Employ This Genius Quality When Picking Stocks

Buying and holding a great stock is the obvious path to wealth, but it is much harder than most investors realize. The problem is that it is very easy to find the huge winners after the fact, but they are rarely very compelling at an early stage.

In behavioral economics, this is known as confirmation bias. If we only look at Apple AAPL, Nvidia NVDA, Microsoft MSFT, Amazon AMZN, and other stocks that have performed spectacularly over the long run, then it is very easy to jump to the conclusion that it is pretty easy to find great stocks to hold long term. But the reality is that it is extremely difficult. What an investor like Warren Buffett does is very rare, but investors like to believe that they can replicate his returns simply by holding on to some promising names for a very long time. Buffett himself has said that only a handful of these opportunities occur in a lifetime.

Psychologist Dean Keith Simonton researched the creativity and idea generation of people who are generally considered geniuses. He didn't look at stock picking, but he looked at the output of people such as Thomas Edison, Shakespeare, Beethoven, Steve Jobs, and others.

All of these geniuses have work that is considered a masterpiece, but none of them consistently produced great works. Their achievements were built on a foundation of numerous failures, mistakes, and incorrect assumptions. Edison once declared that he discovered hundreds of ways not to make a lightbulb before he found one that worked. The genius lay not in the brilliance of the successful ideas, but in the pursuit and willingness to experiment without fear of failure.

For investors, this insight is particularly notable. The process of identifying a future superstar stock is not about instantly recognizing greatness—it is about generating and vetting a wide array of possibilities, knowing that most will not pan out. You may have 1,000 duds before finding the one idea that produces the bulk of your investment wealth.

The goal is to cultivate creative thinking. To find the truly exceptional stock, you have to embrace unconventional stock selection and eschew the comfort of familiar names. The hunt for that next great stock becomes a disciplined practice of exploration, evaluation, and calculated risk, just like what Edison did before he finally found the answer to the light bulb.

The problem with this approach to idea generation is the cost of the failures. You have to keep the cost of failed stock picks very small by cutting them quickly and moving on to the next idea. A great trader can handle hundreds of mediocre stock picks if he employs a strong methodology of cutting losers quickly.

There are many ways to approach the task of ideal generation. Your style matters, but don't let it stop you. It is very important to keep an open mind and consider things that you normally don't when looking for a great stock.

I have an inherent bias against the well-known big caps like Nvidia, Microsoft MSFT, and Meta META because they seem too obvious. There are hundreds of analysts who spend countless hours and huge amounts of money learning every detail about these stocks. I don't have any edge when it comes to picking these stocks. However, there clearly is money to be made picking the right big-cap names, but that has much more to do with market conditions, technology themes, and other things than the specifics of the stock itself.

The big-cap names can produce great results, and they are probably the better approach for investors who have longer-term time frames that don't want to take on high levels of risk. The process of finding these stocks isn't as complicated. It may take some work to find the ones that will perform the best, but the universe of such stocks is small and can be reviewed in a systematic way. The Magnificent Seven names have been performing great for years, and it doesn't take any effort to identify them, but as a source of idea generation, they need to be studied in a different way.

If you are a more aggressive trader and are willing to take higher risks, then small-cap stocks have great appeal. It is almost always the stocks that you have never heard of or know little about that tend to produce outsized gains in a short time frame. Buying what you know is comfortable, but it is the unknown that has the better chance of outsized returns.

So how do you find these unknown names that make the big moves?

Sites like TheStreet Pro and Sharkinvesting.com will offer up a steady diet of ideas for you to consider. I try to post several new ideas every day. Simply maintaining a watch list of these stocks and following them over time will keep you busy, but the process of finding picks yourself produces additional insights and will help you improve your trading.

Typically, when I am looking for new ideas, I start with the charts. I run scanning software that produces a list of stocks that have made big moves on unusual volume. I will add other considerations like relative strength and support levels as I refine my results.

This scanning of charts will give me a rough list to consider. The next step is to quickly look at a chart of each of these stocks. There may be 100 or more, but I can eliminate a good number with a glance at the chart. They may be extended, too thin, have too much overhead, or any number of other flaws.

Once the list is whittled down, it is time to dig into some details. I want to know something about the context of the stock. Why is it moving? Does it have some significant news? Is it in a strong sector? What is the story that explains the chart?

Some traders will completely ignore fundamentals. Their thinking is that the price action is the best proof of value. There is always someone who has superior knowledge about a stock, and their conviction will be reflected in the charts. That fails quite often, but I can't compete on a fundamental basis with the big boys, so I don't waste too much time with spreadsheets, balance sheets, income statements, and earnings projections. I like to see big growth compared to the price-to-earnings ratio, but that is the sort of information that is already discounted and provides little advantage.

Sometimes the best research isn't financial statement analysis but understanding the products and the technology. This is especially so in sectors like biotechnology, where the current numbers can be meaningless.

Once you have narrowed down your candidates, the next step is the stalking process. I like to make an initial buy and put it on the screen quickly, so I can follow it more closely. I want to develop a feel for a stock that I plan on being aggressive with. You don't always have the time to do so, but I find it empowering to approach a stock on an incremental basis rather than to jump in with both feet right off the bat.

The best traders succeed because they are always looking for new ideas and produce a lot of them. The great thing about the stock market is that there is always something great right around the corner. We just need to find it.

At the time of publication, DePorre was long NVDA, META.