How Do We Pick Stocks for Our Model Portfolio

There three major factors that we take into account:

1) Equity Selection
2) Timing
3) Risk Management

Equity Selection

We are looking for stocks that meet the following criteria:
1) Price Momentum – stocks near or breaking out to new 52-week or 50-day high from a proper base. This is based on the so-called momentum drift – stocks that break out to new 52-week highs and have outperformed in the past 3 to 12 months, tend to continue to outperform.
2) Industry Momentum – belong to a currently strong industry. There is no other more powerful catalyst than industry momentum. The shittiest stock in a great industry will outperform the strongest stock in a weak industry. It is the way capital moves – people invest in themes. Industry momentum trumps everything else. With other words, if we see a great technical setup in a hot industry and it belongs to a stock with no earnings, we will still take it.
3) Earnings surprise – we target stocks that have recently beaten their earnings estimates and the market has reacted favorable to their report. Post earnings announcement drift (PEAD) is a well-documented market anomaly that provides an edge. PEAD is the tendency of a stock to drift in the direction of the surprise for several weeks after the report.
4) A great technical setup – a stock that is setting up on both weekly and daily time frame. You could click on the links of our closed positions and see exactly what we were looking for at the time.

The SL50 list has incorporated all four of the above, so it is a great starting point and a time saver.

Safety is derived from proper timing.

We are more aggressive on the long side in the following situations:

1) The general market has corrected more than 10% and it is showing some bottoming signs – in this environment, we focus on mean-reversion and relative strength trades.

2) Russell 2000 (IWM) is trading above its 200-day moving average – in this environment, we focus on price, earnings and industry momentum, also Post Earnings Announcement Drift Strategies.


Risk management

We start a new position with a 5% to 10% capital allocation and add to it only if it shows profit first. Such an approach allows us to keep our losers small enough to minimize the damage and make our winners big enough to make a difference in our returns.
Our average winner has been bigger than 20% while our average loser has been -7%. This means that we could be right on only 40% of our picks and still make money.

Proper risk management doesn’t involve only the using of a stop and well-sized capital allocation. It also deals with overall market exposure. – when to be 100% invested and when to hold a sizable cash position? Our overall market exposure depends on the opportunities that the market provides at any given time. In more volatile, choppy, corrective markets, we could be in >80% cash in order to minimize drawdowns.

Find out How Hundreds of Investors are Thriving