Continuing our series on the pairs of opposites that we find in the markets, the next one is on the subject of whether one should concentrate on some stock(s) or diversify across several when trading and investing. The dichotomy in this is easy to see. One hears the former from successful people (like Titan for Rakesh J or auto ancillary stocks for Nimesh Shah or Hero Motor for Raamdeo etc.) and there are enough stocks that move substantially where we have got some lead early in the game (but never played it). In addition, there are people in our lives who seem to have hit some smaller jackpots because they tanked up on some obscure stock and it came thru big time. I remember an employee of mine whose Dad had bought a very large chunk of Auro Pharma when it was around 150 levels. These success stories leads to a feeling that if we can only get that one elusive stock into our portfolios then we are thru for life.
On the other side is the mutual fund approach- in diversification lies risk control. By not taking concentrated bets and spreading our money around in more number of stocks, it is argued, one is somewhat buttressed by indifferent performances of select stocks as others will compensate with an extra show. There are pros and cons to this approach and it is perceived as something that reduces risk.
Which one is the correct way? Just like everything else in the market, there is really NO correct way. It all depends on the person and the context. For one, concentration pays of big time when you are right but trounces you when you are wrong. So, if you are going down that road, then you better be sure that you have all the facts and figures with you and that you will continue to get facts and figures as time rolls on – first hand and not from some distant source. Further, your insight into the arguments for concentration had better be correct- which means that you need to be capable of and display superior skill sets at stock analysis, stock picking and stock tracing. Not the easiest of jobs. As far as diversification goes, this may work better when the markets are not performing but will lead to significant under performance of your portfolio or holding when the markets are good. So here the skill that is required is a different one- an ability to discern whether the market flavors a strong trended move or is going to be a gentler price action or indeed, is it going to be some sort of corrective phase.
People who are part of my training or mentorship programs ask me whether they should engage in all the stocks or just concentrate on the few. This is a variant of the above pair of opposites. This needs to be seen in a slightly different way. For a beginning investor or trader, it is difficult to be on top of all the variables across a wide list of stocks. While there may be a profitable opportunity in a wide variety of stocks on a daily basis, the context of almost everyone of them would be different from one another. This requires the analyst to tweak the readings of his tools in tune with the context of that stock. It is difficult for a new initiate to do this. Hence such traders are better off trying to concentrate on a few stocks where they can be sure that the stock behavior can be mapped and contoured within certain boundaries and the analyst can then be on top of those. As the skill at analysis improves and broadens, the number of stocks one is dealing with on a daily basis can increase progressively.
There is no real short cut. But there is merit in recognizing the existence of the opposites and that will enable one to deal with the matter in a more efficient manner.