When I research FTSE 100 stocks, I always start with trying to understand the nature of the business itself. For example, when I wrote about passive income stocks yesterday, I covered Aviva, Tesco, and National Grid. It’s easy to understand why insurance, energy, and food are all in constant demand. But, for example, a cryptocurrency miner like Argo Blockchain is signifantly more complicated. And my cardinal rule is never to invest in a stock that I don’t understand.
Then I analyse the fundamentals. Essentially, I try to determine a company’s intrinsic value by assessing its revenue, balance sheet, cash flow, and price-to-earnings (P/E) ratio. If its stock price trades below what I think is its intrinsic value, then that’s a good sign for me to take a position. And if there have been volatile share price swings, like in the case of Scottish Mortgage, then I’ll look at the five-year average to ensure that it’s smoothed out by long-term growth.
Of course, fundamental analysis might suggest that a company with substantial debt and a high P/E ratio is not a good buy. But the opposite is often true for growth stocks. For example, borrowing money to fund an expansion makes a stock riskier, but can also bring higher rewards.
FTSE 100 volume leaders
But to judge the perfect time to take a position, I always check the share’s volume. This refers to the number of shares that have changed hands in a period of time. The higher the volume, the more investors there are buying and selling them. If a stock has a high trading volume and is rising in price, then that’s generally because it has reported good news which is causing investor demand. This creates a positive feedback loop, as the rising price attracts even more buyers.
If the stock’s volume is rising but the price is falling, it’s generally because of bad news. Investors are rapidly selling their shares, which creates a negative feedback loop. This is because the initial price falls cause even more investors to sell. And because there’s often not enough buyers for stocks that are falling rapidly, the price drops even faster.
So when to buy?
If a high volume FTSE 100 stock that’s rising rapidly starts to decrease in volume, then interest is starting to falter. At that point I find there’s usually a small reversal, which is the best time for me to buy. And if the stock I want is falling rapidly, I use the same strategy. I wait for volume to decrease, and then I’ll take a position. Usually the stock will then rebound slightly. So by carefully checking an in-demand FTSE 100 stock’s volume, I can get more shares for my money.
For example, Lloyds was by far the most traded stock last week. It had a trading volume of roughly 90m shares on Friday. This is double its trading volume of the past four days. And its share price has fallen 3%. So if I did decide to invest, I’d wait for volume to decrease to previous levels, which I’d hope would be followed by a share price rebound. But of course, nothing’s guaranteed.
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Charles Archer owns shares of Aviva. The Motley Fool UK has recommended Lloyds Banking Group, National Grid, and Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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