Keeping a watchlist of attractive stocks is a useful discipline for active investors, whether you’re in a bull market [1] that’s grinding higher or a bear market [2] in headless chicken mode [3].
If you’re a passive investor, then regularly investing [4] in a tracker [5] and turning off the TV when share prices fall is a perfectly sensible strategy. Invest for long-term returns [6], ignore the noise, and enjoy life.
If like me you choose to trade some individual shares alongside your passive funds, then it’s vital to keep your head when the market is on the move.
And that’s where your watchlist comes in.
What is a watchlist?
A watchlist can come in all sorts of flavours, but at its simplest it’s just a list of the most attractive companies you’ve found in your research.
There are thousands of stocks out there. By keeping a list of those you like and know best, you have a better chance of spotting great buying opportunities.
As well as the company name, investors often include a note on their watchlist of the price at which a company would be a good buy.
- Technical investors will study the squiggles of stock price graphs to determine this favourable entry price.
- Fundamental investors will relate the price to valuation ratios such as free cashflow, book value, the P/E ratio, or the dividend yield [7].
Stock prices go up and down all the time. If you are to have any hope of beating a tracker fund, you must buy shares according to your strategy, not to the whims of other investors.
Should you use limit orders with your watchlist?
Some investors place so-called ‘limit orders’ with their brokers instead of running a watchlist.
This enables them to automatically buy a share should it fall to a price they’ve previously decided is attractive, regardless of whether they happen to be watching the market at the time.
Note: A limit order is the opposite of a stop loss. With a stop loss, you sell your holding when the stock falls below a certain price. In contrast with a limit order, you’d buy a new holding when the price drops.
I do think limit orders can be useful in chiseling out a better price from short-term volatility. And technical traders often use them, too.
But as a fundamentals-based investor, I don’t set limit orders for stocks on my watchlist, for two reasons.
Firstly, stock prices can fall for a good reason, not just volatility.
A stock on your watchlist might fall because of a profit warning, say, or because of a fire at the factory or some other event. This news may well change what the company is worth. You don’t want to buy such stocks automatically when the price drops – instead you’ll need to see how the valuation is affected.
The other reason I don’t use limit orders is that your chosen stocks may simply fall with the wider market.
In this instance, your watchlist company hasn’t got any better value, compared to other stocks. All stocks are down.
You might still want to buy it at the lower price – say if you’re buying for a particular dividend yield – but you’ll probably want to think about it first.
One way to profit from a price crash
Here’s a reminder of what a stock market in freefall looks like – and how you can step in to bag a bargain by keeping a watchlist of stocks you like.
The video is from Thursday May 6th 2010, when the Dow Jones index fell almost 10% in a state of panic.
Note how Jim Cramer steps in to call Procter and Gamble at $39 a buy.
Clearly, this huge multinational company hadn’t become 40% less attractive in 20 minutes just because traders (or trading robots) were losing the plot. Such moments can be your chance to profit.
More normally, companies on your watchlist may just drift lower on no particular news or market action.
By keeping a watchlist, you’ll spot when your stocks hits an attractive price point, rather than being distracted like other investors by the noise elsewhere.
Do you use a watchlist? Let us know how in the comments below.