Here are the high-level steps I follow to select stocks for my portfolio
Perform Top-Down Market Analysis
- Check the trend of $INDU, $SPX, $RUT, etc.
- Check the $USD versus the YEN, or EURO.
- Check the $VIX (although not hugely important)
- Check Crude Oil futures.
- Check $TNX, $UST (Stocks & $TNX go hand-in-hand).
Perform Industry/Sector Analysis
- In BULL market, pick the Top 4-5 TOP performing sector/industries
- Track the TOP 4-5 stocks in each of the above.
- Look for Bullish price patterns (Mostly continuation patterns)
- Ride the trend, if firmly established at the time of entry.
- If it’s a bullish reversal breakout pattern, ’swing-trade’ until a Trend is established.
Stock Selection (For Trading Options)
- Select Stocks showing a big price move potential in a short-period of time (for Options).
- Select options with a high Open-Interest (>500),
- Should have Low Implied Volatility (Check the curve on iVolatility.com)
- Should have low Bid-Ask Spread (not more than $.30)
- Depending on the length of the price pattern, choose an appropriate time-period of option.
- Depending on the projected size of price move, select the appropriate type of Option (If unsure, just pick an ATM or slightly ITM option)
Diversify
- Always hedge your stock selected above with an equal or slightly less number of positions in the opposite direction. This is known as being ‘Delta Comfortable’. This ensures that if the Market goes against your bias on a given day, you hedged positions offset the losses on your biased postions for the day.
- To diversify, just reverse the process in step 2.
- For e.g. in a BEAR market, look for the 3-4 of the Weakest sectors/industries. Track 4-5 of the weakest ones in each.
- Look for bearish patterns, and go Short or buy Puts
- Also look for sectors/industries that are looking to be rolling over, and take positions in anticipation of further collapse.
