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All stock strategies
 
  • All-Stars Strategies

Long Common Stock

Who Should Run It

Rookies and up

When to Run It

  • Slightly to moderately bullish
  • Degree of sentiment: +1 to +2

Broader Market Outlook

Although it is possible to make winning trades in virtually any market environment, it’s usually a good idea to evaluate the sector and industry for the stock you’re considering, as well as the broader indices. For instance, you really ought to think twice before buying a bank stock if the financial sector or banking industry is in the tank. Even the best swimmers can be overtaken by strong currents, so be aware of the overall market environment before you dive in.



About the Security

Common stock, as the name implies, is the most common form of stock traded in the marketplace. When most investors talk about “trading stocks” it’s usually common stocks to which they’re referring. Stocks are traded through a broker, like TradeKing, who charges a commission when buying or selling shares. Each share of long common stock represents partial ownership in a publicly traded company, though just how much of a stake it represents depends on the number of shares outstanding.

In general, the goal for long common stock is capital appreciation and/or earning income through dividends, but neither is guaranteed. Although common stocks have historically outperformed many other investments over the long term, this potential performance comes with considerable risk.

Stock Basics: A Quick Start Guide covers many aspects of investing in common stock. The nuts and bolts of going short are covered in the article Short Selling: A Quick Start Guide. Before investing carefully consider your investment objectives, the risks, transaction costs and fees.

The Strategy

When you own common stock, obviously you’re hoping that the firm will be profitable and you’ll share in the benefit of those profits. If you own a dividend-paying stock, you’d like to receive juicy dividends and you’d like to see a nice (if not spectacular) increase in stock price after a while. Some investors feel the higher the dividend, the less they are concerned with increasing share price over time, since they are already receiving income from owning the stock. If you own a non-dividend paying stock, then any gains you could receive would ultimately come from an increase in the stock’s price.

This might seem like a most simplistic play, but it’s rendered unbelievably complex by the simple fact that picking winning stocks is difficult. The best way to go about choosing winning common stocks has mystified, confounded and befuddled investors for as long as stocks have been traded. Furthermore, the markets don’t behave in what appears to be a rational manner. You might see stocks grow profits or beat earnings estimates and still decline in the long run. Nevertheless, on Wall Street, you can’t appeal the outcome of your trades. As the old saying goes, “The market may not always seem to be right, but it is never wrong.”

Time Horizon

Long common stock is frequently traded across all time frames, from the extreme short-term to the extreme long-term. Your time horizon may vary according to your investment objectives, skill level, risk tolerance and available capital. If you are planning on a short-term trade and it isn’t working out, don’t give it extra time to perform. Get out according to your schedule and go on to the next trade. If you find yourself saying, “I’ll give it just one more week,” you’re probably guilty of breaking this rule.

When to Get In

You might consider going long common stock if:

  • The stock is already on the rise, generally speaking. It’s usually a bad idea to pick a stock that’s on the decline with the intention of hitting the very bottom of a downswing, because it’s nearly impossible to pick the bottom.
  • Fundamental analysis shows the financial health of the company is sound.
  • There are bullish technical indicators setting up for your stock.
  • Company insiders are purchasing shares in large quantities.
  • There are positive rumors about an upcoming news announcement (earnings, for example) that’s anywhere from two to six weeks in the future.
  • Using sector rotation, the company is in a sector or industry poised for growth coinciding with the next phase of the economic cycle.

Wall Street is not a laboratory, so analysis is not done in a vacuum. Feel free to combine methods to help you get in at the most opportune time you can determine.

Last but not least, try to avoid acting on tips you might hear around the proverbial water cooler. By the time Joe Public knows about it, it’s usually old news

When to Get Out

Long stock holders might sell their positions based on any of the following:

  • You’ve reached your profit target. Don’t get greedy. Get out before the stock reverses.
  • Your predetermined stop–loss has been triggered.
  • Fundamental analysis shows the financial health of the company is under fire and is no longer on solid footing.
  • There are bearish technical indicators setting up for your stock.
  • Company insiders are selling shares in large quantities.
  • Before earnings are released (or before some other upcoming event that’s been creating a wave of downward momentum).
  • Using sector rotation, the company is in a sector or industry expected to face challenges in the next phase of the economic cycle.
  • There are upcoming events that might generate negative news.
  • You’ve given the stock adequate time to perform, and it’s not demonstrating much in the way of bullish activity. Stick to your planned timeframe.

Trade Management

Anytime you enter a trade, you are obviously expecting the results to be outstanding. But as you know, that will not always be the case. Even the most carefully chosen trade can go south in a hurry.

Just because you’re in the trade, it doesn’t mean your hard work is over. It’s just begun. If any of the analysis you used to get into your trade shows signs of trouble, take action to reduce or exit your position, if warranted. You’re responsible for knowing the timing of upcoming earnings announcements and dividend actions. Be sure to check news for the symbol you’re trading in case a merger, spinoff, major lawsuit or the like is announced. It’s important that you thoroughly understand all of the news related to your stock, which is sometimes no small feat.

You need to have a trading plan and stick to it. This involves evaluating your capital for investment or trading purposes, your personal trading style, and your stomach for risk tolerance. There are two considerations most trading plans include. The first is how much is the maximum amount you should invest in a particular stock. The other is the maximum stop-loss percentage. Remember to follow your trading plan not just at the beginning of a trade, but also in the middle of one.

Scaling in and out is an approach planned in advance for getting in and out of a trading position in phases instead of all at once. This appeals to traders who don’t want to rush in (or out) of any investment. Consider “pyramiding up” to buy more when you’re right, but avoid “averaging down” or “doubling down” when you’re wrong. Obviously, the more frequently you trade, the more transaction costs you will incur.

You don’t have to be right all the time
The good news is you don’t always have to be right if you stick to a stop-loss plan. Let’s say you pick ten stocks. Seven might be losers, but if you stick to a predetermined stop-loss you can avoid major catastrophes. Then trades eight and nine might be small winners, and the tenth could be a big winner that puts you into the black even with the seven losses.

Of course, that makes the assumption that you are able to stick with the big winner without getting excited and cashing in early. The less likely you are to stick with your winners, the better you need to be at picking your stocks. The key is simply to have a predetermined trading plan and stick to it without fail, which is sometimes easier said than done.

It’s important to set realistic goals. If a stock has shown a nice rally and then begins to peter out and show signs of a downturn, don’t get greedy and hope the rally will resume. If you’ve hit your predetermined goals, take the money and run. Far too many traders give back a big chunk of their gains before realizing a downturn isn’t temporary.

Conversely, if you’ve picked a major winner and all the indicators are still bullish, don’t get overexcited and cash in your chips. If the stock takes a little dip, but all indications are for a return to higher prices, don’t abandon ship just yet. Just be sure you have accounted for acceptable volatility in stock price in advance, and if it starts to dip beyond that range by all means get out. Feel free to exit piecemeal, as the situation dictates.

It can’t be overemphasized that you must approach every trade with a predetermined stop-loss. Some traders think somewhere around 5-7% is an acceptable range, depending on the volatility of the stock. If you reach your stop-loss, get out. Don’t start to rationalize about why the stock might make a turnaround. Exit the trade and focus your attention on finding better places to invest your money. However, please note if you enter a stop order or stop limit order, this will not protect you from gap risk if the stock opens down sharply overnight or if trading is choppy or halted during the day. Gaps may result in losses in excess of your predetermined amount.

Volatility Factor

Each stock has a figure known as its “beta.” This is the percentage that the stock price is expected to rise or fall as its benchmark index (commonly the S&P 500) rises or falls 1%. If stock XYZ has a beta of 1.5, then it will be expected to go up 1.5% if the S&P 500 rises 1%, or fall 1.5% if the S&P 500 goes down 1%. That means it is 50% more volatile than the market at large. Knowing your stock’s beta can give you some indication of its volatility compared to the broader market.

Some stocks are more volatile than others. How much fluctuation you’re willing to allow to the downside depends on the volatility of the stock. For instance, you may be willing to tolerate a 7% dip in an internet high flyer as opposed to a 5% dip in a venerable blue-chip stock.

Although it’s fine in theory to agree to a potential decline in stock price, it can be nerve-wracking to watch a stock you own decline by 7%. When you see the actual dollar change in value, you might be tempted to get out early before giving the stock a chance to recover.

If it really looks like you’re going to hit your stop-loss, it’s sometimes OK to bail early. But don’t waste time second-guessing yourself if the stock rebounds later. You can only act with the best information available to you at that time. On the other hand, don’t be stubborn if you’re wrong. If your trade looks like a loser, get out, never look back, and stop getting quotes on it.

TradeKing Margin Requirements

After the trade is paid for, no additional margin is required. If you understand the risks, long common stock can be purchased on margin as long as you have a margin account which meets the minimum equity requirement of $2,000. Not all stocks may be purchased on margin. For stocks above $6.00, the initial margin requirement is usually 50% of the purchase price and the maintenance requirement is usually 30% of the current value. These requirements could increase due to market volatility, fluctuations in the stock’s value, concentrated positions, trading illiquid or low-priced securities and other factors. You can read more about this in Long Common Stock on Margin.

TradeKing Tips

  • News events and their impact on stock prices are tough to gauge. If the company’s earnings announcement is coming up (or another important event), you may want to hold off on making that initial investment. On the other hand, if you have good reason to think positive news will boost your upcoming investment, by all means get in before the next big rally gets underway.
  • Think twice before putting all your eggs in one basket. Weighting your portfolio overwhelmingly toward one particular stock or buying a bunch of stocks in the same sector (e.g., limiting yourself to high-flying tech stocks) can expose you to considerable risk. When looking over your portfolio, it’s important to ask yourself, “Are my stock holdings truly diversified?”


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