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Identify Overpriced Stocks


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Identify Overpriced Stocks

  1. 1. Identify Overpriced StocksBy:
  2. 2. A critical ability for both the daytrader and those engaged in longterm investing is to be able toaccurately identify overpricedstocks. To identify overpricedstocks we need to decide by justwhat criteria we arecalling stocks overpriced.By:
  3. 3. For the stock investor a high priceto earning ratio implies that themarket has driven a stockprice beyond the ability of thecompany to make enough moneyto justify that stock price.By:
  4. 4. When, for example, interest ratesare low so is the cost of doingbusiness and getting credit.Companies may borrow with theexpectation that future profits willeasily pay off their debt.By:
  5. 5. During such times companies maydevelop a substantial debt to assetratio. This may seem trifling whenthe economy is humming along.By:
  6. 6. However, if the economy cools offand cash flow reduces these sortsof companies may be in troubleand their stock prices will likelytumble.By:
  7. 7. One way to identify overpricedstocks is to recognize a high debtload as a warning sign. Likewise ina booming market many newinvestors will enter the marketlooking to make profits.By:
  8. 8. As buying pressure increases sowill stock prices. So long as thereare new investors coming on boardthe buying pressure will continueand so will the rise in stock prices.By:
  9. 9. To identify overpriced stocks inthis market environment oneneeds to anticipate what willhappen when the last new investorcomes on boardand traders start short selling inanticipation of a stock marketcorrection or full scale marketreversal.By:
  10. 10. In day trading the ability toidentify overpriced stocks is just asimportant is it is for the long terminvestor. It is just that the timescale is shortened for traders.By:
  11. 11. In day trading the ability toidentify overpriced stocks hingesmore on technicalanalysis than fundamental analysis.By:
  12. 12. The trader is more interested inanticipating price changes thatresult from market volatility anduses technical analysis tools suchas Candlestick chart formations toprofitably anticipate stock pricevariations.By:
  13. 13. Although trading all stock pricefluctuation can be profitable, theability to identify overpriced stockscan result in substantial profits.By:
  14. 14. This is because a truly overpricedstock may be ready to dropsubstantially in price once it startsto correct. By using Candlestickanalysis a trader will often be ableto accurately predict a priceturnaround on this kind of stockand profit by buying puts just asthe stock starts to fall.By:
  15. 15. Continuing to follow Candlestickpatterns as the stock falls, thetrader will successfully anticipatewhen the stock will bottom out. Hewill execute his options contract,sell stock at the strike price, buystock at the now low spot price andpocket the profits.By:
  16. 16. Then he will profit from buying atthe bottom as the stock begins torise again. When Candlesticksignals tell the trader that the stockis about to level off in price,probably at the level it started atbefore its fall, he will sell stock andpocket his profits again.By:
  17. 17. All of this sort of profit takingcomes from the ability to identifyoverpriced stocks, both in the longand the short term.By: