Pick your stocks and then ensure you manage them

Last week we started our Trading Plan for Investors based on the Trading Plan Traders use. We are adapting it for investors. We have looked at setting goals, deciding what entity to trade in, what mechanism to use to physically trade, whether to go full service or online, what information services to use and what style of investor we want be (short or long term). We assumed long term.

Part Two of the Trading Plan for Investors includes some more technical decisions.

Picking stocks

Working out how you're going to choose what to buy. For technical traders this means what "technical set up" you use on charts. For investors it means what "fundamental set up" you envisage using. Without some discipline you are simply blowing in the wind and this is where investors go most wrong. They have no system for choosing what to invest in and without structure you fall for any and everything.

I get a lot of flak for writing about the "moron portfolio" but this is where most idle investors end up, in the portfolio of stocks that is so obvious anyone could pick it. It is the list of big stocks that a lot of "set and forget" investors put their faith in simply because they are big-brand-name stocks. It is also the portfolio of stocks that a lot of financial advisers pick for you, not because it is going to make you money but because they can't get sued for advising you to buy it.

The process involves getting a list of the top 50 stocks by market capitalisation and starting at the top crossing out any stock that you can't understand or spell (which is probably why QBE is in almost every portfolio despite halving). You have to do a bit better. Refer to previous articles on "what to buy".

Position sizing

This is a technical art used by traders but for you it means managing your risk by deciding upfront on a few rules of investment. Typical decisions might include things like not having more than five, 10 or 20 stocks. Never having more than 10 per cent of your money in one stock. Only investing in ASX 200 stocks. Putting 20 per cent in hybrids. Investing for income. A lot of combinations here. Anything that provides structure and stops you putting the whole of your SMSF in one stock.

Monitoring process

This is pretty simple. Set yourself a discipline for monitoring the portfolio. I always laugh when someone says "I'll monitor that". To me it means I have no interest, will do nothing, have already forgotten what it is I'm supposed to be monitoring, please go away. But for you it means setting up a spreadsheet and deciding when you are going to visit and update it. Every Sunday morning for instance. It's a good idea because this decision enables you to partition your investing activities to this time slot. Good for the family, good for you. Otherwise it hangs in the brain all the time. Spreadsheet not open equals life. Spreadsheet open equals focus on the SMSF. When are you going to do that? How?

Loss control

I'm trying not to write "Stop Loss mechanism" because investors get all uppity about stop losses and start quoting all the stocks that in hindsight have done fabulously, while forgetting all the disasters. Who's still in Webjet, for instance. We sold that on a stop loss, sorry, a loss-control system, 32 per cent ago. Still like the company, will hopefully buy it for a resurrection sometime soon, but we've saved ourselves five years of average stockmarket returns by watching the share price rather than ignoring it as most investors want to do. Decide what loss-control system you are going to use.

We recently wrote about the "red cell" conditional formatting technique. Find some system to make sure you don't stick your head in the sand come GFC 2 or Babcock & Brown or ABC Learning. It's not trading. It's just playing the odds by occasionally selling stuff going down a lot on the remote possibility it may not be all right in the end. And in case it starts going up again, you know, you can always buy it back when you open the spreadsheet next week and if it was trending down you have a better than 50-50 chance it'll be at a lower price. Next week, the final instalment.