When I was in the Mumbai office of Online Trading Academy, a student asked me to review their longer-term portfolio with them. I was shocked to see that they owned over 200 individual stocks in various position sizes. One of the first things I asked the student was how they managed and monitored all of these trades. Needless to say the student did not have a plan and was overwhelmed by the holdings.
Upon further inspection, I noticed that many of the stocks were very similar in sector and even industries. That meant that the trader essentially had the same trade going on in different stocks. Many traders and investors fall into the same category. They hear something about a company and blindly jump into a trade without realizing that they may already be participating with their holdings in another position.
What you need to realize about the markets is that roughly 50-60% of a stock’s move is directly related to the movement of the broad market. There are exceptions but as the saying goes, a high tide will raise all boats in the marina. This means that in a bullish market, most stocks will rise and they will similarly fall in a bearish one.
There will be different participation in these bullish or bearish markets depending on the sector the stocks belong to. The sector movement and trend can influence up to 30-40% of a stock’s movement. That only leaves about 10-20% of the movement attributed to the company’s fortunes itself.
When we are selecting trades or even long term investments, we want to be diversified, but not duplicating our efforts. We need to start with a top down approach where we analyze the markets first and determine the most probable trend direction. For longer term trades, I will analyze daily or even weekly charts and use a bit of fundamental analysis to gauge investor sentiment that can influence the trend.
Once that is done, I need to select the sectors that are likely to move the best in that market environment. In our Professional Trader Course and the Extended Learning Track classes, we discuss the effect of sector rotation and proper selection for our trading. By identifying the best or worst performing sector, we are increasing our chances for success.
Now on to the stock selection, we want to maximize our efforts without over-complicating our trading. If I hold two stocks in the same sector, I have two plans I must execute and two positions to monitor. This requires more effort without the reward of more profits. It would be wiser to simplify and put more shares into the more technically sound stock so that I could put in less effort. This is where the before mentioned student failed. By not narrowing down their portfolio, they were overwhelmed by the number of positions and could not physically monitor the trades for peak performance and returns.
So evaluate and simplify. Start with the top down approach and eliminate under-performing holdings. This is exactly what the indexes do in order to maintain a bullish bias. They kick out weak stocks in favor of stronger ones to enhance the overall performance. So take a cue from the professionals and start the spring cleaning of your portfolio today. If you are unsure on how to do this, take one of our courses at Online Trading Academy and learn how.