Investing requires a strategy or a series of strategies. A strategy is like a roadmap that guides you from home to your next vacation spot; without one (strategy) you could get lost and waste both your time and your money
There are principles to be followed in setting up your investment portfolio and strategies.
Portfolios – what kind and how many
Diversification – why, what types of diversification, and how to do it
How to create an investment strategy
I suggest that your portfolio have six to eight investment positions of stocks, mutual funds, or ETFs. The key principal here may sound contrary, but it is critical to the overall performance of your portfolio, of each of your portfolios.
The principal is:
Each investment position is derived from an individual strategy, and THAT strategy is most likely unique to that investment. In other words, one shoe doesn’t fit all your investment strategies or all your groups of potential investments.
Let me give you a few examples. Out of eight investments one is based on a group of foreign ETFs and another is based on a group of Fidelity’s Select mutual funds. Each group will result in one investment choice and each group will have a different strategy for determining that investment. The reason each group has a different set of strategy rules is because the symbols in each group are unique and move differently. Yes, you can use the same buy/sell rules for each strategy but you will not come even close to maximizing your potential if you do.
This example focuses on technical analysis, using relative strength with buy and sell rules. The method for deciding what to buy can be the same for each group, for example:
- Relative Strength Momentum
- Alpha with Standard Deviation
However, the strategies for the different groups may not agree on how many trading days or weeks are analyzed to recommend new purchases.
Likewise, you may find that having a preferred holding time for a position could vary anywhere from a week to three months. The same will apply to the kinds of stops you set to prevent losses. There are a number of other variable sell rules you can set in a strategy that will impact the overall performance of the strategy.
In most cases, the various rules, when customized for each particular group of symbols, will result in the best potential return for that group. When I have tested such buy and sell rules, I can’t recall ever having two identical sets of rules that resulted in the best performance for each group. Since some investment software programs will let you perform back testing, you can find the rules that work best for your objectives and therefore give you the best possible returns on your investments.
What that means is that just because a stock is moving up doesn’t necessarily mean it is the best stock to own from your group of stocks. There may be another stock that is moving up faster. Along that some line, a mutual fund you are holding may be moving up very slowly, but it may not trigger any sell rules because its slow growth may still be safe growth while the other funds in the group may be going down or showing erratic up/down moves. The individual back testing effort and the way you customize your buy/sell rules (parameters) will show this and help you develop the best strategy for each of your particular investment groups.
Dominick is the designer of the investment program Dynamic Investor Pro, an investment software used by individual investors and professional investment advisors for stocks, ETFs or mutual funds.