How to find a strong stock in the market

Retail investors can use simple tools to pick a strong stock that can weather market fluctuations

One of the keys to successful investing and trading is identifying strong stocks. Strength of a stock has to be both fundamental as well as technical. A stock with great fundamental and future earnings at times remain stagnant because the sector in which it falls is not trending. For a retail client, and especially a trader with limited capital, staying invested in such stocks while the market is moving ahead can be very frustrating.
 
A strong stock fundamentally is one with good valuations and strong future earnings. Analyst consensus on future earnings is now easily available which can act as a guide for picking up the leaders. One with the highest earnings growth is the clear leader.

 
But picking up the strongest in terms of momentum requires a little homework. For those who are averse to technical analysis, the best way of judging the strongest stock is to calculate its distance from the peak. One can calculate how far away the current market price is from either the 52-week high or all-time high.
 

Say, if we have to compare the strength of ICICI Bank and HDFC Bank today, we need to know the 52-week high price of both the banks. ICICI Bank presently trades at Rs 317.30 while its 52 week high is Rs 393.30. It is nearly 24% away from its 52-week high level.

 
Similarly, HDFC Bank presently trades at Rs 1051.10 and its 52-week high is at Rs 1105. The peak is only at a distance of 5.1% from the current level. In both the cases, the 52-week high also corresponds to the all-time high levels. Between the two, HDFC Bank is clearly stronger. The Business Standard website on its stock quote page displays the strength of a stock graphically in the section Stock Strength. Strength of HDFC Bank can be seen here while ICICI Bank can be seen here.
 
Another way of judging a stock’s strength is to see how much it retraces as compared to the broad market retracement from its short-term peak. When the market pulls back (corrects or falls), a strong stock will not pull back as much, or may not even pull back at all. These are the stocks to trade in an uptrend, as they lead the market higher and thus provide more profit potential and lower risk.

 
One thing to remember here is that strength of a stock can be short lived. A stock might move up for a short duration in anticipation of news or its quarterly numbers which are expected to be good.
 
 
For those with interest in technical analysis, relative strength index (RSI) is a good tool to select the strongest stock. RSI is a momentum indicator and measures the velocity and magnitude of directional price moves and represents the data graphically by oscillating between 0 and 100.
 
The indicator is calculated using the average gains and losses of the stock over a specified time period. In a nutshell it gives the position of the current price of stock with say, what it was trading 14 days back (most of the technical analysis package has a default setting of 14 for RSI).

 
Traders use this tool to first find the strongest sector and within that sector to find out the strongest stock.
 
Finding and riding a strong stock can make a big difference to one’s trading strategy.