Mastering the core elements of stock selection strategies: A comprehensive guide from fundamentals to technical analysis

For investors new to the stock market, facing a vast array of choices can often feel overwhelming. However, in reality, whether pursuing short-term gains or long-term asset accumulation, there is a systematic methodology to follow. This article will delve into how to use stock selection strategies to identify promising targets and when is the ideal timing to enter or exit.

Investment Timing Determines the Direction of Stock Selection Strategies

Stock selection strategies largely depend on the investor’s time horizon and goal setting. Short-term trading typically refers to operational cycles from minutes to months, while medium- to long-term investing covers one to five years or even longer.

Choosing which period to focus on requires considering multiple personal factors: What is your risk tolerance? Is your personality suitable for high-frequency trading? How much time can you dedicate daily to monitor the market? Are you aiming for quick profits or building assets for retirement?

Short-term trading is inherently riskier because investors often lack in-depth knowledge of the companies they buy. This type of trading requires specific skills and psychological resilience, and is not suitable for everyone. The good news is, investors are not forced to choose one or the other—they can adopt a hybrid approach, adjusting flexibly based on market conditions.

Fundamental Analysis: The Foundation of Long-Term Stock Picking

Find companies with competitive advantages

When engaging in long-term stock selection, view stocks as businesses you own but do not directly manage. Most investors have a clear idea of the type of business they want to hold: companies with obvious growth prospects for future profits.

Ultimately, a company’s profitability is the most critical factor determining its long-term stock performance. A company’s future earning potential largely depends on its competitive position within its industry. Ideally, look for companies that hold near-monopoly positions in specific markets—for example, Google (GOOG.US) in search, Microsoft (MSFT.US) and Apple (AAPL.US) in operating systems, Disney (DIS.US) in entertainment content, and Meta (META.US) in social media.

Conversely, avoid companies that have lost or are unlikely to regain market dominance, with market share gradually shrinking. Historical examples include Nokia (NOK.US) and BlackBerry (BB.US) in smartphones, the once-dominant tech giant IBM (IBM.US), and Kodak (KODK.US) in photography.

While stock picking in highly competitive industries is possible, it is more challenging and requires a deeper understanding of a company’s competitive advantages. In this regard, strong management teams can be decisive—examples include JPMorgan Chase (JPM.US) in banking, Tesla (TSLA.US) in electric vehicles, and Eli Lilly (LLY.US) with its blockbuster drug Mounjaro.

Note that industry professionals may have industry-specific knowledge that allows them to outperform top Wall Street analysts in stock selection. Investors should leverage their own expertise and insights in specialized fields to guide their choices.

Capture Long-Term Industry Trends

Besides company-specific factors, identifying long-term industry trends is equally crucial. If you can anticipate a trend early, most companies within that industry will benefit. For example, the global shift toward clean energy and electrification is increasing demand for raw materials like copper, providing long-term growth drivers for copper mining companies. This is a key factor behind recent gains in copper-related stocks.

Valuation is the Key to Entry Price

Stock selection is not only about finding companies with strong growth potential but also about the entry price, which determines investment success or failure. Buying a stock at $100 may be a good investment, while purchasing it at $200 could trap you in a loss.

Stock valuation mainly involves two methods: based on “discounted cash flow” or based on “multiples.” The former is more complex and requires hard-to-obtain data, making it less suitable for beginners. The latter is easier to understand and widely available across financial media.

The Price-to-Earnings ratio (P/E ratio) is the most commonly used valuation metric, calculated as: P/E ratio = Share Price ÷ Earnings per Share

Two Approaches to Using the P/E Ratio

Compare with historical P/E levels: Compare the current P/E ratio with the stock’s past P/E range over several years. If a stock’s P/E has historically fluctuated between 8x and 16x, and the current P/E is 9x with no significant change in fundamentals, the stock may be attractively valued.

Horizontal comparison within the industry: Use the P/E ratio to compare similar companies within the same industry. If growth prospects are similar, stocks with lower P/E ratios are generally more attractive. For example, in comparing ExxonMobil (XOM.US) and TotalEnergies SE (TTE.US), the latter appears cheaper.

Precautions When Using the P/E Ratio

• If earnings growth prospects are better, a higher P/E may be justified; conversely, if growth prospects deteriorate, the P/E can plummet suddenly (e.g., Netflix NFLX.US in early 2022).
• A low P/E might reflect high profit volatility or risk (e.g., cyclical energy companies or highly leveraged firms).
• Macroeconomic factors such as interest rates and central bank policies also influence P/E levels.

The key is to understand why a P/E is high or low and whether the premium or discount is reasonable. Ideally, buy when the P/E is temporarily low due to short-term factors, but ensure the company’s long-term profitability remains intact. Also, remember the fundamental principles of diversification and position sizing.

Technical Analysis: A Powerful Tool for Short-Term Stock Picking

Short-term trading strategies differ significantly from long-term investing. Short-term traders do not expect slow price movements; instead, they look for emerging or ongoing trends that may continue. Therefore, short-term stock selection mainly relies on technical analysis.

Application of Technical Indicators

Trend indicators help traders identify the direction of a stock’s movement. Simple Moving Averages (SMA), typically based on the last 50 or 200 trading days, are considered bullish when sloping upward, especially when the stock price is above the SMA. Exponential Moving Averages (EMA, often 21 days) give more weight to recent data and respond faster.

Momentum indicators describe the speed, magnitude, and strength of price movements. The Moving Average Convergence Divergence (MACD) is a popular momentum indicator. Traders watch for crossovers between the MACD line and its signal line: a MACD line crossing above the signal line is a buy signal; crossing below is a sell signal. The position of the MACD relative to zero provides additional confirmation—positive values are bullish, negative values bearish.

Chart Pattern Recognition

Technical analysis also involves identifying chart patterns to forecast future trends. Common patterns include:

Head and Shoulders Top/Bottom: characterized by a peak (head) between two lower peaks (shoulders). A break below the “neckline” signals a sell. The inverse head and shoulders pattern indicates a potential reversal to the upside.

Double Top/Double Bottom: signals trend reversal. When the price holds above two lows and breaks the “neckline” connecting them, it generates a buy signal.

Ascending Triangle: support levels trend upward, with higher lows, and a breakout above the previous high suggests continued upward movement.

Descending Triangle: resistance levels trend downward, with lower highs, and a breakdown below support signals a potential decline.

2024 Case Studies of Worth Watching Targets

To deepen understanding of these principles, here are brief analyses of three stocks worth monitoring:

NVIDIA (NVDA.US)

NVIDIA chips are considered the gold standard in the AI industry. Benefiting from investor enthusiasm for AI commercial potential in 2023, NVIDIA’s stock tripled. In 2024 so far, it has risen another approximately 40%. Over the past year, NVIDIA has been a key driver in the US stock market, outperforming other major Tech Stocks. Mid-last year, its market cap surpassed one trillion USD. Earlier this month, NVIDIA overtook Amazon and Alphabet, ranking as the third-largest US company by market value.

Tesla (TSLA.US)

After a stellar 2023, Tesla’s stock has declined nearly 23% from the start of 2024 amid concerns over slowing global EV sales. This decline puts its position among the Tech Stocks at risk, with market cap now well below Berkshire Hathaway, Eli Lilly, Microsoft, Apple, NVIDIA, Alphabet, Amazon, and Meta. Despite short-term challenges such as weak demand, temporary factory closures in Berlin, and Elon Musk’s compensation plan disputes, analysts remain confident in Tesla’s long-term prospects.

Microsoft (MSFT.US)

Leading the AI race with precise bets on generative AI, Microsoft released its FY2024 Q2 (Q4 2023) earnings report, the first after acquiring Activision Blizzard. Revenue, EPS, and cloud segment growth all exceeded expectations. In 2023, Microsoft’s stock gained 57%, far outperforming the S&P 500’s 24% increase, making it one of the biggest beneficiaries of AI trading. So far in 2024, Microsoft has risen about 9%, again surpassing the market’s 3% gain. Wall Street analysts are very optimistic, with 50 recommending buy, only 4 holding, and none suggesting sell. The average target price is about $443, implying roughly 8% upside.

Conclusion

From a long-term perspective, stock prices will ultimately follow company earnings. Therefore, whether you are a novice or a professional investor, the most effective stock selection strategy is to make decisions based on fundamental analysis of the company’s financial health and industry position. Subsequently, valuation assessment is also essential, as the entry price directly impacts investment returns.

Short-term stock picking mainly relies on technical indicators. While different investment horizons emphasize different factors, when fundamental and technical analyses align, the investment outcome is often optimal. Regardless of the approach, a cautious, diversified, and systematic method is the foundation of successful investing.