Updated: 10/5/2010 9:00 AM ET|
Stock picks to change your life
Warning: Buying the 10 stocks listed atop StockScouter's rating system could result in serious money. Here's how the strategy works.
Want to get rich? Here's all you have to do: Buy 10 stocks. Hold them for six months. Sell and repeat.
If that sounds too good to be true and you want to stop reading now, I can't blame you.
But that would be unfortunate because this advice is a twist on a strategy that has worked really well for nearly a decade, through hell and high water. Or at least war, recession and flood.
If you follow it in a low-cost trading account, particularly one in which gains compound tax-free, then there is a distinct chance -- though not a guarantee, of course -- that you could make serious, life-changing money.
Of course, you can't just buy any old 10 stocks. They've got to be the ones ranked at the top of the class by MSN Money's StockScouter rating system. You have to be ready not just to buy them at times when you think it is a terrible idea, but also be ready to sell when you love them so much you can't bear the thought.
The numbers don't lie
Is there a catch? Naturally. You are almost certainly going to have misgivings about the top-ranked stocks sometimes, not to mention the notion of putting your hard-earned money in the emotionless hands of a system.
Trust me on this. I came up with the idea for StockScouter in the middle of the 2000-02 bear market, helped to develop it with a crack team of independent financial engineers and have marveled at its success every day since. Yet even I still sometimes look at the top-ranked stocks and go "Naaah!"
Yet the numbers don't lie. (Actually, they lie just a little -- more on that later.) If you had followed this six-month-hold system on the top-ranked stocks since January 2001, you'd have been up an average of 22.9% per year, as of September 2010, versus a gain of just 0.7% per year in the Standard & Poor's 500 Index ($INX)and 4.2% in the Nasdaq Composite Index ($COMPX).
The little lie? Well, as many of you know, these kinds of returns are more of an ideal than real because in the world of creating quantitative investment models there is no trading-price slippage, bid/ask spread or other difficulties in obtaining the exact quote listed in the market's historical record. In the real world, if 100,000 people try to buy a top-ranked small-cap stock quoted at $10.20, any given individual might actually have to pay $10.50, $10.75 or even $11 to start a position, as the price is driven up by demand. The same goes for sales at the end of the period.
Returns are reduced by commissions and, if held in anything but a tax-free retirement account, the government is going to want its cut -- robbing you of the ability to actually reinvest all the proceeds every six months.
So maybe in the real world you wouldn't be up 3 times your original investment at the end of six years. Maybe the "real" number is only 2.5. No biggie. StockScouter's top-10 strategy has still blown away the market since its launch and shows no signs of wearing out.
How the strategy works
What's the magic recipe, and why am I willing to share it with you? It's nothing more than the strategy I first described in 2001 on MSN Money and in my book "Swing Trading." The only difference: Further refinements allow you to a successful StockScouter portfolio with just with 10 stocks per six-month period, rather than the 50 originally recommended.
Here's a quick refresher on StockScouter ratings. Every day, software at the labs of our research partner, Gradient Analytics, uses a variety of quantitative methods to analyze the fundamental and technical well-being of the 6,000 largest companies trading on U.S. stock exchanges. Stocks are rated on a curve from 10 to 1, with 10 being best, on the likelihood that they will advance over the next six months with the least amount of volatility. If a stock is expected to advance a lot but make holders suffer through a lot of jumpiness en route, it is rated lower than a stock that might be expected to advance a bit less but get to that level more smoothly.
We created the system this way because in 2001, you may recall, volatility was off the charts, and it was hard to persuade people to take advantage of the plunge in values and buy stocks. We aimed to be the first rating system to embed a measure of volatility in our rankings. Rather than just focus on typical rating factors such as earnings growth, price momentum, estimate revisions and insider buying, we wanted to help people find stocks that they could hold comfortably. This proved to be an awesome idea and has accounted for much of the success of the system over the years.
Picking surprise winners
There's another secret to the power of the StockScouter system that doesn't directly show up in the ratings: Recognizing that much of an individual company's price movements stem from the popularity of its market-capitalization, industrial sector and the growth or value styles, the system systematically recommends stocks characterized by the greatest number of these "market preferences."
If the system determines the market has exhibited a hankering for large-cap value stocks in the transportation and capital-goods sectors, for instance, then all of the companies chosen for MSN Money's StockScouter portfolio will have market caps of more than $10 billion, be relatively cheap and slow-growing, and do their work in industries like trucking, railroads or defense contracting.
This built-in flexibility, backed by hundreds of hours of testing, has helped StockScouter make many seemingly odd choices over the years that have turned out brilliantly.
As an example, during the bear market years of 2001 and 2002, the system churned out one profitable portfolio after another because it was focused on small-cap regional banks and real estate investment trusts at a time when most people continued to be fixated on the possibility that their rapidly deteriorating large-cap tech stocks would turn around. Those regional banks were huge winners, while most of the techs never recovered.
The strategy of focusing on strong-trending sectors and market-cap groups kicked into high gear during 2003, though, as the strategy produced a 83% gain, more than three times the excellent advance of the broad market.
What you may not recall about that year is how difficult it was to buy stocks in January 2003 amid a steep decline in both public confidence and share values over the looming crisis in Iraq. It's times like that which make a systematic approach so valuable.
The courage to rebalance
Indeed, I'm not worried about explaining how to exploit StockScouter portfolios because I know that most people won't have the discipline to execute the strategy and will kick out stocks with which they are unfamiliar. It's just human nature. If you decide that you want to give it a try anyway, remember that success in the market often demands that you do things that feel uncomfortable. Consider the courage that a re-balance might have required July 1, 2006, during a scary plunge in prices. Many pundits were predicting a return of the bear market. Yet StockScouter's top 10 produced a return of around 16.9%, led by FTD Group (FTD, news)and Claire's Stores (CLE, news)up 30% apiece over the next six months.
Start with the current top 10 and then pick up with the half-yearly re-balance schedule on January 2 or July 2, whichever comes first. Decide how much you are going to invest in the strategy and then divide that amount equally into the top 10 names. On the last trading day of the half-year or thereabouts, sell them all and reinvest the proceeds in the new top 10. Repeat until rich.
Ratings can change fast. Don't worry about that. Every current crop of ratings is good for six months.
The 50-stock Scouter portfolio, re-balanced every six months, has returned 16.9% on average per year since inception in 2001, or nearly 6 percentage points less than the 10-stock version of the model.
This column was originally published in February 2007. At that time, Jon Markman did not own or control any shares of companies mentioned.
VIDEO ON MSN MONEY
I don't remember Jon promising you a profit every 6 months, so what's the problem? The story says the 17% annual returns are an AVERAGE. An average since inception(2001). Do you comprehend?
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Have you done any research on doing a 3 month interval runnning 3 different portfolios? ,
Do not be deceived. This does not always work. The Top Ten Stocks from the end of July 2011 were down over 2% at the end of January 2012. Buyer Beware and Jon is hiding in the bushes refusing to communicate about this.
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Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
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