We have recently been reading Mike Bellafiore’s book “One Good Trade.”* Although the book focuses on the practice of proprietary, i.e. intraday, trading it holds some lessons for traders and investors of all stripes. In particular we found Chapter 7 entitled “Stocks in Play” of interest.
“Stocks in Play” at SMB Trading consist of stocks that meet a list of criteria that make for more consistent intraday setups. What Bellafiore and his colleagues don’t do is overlay any additional criteria that limit this list based on industry, sector, etc. This allows them to adapt to what the market is giving them. As Bellafiore notes:
After 12 years of trading, there are some mornings when I am trading a stock for the first time ever.**
He goes on to recount many calls and e-mails from traders struggling to find profitable trading opportunities in part because they are “unwilling to move away from their normal basket of stocks.”
Why is that important? If a trader or investor has a profitable, replicable strategy then it makes sense to apply it to as many securities as possible. In short, one’s profit opportunity is a function of how many independent bets one can make in a universe of securities.***
In a certain sense it may be more difficult for successful traders to recognize this necessity. It is easy to get comfortable with a specific approach to the markets, especially after a period of success. That is until the markets change, and they always do. At least a struggling trader knows that changes need to be made.
Nor is this concept specific to short-term traders. Investors also face an ever changing set of market opportunities. If your investment methodology is not designed with adaptation built in, then it may be time to think about a new approach to the markets. Eventually every investment approach will need to adapt to keep up with the times.
In short, things change. Markets change. Your basket of stocks should change with the times as well.
*Wiley Trading was kind enough to send a review copy of the book.
**p. 167, One Good Trade, Bellafiore, Mike, John Wiley & Sons, 2010.
**Some readers will recognize this as an application of the Fundamental Law of Active Management. For a nice explanation see this piece by Cam Hui at Humble Student of the Markets.