Four questions to ask before entering a trade

Petra HessPetra Hess ·

There once was a time when traders could rely on a price chart to make all their trading decisions. However, trading has evolved and gotten more sophisticated. To succeed in today’s markets you’ll need to more than what the “chart” is telling you.

Now, that doesn’t mean you have to be a chartered financial analyst but you should be asking some basic questions before entering a trade. Below are 4 key questions that you should consider 

Does The Stock Have News?
You’d be surprised to hear how many traders jump into a stock without checking to see if there is any relevant news. For example, on July 5th, O’Reilly Automotive (ORLY) released its second-quarter 2017 comparable store sales results.

Source: BamSEC

Source: TradingView

The stock opened 20 points lower and continued to decline throughout the day. Shares didn’t drop because of an analyst recommendation or a rumor. This was the company warning investors that that sales were weak. You see, negative stories can be spun but it’s very difficult when it’s the company warning you.

One of your jobs as a trader is to decipher what the news is and if it’s coming from a reliable source. Now, if the stock dropped because of a blog post or analyst recommendation, eventually buyers would step in, but that wasn’t the case with O’Reilly.

For SEC filings check out BamSEC. If you’re looking for breaking news, Twitter is very good. However, there is also a lot of noise on Twitter so make sure that tweets are coming from reliable sources and not “fake news.”

You can also find headlines on Yahoo Finance, Google Finance, and Finviz. They are all similar making it a matter of preference.

How Is The Group Performing?
Many sectors perform together. For example, when O’Really released its statement, similar companies reacted poorly to the news.

Source: TradingView

Advance Auto Parts (AAP) gapped down as well that day. The logic if O’Reilly is lowering guidance, Advance Auto Parts is probably going to have weak numbers as well.

Now, if you just did a quick look to see if Advance Auto Parts had news you might have missed it because the news was in O’Reilly.

It pays to see how similar companies are performing before jumping into a trade. You can find this information for free via Google Finance.

Source: Google Finance

What Is The Market Cap?
Market cap is defined as the number of outstanding shares multiplied by the current stock price.

For example, On Friday, July 7, 2017 Starbucks Corporation (SBUX) closed at $58.04 per share. The company has 1.45B shares outstanding and a market cap of $84.048B.


Source: Yahoo Finance!

Why Is This Important?
Generally speaking, small-cap stocks will have greater volatility than large-cap companies. A small cap company will react more to a positive or negative catalyst than a large-cap company will.

Case in point, on July 7th, ZIon Oil & Gas Inc. released an update on its drilling operations update. Shares jumped 39%, lifting the firm’s market cap to 281.3M.


Source: Yahoo Finance!

As you can see, small-cap stocks can have strong reactions to news. A large cap, on the other hand, may or may not react to news at all.

What Is The Short Interest Ratio?
Let’s say a stock has had a breakout move but you believe it’s overdone and think it’s a good short. Make sure to check to see what the short interest ratio is before getting involved.

The short interest ratio is the ratio of shares relative to the float.

If a stock is highly shorted, it’s vulnerable to a “squeeze” higher.  Heavily shorted stocks can trade higher on a positive catalyst, buyers are driving the stock up and shorts are covering resulting in upside momentum.

Source: finviz

We see this happen often in Tesla, Inc. (TSLA) after the company announces positive news.

Shorting a stock because the price is too high might make sense. However, the stock can trade much higher if it has a high short interest. This information is important if you’re swing trading and holding overnight positions because the stock has the potential to gap higher on the open.

Day traders can use this information for their entries as well. Instead of jumping right in, exercise patience because the stock can move higher than expected.

Final Thought
There is nothing wrong with using technical analysis to base your trade ideas. However, you’ll have a greater edge if you take the time to ask some basic questions before entering a trade. Answering these questions will help you with position sizing, as well as entries and exits. Most importantly, whether or it not makes sense to get involved with the trade in the first place.

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   Petra Hess runs PetraPicks.com. She is a technical swing trader and long-term investor in domestic and Canadian stocks and ETFs.

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