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When buying property, the often repeated phrase is: location, location, location. For investors and traders, the critical phrase needs to be: process, process, process. I have often written about the importance of process, as it removes the randomness of our stock selection.
Think about it: If you’re simply using a random methodology to try and select winners for your portfolio, you may as well be throwing darts at a list of shares.
Now, sure, this random methodology may result in a series of winners (not likely, but possible). But what if it does provide you with winners?
Replicating this by throwing another round of darts isn’t likely. Unless they’re magic darts.So, without magic darts, you need to establish a process that will help you select winners; a process that can be replicated in order to find more winners.
In other words, process enables you to repeat your selection – and while it’s impossible to remove all risk of losing positions, a solid process over time will help you find more winners than losers.
Yet, when it comes to formulating a process, it’s easy to get stuck before you even start. That blank screen or piece of paper seems absolutely daunting, with endless possibilities and the risk that you might design a process that misses the winners.
But here’s the thing: No process will be perfect. All processes will miss out on some winners.
The point of having a process is to reduce your future workload and to clearly define your investment strategy. It is also important to remember that this process will evolve over time as you gain more experience and, frankly, as you get better at investing. You just have to start.
You could start by looking at stocks that have grown profits and dividends consistently over a period of time and use that as an initial filter to narrow down the list of possible shares to a more manageable number.
Thereafter, you can add more filters until you arrive at a shortlist of stocks. Alternatively, you could start by looking at stocks within sectors you like and believe to have sustainable growth, before turning to fundamentals.
But I would add another step to the process. I’d throw out all the sectors I don’t like at this point. Deciding which sectors these would be, depends on my portfolio management strategy.For my long-term, ’til death do us part, stocks I want no cyclical sectors; none with regulatory risk; and no sunset industries.
But, for my second-tier portfolio, I will gladly include stocks from cyclical sectors, as my holding period is not forever; I am happy to have to exit in a few years when the tide turns. (Bear in mind that exiting is also part of a defined process.) Knowing what your investment strategy is, is very much part of the stock selection process.
While you can have multiple strategies, you need to be very clear on what strategy you’re building a process for, as each will differ – as I’ve illustrated above.
What’s also very important is that you document the way in which you have designed your process, so that you are always clear on what it is you’ve done in the past.
You also need to check your process to ensure it actually works. Just because you have a process in place, doesn’t mean it’s actually resulting in selecting winning stocks.
I know I said you must just start, but don’t worry about hitting dead ends; you’ll still be smarter for knowing what doesn’t work.
I do spend time every year-end going over my processes to see if they need any changes. When I first started building my processes, changes were frequent and at times fairly large. But, over the years, my processes have been refined to a point where changes are seldom and small.
Don’t fear the process. Embrace the learning curve.
It’s one that will make you a better trader or investor over time – one with a much better understanding of your strategies and making profits.
This article originally appeared in the 6 February edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.
