We always enjoy this time of year when the different financial newsletter publishers sponsor their annual investment conferences. It’s exciting to listen to world-class speakers, interact with investors from around the world, and get to be up close with the newsletter editors who always have a few stocks they like to talk about.

As you can imagine, our booth always has high traffic during these conferences. People like talking about stocks and how to maximize their profitability (or minimize their losses) in the stocks they hear the experts talk about. The No. 1 question we get is, “Which stocks do you think will be moving higher?”

Of course, we can’t answer that question; we’re not registered investment advisors. But the No. 2 question we get might be the most important one for the long-term health of our members’ portfolios.

“I’ve bought all the recommendations of this publisher and now I own too many stocks to manage. How can I decide which stocks to sell and which ones I should keep in order to more effectively manage my investments?”

Now that’s a question we can help with! Managing a portfolio is an ongoing process, and it’s not difficult to end up with too many stocks. After all, the stories for many of the stocks just sound so good. When you make the decision to downsize your portfolio, look at it as a process that could take several weeks or even months to accomplish. It can’t be done in an hour or two.

The first thing to do is understand why you want to downsize. TradeSmith has said on many occasions that portfolio concentration, owning a portfolio of 20-40 stocks, is one of the biggest advantages that we as individual investors have. Owning hundreds of stocks is like investing in an S&P 500 fund. The stocks that do well have a small effect on the portfolio rather than leading a portfolio higher.

Part of this initial examination will be to decide how many stocks you can comfortably manage and how long you want to take to get there. Another part of this examination will be to determine how much risk you’re willing to take in each position. One way to do this might be by deciding to not own stocks with a Volatility Quotient (VQ) of more than 40% or 50%. Making these decisions now will help you complete the downsizing more efficiently once you get started.

Now let’s get to some concrete steps you can take. Imagine a portfolio of 150 stocks or more that has stocks in all three Stock State Indicator (SSI) zones — Green, Yellow, and Red.

The first step you might want to consider in the actual downsizing process is to sell off all of the stocks that are in the SSI Red Zone and that you’re carrying at a loss. It’s easy to determine this. Just click on the column that shows the results of the trade; we prefer the column titled “Gain Ex Dividend.” That’s the gain (or loss) in the trade, minus dividends, since purchasing the stock. These stocks are likely also in the SSI Red Zone.

Why would you want to sell these stocks? Because the goal of managing a portfolio is to make money! These stocks aren’t doing that for you now. At some point in time, if they turn around and move into the SSI Green Zone, you could consider owning them then. But for now, they’re a good candidate to sell.

If you own a large number of stocks, especially in this market, it shouldn’t be difficult finding stocks that are in the SSI Red Zone and that have lost money since you bought them. It’s possible that you could reduce your portfolio size by 20% or more with just this one move.

That’s the easiest part of the process. For the next step in the process, you might want to consider selling your smallest gainers so that they offset the losses you took in the previous step, especially if the gainers are also in the SSI Red Zone. This could reduce another 10% of your holdings and it’s also an easy decision.

The next steps could be more difficult. There are a couple of ways to go with this depending on the initial decisions you made when deciding to downsize. You could choose to sell those positions that have a higher VQ% than what you determined you want to hold. Or, you could examine the remaining stocks that are in the SSI Red Zone to see if they’re trending higher or lower.

Most every day that you are in the process of downsizing, you’ll likely be getting emails to buy this or that new position. This is where your initial discipline will come in handy. Even Warren Buffett doesn’t own every stock.

Once you’ve determined how many stocks you want to own, stick with that number. If you decide that you just have to buy a new position, find a stock that you currently own to sell at the same time.

The rules that we’ve developed for our Pure Quant tool could be a good guide for you in setting up your portfolio. Here are the rules:

  1. Remove all stocks with a Red, Yellow, or Gray SSI signal (only use stocks that are in the SSI Green Zone).
  2. Remove all stocks that have an average VQ of greater than 40%.
  3. If the list of stocks is from the Billionaires’ Club or the Newsletter editors, remove all stocks that are trading at a loss since the SSI Entry signal.
  4. If the list of stocks is from Watch lists, remove all stocks that are trading at a loss since the SSI Entry signal was triggered.
  5. Sort the stocks by the number of days that they have been in the SSI Green Zone with the smallest number of days at the top of the list.
  6. Choose the number of stocks that you want in your portfolio and put them in the Risk Rebalancer.

Obviously, you can adjust these rules for your goals and risk tolerance, but this might be a good place to start.

We’ll continue this discussion in a couple of weeks and focus on our research that shows the “best” number of stocks to hold. The results might surprise you.


Tom Meyer
Research and Educational Specialist, TradeSmith