early on in my career as a trader and even long before that as both an investor and stock broker, i found it very difficult to successfully outperform the stock market with my trades/investments. when i began my career as a full-time trader, i was largely focused on outperforming the market by out-trading the market (via the broad index tracking vehicles such as the futures, options, and etf’s such as the SPY, QQQ, etc..). however, i gradually learned that it was much easier, and profitable, to focus on only trading the best looking technical patterns on individual stocks and sectors vs. trying to successful game the broad market.
remember, every time you buy the SPY or go long the ES (S&P500 mini-futures), you buy the best performing stocks in the index as well as the worst performing of those 500 stocks. you might be buying some leading technology stocks when the tech sector is on fire but you are also buying the worst performing stocks & sectors at the time as well. ditto when shorting the broad markets. even during a recession or bear market, there are always stocks that do well, such as utilities or other defensive sectors. when you short the SPY, you are shorting some of the best capitalized, solid dividend paying blue chips stocks in the world. in other words, you trade the good, the bad and the ugly…. all at once. although trading the broad markets does provide the benefits of diversification, it also puts a significant damper on your profit potential.
then why do i constantly post broad market commentary and charts? i do so in order to align my trades, or overall market bias (long, short or both), with the overall trend, or more importantly, what i expect the trend to be going forward. as i like to say, one day does not make a trend but i do think that this example does help illustrate my point. one of my favorite sectors on the short side over the last week or so has been the biotechs, in particular biotech stocks that are listed on the nasdaq (nasdaq listed stocks often tend to be more volatile and less established than NYSE listed stocks).
as of the time that i made this chart (3:30pm ET), both the DOW & S&P500 have gone positive on the day. meanwhile, the IBB (my preferred ETF for shorting the biotechnology sector) is down 2.34%. to take it a step further, the 14 individual stocks that i listed as my favorite shorts amongst the 116 components of the IBB are all negative and down an average of 3.8%. my point is to illustrate that although diversification in any portfolio, including a trading account, is absolutely necessary, too much diversification can be detrimental, or dillutive, if you will, to your overall returns even if your charting/market timing skills are superior.
my trading style uses a top-down approach: determine the overall market trend or bias via analysis of the broad markets, then drill down to select the most attractive (for longs) or bearish (for short) sectors to focus on. from there, drill down to the individual components of those preferred sectors or industries to determine the best looking individual stocks within those groups. i believe that employing such as strategy, whether trading or investing, is much more effective and less frustrating than trying to beat the market by “trading the market”.