Stock picking

A stock pick represents an active portfolio management technique, where an investor uses a fundamental and price analysis to decide, whether a particular stock would represent an interesting investment and should be added to investor’s portfolio. The outcome of this analysis can have two different conclusions: 1. the data shows that the stock is under-performing and has greater inner value, so investor enters long position 2. the stock is over-valued, and investor decides to open short position.

Performing a stock pick is a very demanding process with many steps, while there are many factors to be considered. First of all, an investor should choose his investing screen. Does he want to invest in the early-stage industry or mature industry? Does he want to invest in high growth companies or companies with higher dividends? Does he want to concentrate on small-cap or higher-cap companies? All of these factors should be considered before stock picking. Once the investor sets his investing screen, he continues with analysing each stock individually according to indicators such as P/E ratio, balance sheet, debt and many others.

The reason behind the active management of a portfolio is the prospect of higher profits compared to passive portfolio management. Investor, that invests passively to ETFs automatically buys a basket of stocks that he cannot manage. This basket is usually derived from an index such as NASDAQ or S&P500. The main goal of the stock picking strategy is to beat the benchmark set by passive investing with picking the better-performing stocks.

However, this strategy on its own brings not only higher profits but also higher risk due to the limited risk diversification. Using only stock picking strategy, the investor does not hedge his positions by other stocks, the portfolio might not be diversified enough across industry sectors, and country risks might not be spread as well. Therefore, the strategy of stock picking could be considered as a great asset, mainly in combination with other trading technique.

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    The Encyclopedia of Quantitative Trading Strategies

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