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Apprenticed Investor: Six Keys to Stock Selection

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) (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

At the time of publication, Ritholtz was long BP and ConocoPhillips, although holdings can change at any time.

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback; click here to send him an email.

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