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Monday, January 23, 2006
Market Recap
The market attempted to bounce from that wicked sell off last Friday, but it fizzled out after a nice morning pop. There were some stocks that acted great today. For example, GOOG bounced back strong and gained $28. SNDK also had a nice gain. Some stocks from our day trade pre-market alert did very well including GMXR and EPEX gaining over 6% and 8% respectively. Some of the shorts listed in that pre-market alert also had nice moves down. Overall, with the exception of a few movers, the market stumbled and failed to put in an impressive bounce. The Dow closed up 21 points, a far cry from the 213 it lost Friday. The Nasdaq was up less than a point and the S&P gained 2 points.
Diversification
Diversification is very important for long term investing. You do not want to have all your money in one or two stocks, or even one sector for that matter. It is best to spread your money out over multiple stocks in multiple groups if you are putting money away in a long term investment account. Diversification is very important for risk reduction and serves a very important purpose. Since you will not always be correct in every investment you make, diversification is necessary to limit risk and preserve your capital.
This is a big contrast from short term trading. While diversification is a must for the investor, it is not necessary for the short term trader. In short term trading, diversification is highly over rated. In fact, the swing trader wants to be in only the hottest stocks and the hottest groups. If there are only 1 or 2 hot groups then the swing trader piles in to that group of stocks to maximize their gains over the shortest period of time.
That Brutal Gap Down
We are not saying it is a good idea to ignore diversification if you are a swing trader. The fact remains, if you put all your trading capital in one or a very limited number of stocks, you are just asking for trouble and increasing the risk you are exposing your money to. At some point, if you trade long enough, you will experience owning a stock that drops like a rock for one reason or another.
Today's meltdown of SUF is a good example. SUF had a great chart for weeks and then out of nowhere today, there was brutal gap down and heavy selling for the rest of the day. Most people who have traded for any length of time have been there, and it can be brutal when this happens.
Having said that, diversification can be over rated when it comes to swing trading and is certainly not needed at all when day trading. For instance, if you were to put all your money in 5 or 6 market leading stocks that are on the move, then chances are you will out perform the market by an enormous percentage. Even if these leaders were in the same sector such as technology.
For example, if you owned AAPL, GOOG, ISRG, ESRX and SNDK in the strong technology group, you would have out performed almost all market participants over the last few months. These stocks are in the same technology group but are in different sectors within technology.
This is somewhat diversified because of the different sectors they are in within the technology group. However, this is not as diversified as more conservative investors would like to be. For instance, having the leading stock in each of the following groups is much more diversified: Retail, Internet, Energy, Transportation, and Financial. It is all a matter of preference, each way will work, but in my opinion, diversification is over rated for the short term swing trader. Tight stops are your insurance or protection against any market turn of events. Even a diversified portfolio without stop loss orders in place will get crushed in a market correction. But the person with a diversified portfolio with tight stops will be out of the market, sitting in cash, and waiting for the next opportunity at the first sign of a market reversal.
Today's Bonus Chart: RES
Click the following link to view today's bonus chart in the Public Chart lists:
http://stockcharts.com/def/servlet/Favorites.CServ... (first chart) |
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