I often get emails asking for what are the good shares for trading in the Indian stock markets? One particular inquirer asked me to name some – fundamentally strong stocks for trading. I think this is worth writing about.
At first, to come up with any coherent answer, the question must be broken in at least three parts depending on the type of trader, and the time horizon with which one works. Let me then answer three separate questions:
I. What are the best stocks for day trading?
Day traders work with one strict principle – never go home with an open position. Naturally then their time horizons are extremely small. Typically they trade in the futures & options (F&O) markets and implement trading strategies to benefit from price differentials across various segments of the market (i.e. cash, futures & options).
Major practitioners – Arbitragers, algorithmic traders and technical or chart based traders.
II. What are the best stocks for short term trading?
Short term traders typically buy and sell derivatives in the futures and options markets with a time frame that typically ranges from a single session to 3 months.
Common characteristics and the most important aspect of day and short term trading stocks:
- Selection – The security (or the underlying security in case of F&O markets) need not be a fundamentally strong stock of a well managed company. The focus is on looking for scripts which get traded extremely frequently (i.e. generate high volume). There is no emphasis whatsoever on fundamentals such as financial record or quality of management.
- Liquidity – the most important aspect of a good trading script is just that – It should be “highly traded” i.e. there should be a good volume of shares changing hands in each session.
- Volatility – volatility is a trader’s best friend. The more frequently a share moves between ranges, more potential it offers of making profits.
III. What are the best stocks for someone who trades in the cash segment of the market with a time horizon ranging from a week to a few months?
A vast majority of retail market participants who do not indulge in the F&O markets buy and sell shares with a simple principle – “if the share price rises in the next few weeks or months, I will sell it, if it falls I will add more to my portfolio”.
A lot of such retail participants end up losing money because they over-commit to the markets (i.e. invest more than they should without paying attention to their need for cash in the near future). They expect or rather HOPE that the share will rise in future but if that does not happen for a few months, they either get tired of holding or their need for cash forces them sell.
If you belong to this third category, make sure that you are not looking for trading ideas on social media and in other online posts. Such posts are typically made by day traders who work with a completely different strategy, oftentimes buying and selling for not more than a few minutes. This third category of traders / investors (and for those who may well be a hybrid mix of the two) will find this particularly helpful. Look for (all) 3 traits before selecting a stock to trade in:
a. If you want to indulge in short term trading, look for fundamentally strong stocks.
With a fundamentally strong stock, even if you do not make quick profits, you have the option of holding on to it for a longer term. With a high quality stock, you should not be worried if the tide goes against you in the short term. You should have strict selection criteria. Sometime back, I had written a post on this aspect with a 6 step stock selection criteria to select high quality investment grade stocks.
b. Look for scripts which have not run up substantially in terms of prices.
One of my favorite Warren Buffet Quotes:
“For some reason, people take their cues from price action rather than from values. What doesn’t work is when you start doing things that you don’t understand or because they worked last week for somebody else. The dumbest reason in the world to buy a stock is because it’s going up”.
I have nothing more to add in this regard.
c. Make sure that you do not over-commit.
As I said above, a majority of investors make losses not because they end up buying bad stocks but mostly because they over-commit to the markets.
- Ideally, when you buy stocks for trading, invest only so much as you can afford to speculate with.
- If you must trade beyond that threshold, make sure that you don’t need the money that you so allocate for at least – X + 2 quarters (where X = the amount of time for which you will be happy to stay invested).