Saturday, October 10, 2009

What Should I Trade?

The question I am most frequently asked is: how do I find candidates to trade? There are numerous considerations that can be taken into account, but as I am constantly writing and preaching, the first consideration is the trader's individual plan and trading personality. What might be a great candidate for me might be a terrible choice for you and vice versa. In this article, I'll try to offer some suggestions that could help a trader decide on what approach an individual trader might prefer in seeking candidates. In looking at some of the possibilities, I think it is important to understand that almost any choice involves a compromise of one sort or another.

Though not usually the first choice of many newer traders and investors, one of the first candidates to consider is to trade a whole market. ETFs (Exchange Traded Funds) are available that permit investments in whole markets like the Dow 30 (DIA) or the S&P 500 (SPY) or the Nasdaq 100 (QQQQ). In general it is somewhat easier to trade a whole market than it is to trade an individual stock because the whole market is not subject to quite the same risks as the individual stock. The price of a single stock, for example, could be dramatically influenced by news that a competitor is introducing a new product, or by news of an SEC investigation, or by postponement of an earnings announcement, or by the arrest of a corporate officer, or by the announcement of the acquisition of a big new customer, etc. While events like those may have a huge influence on the price of the individual stock, it likely would have a much lesser influence on the market as a whole. In essence what I am saying is that one could expect less volatility in a market than in an individual stock under many circumstances. As a corollary, under most conditions, it is probably somewhat easier (not necessarily easy) to follow market direction than individual stock direction for many of the same reasons. On the flip side, movement may not be as fast or far in whole market trades as in individual stocks and, of course, that can be good or bad depending upon one's position.

If the trader is seeking a little more movement, a little more volatility yet wants to avoid single stock risk, another alternative is to trade sectors. Again, sectors can be traded using ETFs that essentially are baskets of stocks. The investor can choose an ETF for any given sector and essentially own an interest in all or a chosen group of stocks in a given sector. Much has been written about a phenomenon known as sector rotation. Basically the theory suggests that money flows from sector to sector with some gaining favor while others may be losing support. As an example, as of the time I am writing this article, over the past month a couple of the hottest sectors have been Information Technology and Hotel/Motel REITS (real estate investment trusts) while some of the less favored were Residential Construction and Health Care Plans. Seeing that, a trader could choose to make a bearish play on the Residential Construction sector or a bullish play on Information Technology until he or she saw a change in momentum. Once again, at least some of the risk of individual stock ownership is removed though certainly less so than if the trader was in a "whole market" ETF. In many cases, volatility or price movement could be expected to be somewhere between that of individual issues and whole market ETFs.

Of course, the trader can choose to trade individual stocks as many do. Movement in them may well be farther and faster than in whole market or sectors and that can be a good or a bad thing depending upon the position taken.

Issues of risk control and monitoring are critically important no matter what the investor chooses to trade. In a DVD entitled "Trading for Keeps" that I was invited to do in Chicago, I cover a number of issues related to those subjects including some important principles of disciplined trading, trend line and stop loss use, and protecting positions and portfolios. You can purchase a copy by following the link in this paragraph.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
All Rights Reserved

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Scott said...

Have you ever considered creating a service for trading ETF's?

Just thought it might be interesting.

I enjoy the weekly comments.

Scott Smith

Bill Kraft, said...

Yes, Scott, we have and it is a project we may undertake.
Bill Kraft