I Made This Big Mistake, So You Don't Have To
After three decades of trading, I'm still constantly refining my strategy and here's a hard lesson we can all learn from.
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I’ve been actively trading for nearly 30 years and have done pretty well, but like all good traders, I’m always looking for ways to improve my trading results.
There are several strategic things - like holding more concentrated positions, taking bigger size, being more aggressive with loss cutting, and so on - that I’m always working on. But after some reflection, I’ve concluded that my biggest obstacle is my bias against large capitalization stocks. I simply do not like to trade them for a number of reasons.
I have always favored small stocks because they move bigger and faster than any big-cap name if you pick the right ones. I can find dozens of small caps that double in a matter of weeks or days, but very few big caps make moves of that size.
Another reason that I prefer smaller stocks is that they are much more likely to be mispriced. Stocks like Apple AAPL or Microsoft MSFT have dozens of analysts who do little more than study the fundamentals of those stocks. Nothing about these stocks isn’t already known to institutional investors.
Obviously, the higher returns generated by small caps carry the price of elevated risk. When you have a bad small-cap trade, you can be hit with very sizable losses very fast.
If you are going to trade small caps, you have to be very disciplined and have a very effective trading methodology. It also requires much more tolerance for volatility. If you can’t handle a 5% daily swing, you will have some problems.
The problem with focusing primarily on small caps is that there are periods when the entire group performs poorly. That has been the case for several years now, and the Russell 2000 IWM is still far from all-time highs, while the S&P 500 and Nasdaq 100 QQQ have been hitting dozens of new highs in 2024,
My mistake is that I need to recognize that there are periods when I would be better off trading the big-cap favorites or allocating more capital to the group. I also have to trade large caps differently than I trade small caps. What I don’t like about big caps is that I feel like I have no unique edge, because they are so crowded and have so many followers, but that is why simplistic technical analysis often works best with big caps. It always surprises me when individual investors think they know something about a stock like Nvidia NVDA that institutional investors don’t know.
The investors that benefited the most from the recent outperformance by the Magnificent Seven didn’t have any unique insight or knowledge. They just stayed focused on relative strength and rode the momentum. Many will ultimately be burned at significant turning points, but running with the herd in bid caps is often the best approach.
My main focus will always be on smaller stocks, but I am working harder to develop different methodologies for well-known big caps. They are a totally different animal than small caps, and failing to fully recognize and embrace that fact has been the biggest mistake of my trading career.
At the time of publication, DePorre had no position in any security mentioned.
