When Should I Buy A Stock? | Exploring Markets

When Should I Buy A Stock?

We are often asked a simple question: when is the best time to buy a stock?

There aren't many people in the world who can answer that for you. It's a VERY difficult question. Buying stocks and making money off those purchases is one of the world's hardest professions. But we are going to try and help you. We're going to look at a few things you need to know before buying a stock.

1. Supply and Demand

You have to get a sense of a stock's supply and demand. For every stock there are buyers AND sellers. There are traders, money management firms, and mutual funds all over the world. Together they all dictate the stock market and that means what stocks go up and what stocks go down. If a stock is going up over a period of time it means there's more demand than supply. More traders, investors, and firms are buying the stock than selling it.

There are several ways to gauge supply and demand:
  • Trends - Is the stock trending up or down? Look at a chart to see if it's been going up or down over the last 3 months, 6 months, year, or longer. Draw a line from the stock's low point to where it is today. You want to see that line trending up.
  • Relative Strength - Check to see how the stock is performing compared to the general market like the S&P 500 Index. If it's outperforming the market it means there's more demand on this stock than the others. If it's underperforming the market that generally means there are better stocks out there.
  • Moving Averages - The moving average is the average price of a stock over a period of time. You can use the 10, 20, 50, 100 or even 200-day moving average. This is a great way to see the price of a stock smoothed out. For example, a stock might be spiking over the last few days or weeks. But look at the moving averages to see if the current price is above or below its average price. Generally when stocks trade above their moving averages it means there's consistent demand. If they are below then it means there's still more people selling.

2. Earnings

If you made it through step one you can now actually think about buying the stock. But now you need to know what the company does and how it makes its money. There's a classic rule about the stock market that goes like this:

"Never buy a stock if you've never used or seen that company's product or service firsthand."

The theory here is simple. If you know what a company does and how it works you will have an easier time understanding how it makes money. Now it's time to do some research.

You'll need to research how much money this stock is making. Find the basics first like revenue, profit, cash in the bank, and earnings per share. Find what this company has earned in the past and answer these questions:

  • Do they make enough money for me to want to own? 
  • Are they going to continue making that money?
  • Are they financially secure with cash in the bank?
  • Could they grow revenue in the future with new business plans and ideas?
If you answered yes to all of those questions you are getting close to knowing when it's the perfect time to buy a stock!

3. Risk Management

One of the final tasks is risk management. It is far too easy to go broke and lose everything in the stock market. That's what makes it so dangerous. This is why you have to understand risk management before you buy a stock. Here's what that means in some simple bullet points:
  • Only buy a stock with money you can afford to lose.
  • There are no get rich quick scenarios in the stock market.
  • Do not risk all of your money on one stock.
  • Know when you would want to sell a stock.
One of the most crucial aspects of risk management is knowing how much money you can afford to lose. Stocks can literally drop from $150 per share to $3 per share in a year or less. Yes, the stock market is that wild. Before you buy a stock make sure you understand that you could lose your money. Have a plan in place BEFORE you buy. Maybe you will sell a stock if it drops 20% or more from the time of your purchase. Maybe you will sell a stock if it starts to invalidate points one (trend) or two (earnings) mentioned above. These are only a few examples but the point could not be more clear – have a plan in case everything starts going the wrong way.

4. Keep Learning About The Stock Market

If you've made it this far – congrats! But it does not stop here just yet. After you've figured out the right time to buy a stock the real lessons begin. You will now learn how it feels to be up a lot of money or down big money. You will see how the news can influence stock prices. You will see the fear and greed that runs rampant through the stock market. It is now your job to watch, learn, and grow as much as possible. From this moment on you must educate and grow yourself into a wise stock picker with a sound understanding of risk management.