WEEKLY COMMENTARY

Since 1990 the Money Talks Conference Series has established itself as the first choice for Canada’s sophisticated and active investors. The Conferences have provided individual investors access to the world’s top rated financial analysts through years of unsurpassed market volatility.

Host of MoneyTalks, Michael Campbell, is hosting events in October including two dates with me, Calgary October 29th and Vancouver October 30th. In addition, there is an event October 10th in Vancouver with market analyst David Bensimon.

I hope to see many of you at one of these events. All attendees to my event October 29th and 30th will be the first to receive my new book. During the event, I will discuss some of the important lessons taught in the book and show how you can find short and long term trading opportunities with a few minutes of work. Your ticket for the evening includes:

– Attendance at the event
– A first edition hard cover copy of The Mindless Investor (value $29.95)
– One month of my daily newsletter (value $59, new subscribers only)
– One month access to Stockscores.com (value $29, new subscribers only)

For more information, click on the appropriate link below:

Evening with Michael Campbell and David Bensimon, Vancouver Oct 10
Evening with Michael Campbell and Tyler Bollhorn, Calgary Oct 29 and Vancouver Oct 30

To get 20% off of the ticket price, use the special offer code SSTB2013 at checkout.

Trade the situation, not the stock. Learn how pro traders approach the trade plus get Tyler Bollhorn’s weekly market analysis in this week’s Market Minutes video. You can watch this week’s video on Youtube by clicking here. To receive email alerts any time I upload a new video, subscribe to the Stockscores channel at www.youtube.com/stockscoresdotcom.

Here is an excerpt from my upcoming book, The Mindless Investor, How to Make Money in the Market by Overcoming Your Common Sense. This piece is from the chapter, Bad Traders Diversify.

The traditional way to manage risk is to diversify your holdings. The hope is that owning a number of stocks from sectors of the market that are not correlated to one another will lead to more consistent returns. If one stock in the portfolio suffers a large loss, it should not have a significant impact on the overall performance as the other stocks make enough of a gain to compensate.

I don’t believe in using diversification to manage a portfolio. That doesn’t mean I think it’s appropriate to put all of your capital into just one stock; it means that the mindset that diversification is based on makes little sense to me.

Diversification Weakens Your Winners
Diversification’s aim is to remove the alpha risk component and pursue the beta component. Strong moves up or down by individual stocks will not have a significant impact on the performance of the portfolio because they get watered down by diversification. By owning a basket of stocks, the diversified portfolio should perform in a way that is similar to the index. Why not just buy the index through an ETF?

In order to beat the market, you must find alpha, not take it out of your portfolio. Diversification would not allow you to buy a number of strong stocks if they were in the same sector because those stocks will tend to move together, increasing the risk of a substantial loss if the sector moves lower and takes your stocks down with it.
If the stocks you buy are trading on their own story then they shouldn’t move together. Here is an example that shows what I mean.

Suppose you find a biotech stock that makes an abnormal break from a predictive chart pattern. The chart has everything your strategy seeks, so you buy the stock. You do some research and find that this company has a treatment for colon cancer. It’s in testing, and they expect results in a month. It is apparent that the market is speculating on what those results will be, and those who know the most seem to think the results will be positive, which is why the stock is moving up abnormally.

The next day, you’re hunting for opportunities and find another stock trading with abnormal activity and breaking from a predictive chart pattern. It turns out that this stock is also a biotech stock, but this company has a treatment for obesity. It’s in clinical trials, and the buzz is that it’s working very well. The market is speculating that this company’s treatment is going to have a dramatic impact on its long-term ability to make a profit.
Given that these stocks are in the same sector, buying both would go against the principles of diversification because the expectation is that they will move in similar fashion. As the biotech sector moves, so too should these stocks.

However, these stocks are not trading higher because of their correlation to the overall market or the sector. They’re trading up because of company-specific factors that are completely unrelated to one another. One company has a treatment for colon cancer and the other for obesity. If one company’s drug fails to work, it won’t take the other company lower, because one company’s future earnings are not dependent on the other.

The aim of diversification is to mitigate the damage from being wrong. The hope is that losses in one stock can be overcome by gains in the others. Unfortunately, stocks that aren’t trading on their own story tend to be highly correlated to one another regardless of their sector. If the S&P 500 index is down 2% in one day, you can expect that almost every stock that trades in the market will be down. Not just in the U.S.-these strong down days tend to affect the markets globally. When the markets sell off, there are few places to hide.

What you can do, however, is limit the effect the loss has on your overall portfolio. If a stock you own falls through support-if the market gives you a message that the stock is likely to fall lower still-then sell it. Take the small loss and move on.

If you really like the company (I hope you never like any company, only the trade of it!) then you’ll get the opportunity to buy it back later, probably at a lower price. When a good trade goes bad and requires you to take a loss, take it and move on.

By diversifying, you are expecting to do a bad job at picking stocks. You intend to hang on to losers and use the profits from the winners to overcome the loss. It’s better to focus on a strategy that does a better job of picking trades with a positive expected value and work on the discipline to take a loss when the market tells you to.

STRATEGY OF THE WEEK 

The market gave us a sign that it is going to pull back in the near term. Here are a few vehicles to take advantage of a market sell off:

STOCKS THAT MEET THAT STRATEGY

1. T.VXX
The VXX tends to go up when the market goes down because investors buy options as insurance, raising the premium paid for the option. The VXX is based on the option premium in the S&P 500 index. It is a great hedge against market weakness and it broke a short term downward trend line today. The Canadian version trades with the symbol T.VXX.

2. QID
20% of the Nasdaq 100 is based on Apple (AAPL) and that stock has been falling for a few days. That has helped the QID go up since it is an inversely correlated ETF to the Nasdaq 100. I won’t be surprised if the sell off on the Nasdaq stalls in the next few days as AAPL is near some support, but as the month progresses I think there is a good chance the QID moves higher as the Nasdaq moves lower.

References

• Get the Stockscore on any of over 20,000 North American stocks.
• Background on the theories used by Stockscores.
• Strategies that can help you find new opportunities.
• Scan the market using extensive filter criteria.
• Build a portfolio of stocks and view a slide show of their charts.
• See which sectors are leading the market, and their components.

  Disclaimer
  This is not an investment advisory, and should not be used to make investment decisions. Information in Stockscores Perspectives is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. The writers and editors of Perspectives may have positions in the stocks discussed above and may trade in the stocks mentioned. Don’t consider buying or selling any stock without conducting your own due diligence.