Stock Selection: Go With The Flow

I was returning from a business trip recently and found myself walking on one of those moving walkways at the airport and as I was walking on the belt, I felt the sensation of gliding effortlessly along. I glanced over to my right and observed several people who were trudging along with bags in tow as I breezed past them.

When I got to the end and anticipated stepping of the moving belt, I noticed children on my left playing on the walkway that was moving in the opposite direction. They were running against the flow of the belt almost giving the impression that they were running in place.

It occurred to me that there are times when we put forth a smaller effort yet make greater strides. There are also times in life when we seem to max out and go nowhere. So it is with trading. One of the primary themes we have at Marketamer is that our trading methodology emphasizes stock ownership and the consistent reduction of the cost basis of those stocks through the use of options.

So with that said, stock selection is critical to what we do. I understand that many of you have not yet built your portfolios to the size that will allow a diversified portfolio of stocks. That's fine because we have strategies to help you build your portfolio without stocks, so stay tuned and you will learn.

OK, so it's about stock selection. We must find stocks that are insulated to a great degree from economic downturns. We find those stocks through fundamental analysis. When normalcy returns to the market, those stocks we have selected have the ability to rebound nicely.

Sectors, Industries and Stocks come in and out of favor. The approach is to choose only the best. Back to my airport walkway analogy; having holdings in a Sector, industry and Stock that is currently out of favor is similar to running in place against the moving walkway. In fact you could even go backwards. Trading those types of stocks makes it a battle. As I said before, you may be putting forth a maximum effort and going nowhere.

So here's the plan for stock selection. We employ "Top Down" analysis:

We start with the total market to determine what it is doing. Is it up, down or sideways? Is the volatility high or low? Immediately, you can determine if it is a market that you want to participate in.

Lately, this market has been ideal for those that feel comfortable shorting. If that's not you, then maybe it is best to stand aside until the dust settles. We'll assume for the sake of today's discussion that you don't wish to short the market and are waiting for more bullish conditions.

Let's assume that the market conditions are now neutral to bullish and you feel that it's time to get back in. We begin to look for the sectors that are performing the best. Let us say that after your due diligence you determine that the Petroleum Sector is alive and well.

The next step is to find the Industries within the Petroleum Sector that are doing well. After your analysis, you feel that the Refineries are the place to be.

Our final step is to find the Stocks within the Refinery Industry that are the strongest.

You have now given yourself the highest probability that you are "walking with the movement of the stock market walkway." You are gliding along as others are struggling. Google "stock market research" and you will find a wealth of information to help you with your due diligence.

Do not forget the importance of diversification. It would be wise to select several Sectors, Industries and Stocks that are in favor, even though some may not be as "hot" as others. With this method, you are deselecting those Sectors, Industries and Stocks that are definitely out of favor.

What you may lose by not placing all of your capital in one Sector, even though it appears to be the best, is more than made up through prudent diversification.

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