Additional Rules
Besides the screening and selection criteria, I also follow a handful of other rules to make my trading system more robust:
Number Of Stocks Held
In my book I use the analogy that the fewer the stocks you hold, the faster you drive on the freeway. There is no right or wrong answer, but as the amount of stocks held declines, your risk greatly increases as you approach a quantity of one. As the quantity of stocks increases, you return approaches that of the index as you hold great numbers of different stock ie, you can hold all the stocks in the index and hope to beat it because you become the index. I like to say that you are driving 55mph with 12 to 15 stocks and you are driving 95mph with four to six. In the past I've held ten to twelve stock but lately have I've been working to stick in the eight to ten range. This matches my comfort level.
Best Sector
I don't believe in a best sector. I believe in diversifying and so my rule is simply "never buy two stocks in the same sector. This means that if you have ten stocks, that quates to ten sectors. This again ads stability and robustness to returns in the long run.
Logic Without Emotion
When you start to care about a stock, you make mistakes. I try never to fall in love with a stock...it's just a tool I'm buying to achieve a return. I don't buy Nike because I love their shoes and I won't buy Toyota because I drive their cars. Most stocks I barely know what the company does since that is irrevelant to me. I only care that they have great financials and great technicals. Don't buy stocks you are emotionally invested in and you will more able to stay logical and disciplined in difficult times or when the stock make difficult mores.
Release Creative Needs
Stock trading is often boring. I often think that people dat-trade out of boredom and to satisfy that vegas gambling urge. Boredom can be dangerous. I build a check-valve into my trading and allow myself to purchase one stock for reasons other than that of the mechanical system. This is a nice outlet and brings some gambling fun back into the system. I am sure it hurts overall returns, but it prevents me from wanting to fiddle with the system because I am bored...so it's more of mental insurance for system stability. I have occasionally held up to two stocks in this manner, but would advise against it. Currently I am holding two stocks in this way; both amazon and invisalign are creative purchases. ALGN is so close to my normal mechanical rules that I allowed it in. It passes most of my tests except the net profit and revenue rules. It's risky to own two stocks purchased in this manner and I would advise against it. I need to take my own advise. :) LOL I trade the creative purchase the same way as all other stocks...entering with a buy-stop and exiting with a sell-stop.
If you are enjoying these posts and would like to read with more detail on my trading philosophy, you might enjoy my book - Great Companies, Great Charts.