

Market or Stock Price Trend

The general direction of the market will have an effect on how well your stock trades do for you. Before making a trade, you must know if the market is trending up or down or not trending at all. For example, you would probably want to go long in example A and short in example B.

Fundamentals

For company fundamentals, a high probability factor could be increasing or decreasing earnings, sales, return on investment (ROI) or any other fundamental criteria that can have an impact on the stock price’s value. Theoretically, a company that’s a good value and has good earnings will rise in price. But that’s not always the case as other factors affect the price of a stock, and fundamentals alone should not be used.

Technicals

News, market trend and fundamentals can be a part of your list of stock trading probabilities, but it shouldn’t be your only criteria. News and fundamentals alone can actually be more speculative than applying knowledge of technical indicators to recognize what is occurring with a stock’s price.

Combining technicals with fundamentals can be an effective long-term strategy. However, consider that many mid-term holds for several months that are price “high achievers” may not have the strongest fundamentals so a choice has to be made. Do you want to hold a position in a fundamentally strong stock or a stock with strong price movement?

Most probability discussions are associated with technical indicators and that’s what the rest of this discussion will be about.

Why Technicals?

There’s a theory called Efficient Market Hypothesis (EMH) that proposes a stock price reflects everything that is known and could possibly change the value of a stock’s price. In other words, all of the circumstances that can affect the value are exhibited by the current price.

If that’s true, than studying fundamentals to conclude a stock’s value is redundant. If that’s also accurate, what’s left to interpret price direction? The answer is trader sentiment.

For example, on paper, WTNY is an unimpressive stock. If you look at the fundamentals, they don’t look so great. A look at the competition in the industry group reveals that it is not the best in its group. It’s news hasn’t been overly compelling. So what would induce a non-volatile stock like WTNY to increase in value by 87% in 5 months?

A trader’s job then is to choose a technical indicator to use as a factor of probability for how to pick stocks and focus on the characteristics of a stock exhibiting some kind of momentum or other redeeming factor.

All of the probabilities for how to pick stocks then come together to form a stock trading strategy. The strategy has to be logical, as historically consistent as possible and the potential strategy’s success has to be confirmed by back testing or paper trading it to see if it has some measure of being successful.

Some technical indicators are MACD, Stochastics, Bollinger Bands, moving average (MA), average directional index (ADX) and there are others. Additionally, Japanese candlestick formations can give you probable pattern setups too and should be added to the list of probabilities.

With all of the choices of indicators you could use, you may be wondering how to decide on a strategy for how to pick stocks that will be successful. The first thing is – it’s got to sound good to you. Using probabilities and parameters, think about what has to occur for you to make a trade and create a checklist of criteria as part of your trading plan that any stock candidate must meet. Some combination of factors will generate the most success with one indicator as your main information resource and any additional indicator as a confirming resource. That’s the practical aspect of how to pick stocks using probabilities, but it’s not the end of the exercise. Be certain to spend a bit of time back testing the potential strategy. Ask yourself - did the strategy hold up over a larger percentage of found stocks? Or did it fail more than you’d like? No strategy is 100% accurate, but the higher the percentage, the better.

How to Pick Stocks Using Probabilities Summary

1. Identify probabilities that you think are the strongest.

2. Back test the probable setups.

3. Set up scans to find them.

4. Examine chart patterns/setups.

Now you understand the skill and intellect of how to pick stocks using probabilities! If you're ready, it's time to move on to a list of stock trading strategies and how they piece together to create a setup.


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