I find a 5-to-1 risk-reward ratio is ideal, meaning I can reasonably envision $5 of gains for every $1 of potential downside, but at a minimum, you want a 3-to-1 ratio. That way, even a .500 batter comes out ahead. Use your upside target and your stop-loss to calculate this ratio.
News and Earnings
Lastly, potential purchasers must familiarize themselves with all of the recent news on the stock, if for no other reason than to avoid an unpleasant surprise. Trust me, that's no fun.
Learn if there are any significant upcoming dates that could affect your holding. I've seen unaware investors buy stocks the day before earnings, only to have a weak report crush the stock price (ouch). Are there any upcoming court decisions, or a new-product introduction on the horizon? Pay particular attention to litigation, government investigations or regulatory agencies.
These items are not usually fatal, but they introduce another element into the mix. Indeed, sometimes it even creates opportunity. When Altria (MO - Get Report) (then known as Philip Morris) was in class action litigation, the stock became a teenager. If you understood the litigation, and were willing to accept the risk, there was a lot of upside.Finally, if you want this checklist to be of any value, I suggest you actually track every stock you buy or are considering buying. Save them all in a binder and then input the results to a spreadsheet such as Excel. The goal is to create a data source that allows you to eventually be able to see where you are going right -- and what you might be doing wrong. It's an invaluable tool.
P.S.Notice that this list contains elements from the technical, fundamental and quantitative schools. When it comes to stock selection, I'm agnostic -- I use whatever tools contribute to the process. Just as you do not build a house with only a saw, there's no reason to ignore other tools, if they have value.
|1.||Expect to Be Wrong||2.||Your Fault, Reader|
|3.||The Wrong Crowd||4.||Bull or Bear? Neither|
|5.||Know Thyself||6.||Prepare for Battle|
|7.||Bite Your Tongue||8.||Don't Speak, Part 2|
|9.||The Zen of Trading||10.||The Folly of Forecasting|
|11.||Lose the News||12.||Tracking Elephants, Pt 1|
|13.||Tracking Elephants, Pt 2||14.||Nothing Doing|
|15.||Surviving Silly Season||16.||The Zen of Trading|
|17.||Curb Your Enthusiasm|
|Check back for more of Barry Ritholtz's
Apprenticed Investor series