There are almost 6,000 stocks listed on the NYSE. Another 3,500 on the Nasdaq. Thousands more in the smaller OTC market. Your job: Winnow from those numbers a handful of high-quality issues in attractive chart positions.
But how many, exactly
If I have a $ 25,000 trading account, should I be jumping into 10 or 12 stocks, or two? What if I have a $ 2.5 million account
Investors are often susceptible to the feeling that there is safety in numbers. As a result, many make more and smaller buys. Financial advisers sometimes further provoke the fear by promoting the wisdom of diversification.
But diversification can become a recipe for mediocre results, unnecessarily heavy portfolio trading and management fees, not for producing the best returns. IBD’s CAN SLIM rules counsel investors to concentrate their money in fewer, better stocks. Diversification, in a way, is a cop-out for expertise.
“The more you diversify, the less you know about any one area,” IBD founder and Chairman William O’Neil wrote in “How To Make Money In Stocks.” “The best results are usually achieved through concentration, by putting your eggs in a few baskets that you know well and watching them carefully.
O’Neil suggests investors with portfolios of $ 20,000 to $ 200,000 limit themselves to four or five carefully chosen stocks that they know and understand. Portfolios of between $ 5,000 and $ 20,000 might need just three stocks. If you are just dipping a toe with a portfolio of $ 5,000 or less, narrow your watch list down to the two best stocks you can find that are in actionable chart positions.
Let’s say the market is just coming out of a correction. It sets up a bottom, climbs for a week, then punches higher in heavy trade to mark a follow-through day and launches a new uptrend. An investor with a $ 50,000 portfolio has his watch list researched and knows exactly which stocks he wants. He makes his buys just as stocks are breaking out in heavy volume, not before the breakout.
He decides he will focus on four stocks, so a full position will be $ 12,500. He has a dozen potential candidates on his watch list, because not all will be breaking out on the follow-through day and he’d like to get in at the start of the rally.
He pyramids into each stock, opening with a purchase of, say, $ 8,500 — two-thirds of a full-size position. In a $ 25 stock, that means 340 shares. He adds to those positions as each stock proves its strength and moves up through its buy range. By the time the stocks reach 5% above their buy points, each position shows a total cost of $ 12,500 each.
It’s easy to fall into the habit of placing bigger bets on some stocks and smaller bets on others at the start of a rally. It is natural to feel more confident in certain stocks. But investors should use that confidence as a gauge. If you are feeling less certain, is this really a move you want to make
The fact is, you have no idea which of your initial buys is going to move the highest. If you start a rally on equal footing, you leave yourself free to rotate out of those that prove to be slow movers and move more cash into better plays.
The goal, by the end of the rally, is to have your capital concentrated in your two or three best advancers — not spread among two dozen or more small positions showing varying growth.
