Stock Trading Diversification
This is the continuing story of our two imaginary traders, Peter and Paul.
Peter is a professional trader, Paul is not. Peter has a tested, proven, written trading plan that he follows each time he enters a trade, Paul does not.
Peter and Paul have had vastly different Stock trading experiences - Peter has just made another substantial profit - this time from the Bear market, Paul has lost heavily.
A chance meeting with Peter's group of friends one day at lunch launches Paul on a learning curve that will see him become a good trader, but not without some hard lessons along the way.
In discussing the different attitudes of our two hypothetical traders, Peter and Paul, I have tried to share with you the thought processes that make a successful trader.
If you read any of the marketing material from the Financial Planning community or the Mutual Fund promoters, they all stress the principle of diversification.
They say it enhances returns while minimizing risk - Peter believes that ,as Frank Watkins says in his book, Exploding the Myths, "Diversification is another word for risk minimization, but it has very little to do with making profits."
As one of the World's greatest Investors, Warren Buffet, has said on many occasions - diversification is simply an antidote for ignorance!
Diversification for diversification's sake simply means that you will have your money in a lot of Stocks or markets that aren't performing to their fullest potential - some will be rising, some will be falling, some will be going nowhere.
Hardly the best way to run your trading Business is it?
Peter's view of diversification is different to that of the herd - use technical analysis to find several quality Stocks that are rising, then buy all of them in equal dollar amounts to reduce the risk of one Company crashing and taking all of his capital with it. When these quality Stocks stop going up, sell, take a profit and move on.
Why hold Stocks in a Portfolio that are not rising, or worse, falling in value, simply because you want to have some diversification?
If you look at the typical Brokers Portfolio recommendations, they will include Stocks that are in various stages of trends, both up and down. When you ask them why they would recommend something that is falling in price, they tell you, "Well you have to have some diversification.
And based on fundamentals, it's valued at much more than the Market is quoting it. Don't put all your eggs in the one basket, spread your risk through different sectors, etc. etc."
Peter merely takes the prudent step of diversifying across several quality Stocks that are rising in price. Simple.
Below are some charts of Stocks that Peter found met his criteria - of course, this is in no way a recommendation to go out and buy any of these - they are simply examples of Stocks that met Peter's buy criteria at the time of entry.
They might not fit the buy criteria now, and some have given Peter sell signals, but they will give you an idea of what to look for when a Broker or well meaning friend gives you that 'hot tip' and says you should buy as many of 'such and such stock' as you can get your hands on straight away.
(Charts available at www.StockTradingReview.com)
Study the charts above and you will notice that all of these Stocks were trending strongly with small reactions. The moving averages crossed and gave a buy signal - some gave a sell signal early and then another buy signal, and then they never looked back.
Of course, not every Stock Peter bought rallied like these did. If they didn't, they were sold and the proceeds were used to buy something that had more potential.
These are the types of trends Peter looks for and diversifies into.
He doesn't buy, hold and hope for profits, based on some imagined intrinsic value that his Broker says the market hasn't identified yet...
Remember though, if things don't go according to plan, Peter gets out quickly and looks for the next trade - but while the price is going his way, he simply looks for opportunities to compound his position.
"Remember this simple rule", Peter tells Paul with monotonous regularity - "With any Stock you are considering buying, don't buy it or hold onto it if it isn't going up!!"
Pretty simple advice, really...
To Your Trading Success,
Tony Spann and the Team
Stock Trading Review is dedicated to helping you succeed as a trader by sharing with you simple and easy to follow tips and techniques.
Discover more insider secrets and the exact proven strategies to trade stocks profitably: http://www.stocktradingreview.com
Copyright © 2005 Stock Trading Review.
More Resources
Unable to open RSS Feed $XMLfilename with error HTTP ERROR: 404, exitingMore Stocks & Mutual Funds Information:
Related Articles
Stock Market Education; Day Trading for Beginnners; How to Pick Stocks
The trading method you employ to approach the stock market can make a big difference in your results.Stock trading is a very competitive field and in order to succeed you need to FOCUS on a set of simple strategies that you can implement without hesitation.
Kick The Tires
Before you buy another car you walk around the lot, kick the tires, slam the doors and look at the mileage indicator. That's an odometer.
Stock and Fund Dividends
When is a dividend not a dividend?The latest thing "conservative" brokers are preaching these days is to buy stocks that pay dividends. Everyone likes dividends.
Valuation
Every day I hear from the "experts" on CNBC-TV and the radio gurus that the way to buy stocks is find value. One man's Rembrandt is another man's connect-the-dots and fill in the spaces.
I Love You, Warren Buffet
Sometime around 1980, can't remember exactly, there was a flight of money from many countries to Switzerland. The clock makers had so much money pouring in that the banks took interest rates to zero and even for a period of time were actually making you pay ½% interest to them to put your money in their banks.
Value Investing: Selecting From The Bargain Bin
Picking a beaten-down stock requires a different kind of selection process. Normally, most companies beaten down this far have no earnings to speak of.
Price Targets
Every day in any financial publication you will find the Wall Street mavens giving their predictions on many stocks. It was issued here and should go there.
VIX
No, this is not a symbol for some Latin number. The Wall Street mavens talk about this market timing device as if they knew how to use it to determine which way the stock market is going - up or down.
Momentum
One of the basic laws of physics states that a body in motion will continue in motion in the direction it is going until interrupted by another force.That basic physics law also applies to stocks and mutual funds.
What is a Trading Plan - and Why You Need One?
How do you make money without picking tops and bottoms?I am glad you asked..
Structured Settlement; Lawyers in NY and Mutual Funds
Minority Report the movie may not be far off if the Head of the SEC has anything to say about it. At a Senate Banking Committee hearing on CSPAN, William Donaldson said that the beloved SEC can no longer sit back and "mop-up" after scandals break.
10 Tips For Creating Wealth From the Stock Market
1. Do not spread your money too thin.
Mutual Fund Expense Lies
When purchasing mutual funds we are cautioned to read the prospectus, look at past performance, check out the fund manager's record and see what their expense ratios have been.We are also told that we should not buy funds with expenses exceeding 1% to 1.
How to Find Value in No Load Mutual Fund Investing
What are you thinking when it comes to your no load mutual fund selections? Are you saving pennies and sacrificing dollars?Are you spending your time looking at expense ratios, analyzing Morningstar ratings and searching for funds with low fees and no 12b1 charges? If you are like most people, you know these things in and out. You've spent hours evaluating them, and your chosen mutual funds cost little to purchase and maintain.
Trading Education: The Best of Both Worlds!
I made my very first investment in the stock market when I was ten years old. Ever since then I have been hooked! Now I check out hundreds of trades each year with the same excitement andenthusiasm, and each time try to find that one market at the right time that could dramatically create wealth.
Trading Stocks -Never Forget About A Past Trade
We all know that emotions control every decision that an investor makes in any type of money related vehicle. Whether is be the stock market, real estate, art work or antiques, emotions ultimately set the final price on both sides of the transaction.
"Fears Only Enemy Is Action"
What a great statement!I just heard someone use it in the context of personal and financial success and it struck me as a brilliant summary of an issue we raise in the SMG Tutorials.Fear is a huge issue with a lot of traders.
Long-Term Investment In Todays Market?
The stock market is very unstable at this time going up and down while interest rates are so low you want to be a borrower and not a lender. Would you like some suggestions on how can you get the most out of low interest rates while being assured your principal will not disappear while you are trying to make some money? Of course, there is always the danger of borrowing the money and then spending it just because it is there.
Robert Rodriguez Weathers the Stock Market
Robert Rodriguez likes to buy stocks at their lows. When there are not enough stocks hitting new lows, he closes his fund and piles up cash.
So, What is This Stock Market Thing Anyway?
We've all heard of the stock market and probably have a general idea of what it is and how it works either from high school economics classes, television financial reports, and the countless film depictions of what happens on the floor of the New York Stock Exchange. But how does it really work and what is meant by "playing the stock market?"The Stock Market in a NutshellCompanies sell shares of stock as a means of raising capital.