The Stock Market Rotation

The Stock Market Rotation (SMR) is a system for picking stocks and investing in the stock market.

The goal of using SMR is to “beat the market.” That generally means performing better than the S&P 500 index.

Following the SMR system has several benefits:

It has a long-term outlook that eliminates the need for any kind of market timing or short-term predictions.
It encourages buying many stocks to diversify your portfolio and reduce risk.
Its “hands-off” approach requires you to pay attention to the stock market only once a week, at most.
You can invest aggressively in high-risk growth stocks without taking on a lot of risk and stress.
SMR is a system, not a strategy, so it can evolve with you as you gain knowledge and your financial circumstances change.

Essentially, SMR involves buying and selling stocks at regular intervals and keeping track of your investments and strategies using spreadsheets and portfolio applications. It is a system for long-term investing that requires you to hold each stock for over a year to achieve better returns than the S&P 500.

Who is this guide for?

Although the principles of the Stock Market Rotation (SMR) system can apply to any type of investments anywhere in the world, for the purposes of this guide I will only write about what I have direct experience with. I make a number of assumptions:

You live in the United States (though this system will work in any country)
You will invest in US stocks (though this system will work with any investment type)
You use an online zero-commission brokerage like TD Ameritrade or Robinhood (though SMR will work with any brokerage)
You have enough money to invest (more on this in the next section)

Step 1. How much do you have to invest?

The first decision you should make before investing is, “how much money can I set aside for investments?”

The money you invest should not be money that you will need within the next year. Holding stocks for more than one year has tax benefits that can make it much more profitable than short-term investing.

Look at your finances and decide how much cash you can set aside for investments over the next 18 months. Pay attention to any cash that you’re not using effectively, like cash sitting in bank savings accounts. Also, look at how much money you can save from your regular paychecks. Remember, money typically devalues by 2-3% each year, so it’s not a good idea to leave too much money languishing in bank accounts or under your mattress.

How much cash can you commit to investing over the next 18 months?

Write the number down: $________________; This number will be your [Investment_Amount]

Step 2. Calculate position sizes

A “position size” in investing is the amount of money that you spend for each transaction.

If ABC stock costs $100 per share and your position size is $1,000, then if you buy ABC you would buy 10 shares ($100 x 10 = $1,000).

If XYZ stock costs $1,000 per share and your position size is $1,000, then if you buy XYZ you would buy 1 share ($1,000 x 1 = $1,000).

Depending on how strict you want to be on your position costs and whether or not your broker supports fractional shares, you can either round down or round to the nearest whole number of shares.

List ten stocks that you’re interested in buying and how much each costs per share:

Stock #1: __________ Share price: $_____

Stock #2: __________ Share price: $_____

Stock #3: __________ Share price: $_____

Stock #4: __________ Share price: $_____

Stock #5: __________ Share price: $_____

Stock #6: __________ Share price: $_____

Stock #7: __________ Share price: $_____

Stock #8: __________ Share price: $_____

Stock #9: __________ Share price: $_____

Stock #10: __________ Share price: $_____

What is the share price of the most expensive stock on your list? $ ____________; This number will be your [Most_Expensive_Stock]

Now, do this division: [Investment_Amount] ÷ [Most_Expensive_Stock] = ___________; this is your [Max_Positions]

What is your ideal interval for investing? (Circle the one that applies to you)

If [Max_Positions] is 78 or more, your [Interval] is “once a week”
If [Max_Positions] is 39-77, your [Interval] is “once every two weeks”
If [Max_Positions] is 18-38, your [Interval] is “once a month”
If [Max_Positions] is 9-17, your [Interval] is “once every two months”
If [Max_Positions] is 8 or less, I don’t recommend you invest in the stock market at this time. What you should do instead is focus on making more money by working and cutting your costs of living until you can regularly save enough money to invest.

Let’s figure out your [Position_Size] now:

If your [Interval] is “once a week,” do this division: [Investment_Amount] ÷ 78 = $ _____
If your [Interval] is “once every two weeks,” do this division: [Investment_Amount] ÷ 39 = $ _____
If your [Interval] is “once a month,” do this division: [Investment_Amount] ÷ 18 = $ _____
If your [Interval] is “once every two months,” do this division: [Investment_Amount] ÷ 9 = $ _____

It’s okay to adjust your position size so that it’s a round number. For example, if you come up with a position size of $924, you can round up to $1,000 or round down to $900.

It’s important to plan for 18 months because you shouldn’t sell any stock before you’ve had it for over a year. Holding each of your stocks for an average of 18 months gives you a choice of several stocks to sell when it comes time to sell stocks after a year.

Also note that your position size may limit which stocks you can buy. For example, if your [Position_Size] is $500 and DEF stock costs $1,500 per share, you will not be able to buy any DEF stock (It’s simply too expensive and over your “budget”).

To sum up, write down this statement, substituting in your numbers: “I will buy [Position_Size] worth of a stock [Interval].”

Step 3: Set up your investment strategy tracking system

Now you need to set up a system for deciding which stocks to buy. This is where the flexibility of SMR shines. You can decide which stocks to buy in any number of ways:

You can subscribe to investment newsletters and choose stocks from their picks
You can come up with stock screens to shortlist investment ideas
You can simply buy stocks of companies you like
You can buy stocks based on technical analysis
…and many more

The important thing is to track the performance of each investment strategy so you know what’s working and what is not.

Personally, I use every strategy I discussed above and track the performance of each one on Google Sheets, TradeStops, and Yahoo Finance. I set aside about two hours every weekend to update my tracking spreadsheets and decide which stock I will buy on Monday morning.

Right now, I want you to decide these things for yourself:

1.What kind of spreadsheet or portfolio will you use to track stocks and strategies? __________ (I use Google Sheets and two others, see Resources chapter at the end)

2.What day during the week (or month, depending on your interval) can you set aside an hour or two of time to update your tracking portfolios and work on your investing strategies? __________ (I usually take two hours on Saturday mornings)

3.What day during the week can you set aside a few minutes to buy and sell stocks? __________ (I buy and sell stocks when the market opens at 9:30AM EDT every Monday)

4.Brainstorm a few investing strategies or financial newsletters that you think may outperform the market in the long term: __________, __________, __________, __________, __________, __________, __________, __________ (I use an ever-changing mix of different strategies, see Resources chapter at the end for links. An example strategy: buy the Yahoo Finance Growth Technology Stocks screener with the highest volume. Another example strategy: Of the top ten most active stocks in the S&P 500, choose the one with the lowest P/E ratio)

Paper trading is investing with fake money. You track investment ideas as if you’ve invested in them, but you never actually put any money into them. This way, you can see how an investment idea works out without risking any money.

With SMR, you will manage a number of paper trading portfolios—each using a different strategy—and track their performance.

Hot tip: In Google Sheets, you can get recent stock quotes using the formula =googlefinance(“tckr”), where you put the stock ticker symbol in place of tckr.

Update your spreadsheet regularly. How often you update it depends on your [Interval]. You should generally update it some time (perhaps a day or two) before you pick your next stock to buy. Look at the performance of each strategy and record it in your spreadsheet.

Updating your spreadsheet involves going through each strategy and picking a new stock to add to the portfolio associated with the strategy. You’re paper trading with pretend money. Your spreadsheet will come in very handy when it’s time to pick a stock to buy with real money.

Step 4: Manage your stocks

Now comes the fun part. You’ve set aside some money to invest. You’ve already figured out your interval and position sizes. You’ve carved out time to update your strategy tracking portfolios and learn about investing. Now it’s time to make your first stock purchase.

As a beginner, it’s toughest in the beginning, because you have less data to work with. But no worries. We’re investing long term here, and you will have more than a year to find some profitable strategies.

How often you buy stocks depends on the [Interval] you calculated in Step 2.

You need to stay disciplined and buy stocks whenever it’s time to buy, no matter what. It may be tempting to hold off on buying stocks if you see turmoil in the stock market or you think the market is trading “too high.” But I recommend against trying to time the market. Nobody can predict how the stock market will behave, even in the short term. If anyone was 100% sure how the stock market would behave, that person would be very wealthy (For example, if you knew for a fact that a certain stock would drop by 10% within the next week, you could borrow as much money as possible and short the stock and make a massive profit. But in real life, there’s always a chance you could be wrong and lose everything).

So long story short, when it’s time for you to buy a stock, buy a stock, no matter what. Even if the market goes down, you will continue to invest new money into it and eventually ride the next bull market back up.

When buying a stock, only buy stocks that are not already in your portfolio. Ultimately, we want to have a portfolio of unique stocks so that you’re properly diversified (diversification reduces your risk). Once you buy a stock, you’re committed to staying in the position for at least a year, even if the company looks like it’s going to go bankrupt. The reasoning for this is the same reasoning I provided above. Nobody can predict the future. Sometimes a company looks like it will go bankrupt, but makes a surprising comeback. On the other hand, sometimes a stock looks like a sure bet, but proceeds to drop. Trust your reasons for buying the stock in the first place. Don’t worry about individual stock performance until you’ve owned it for at least a year. By creating a large portfolio of unique stocks, you reduce the risk of any single company affecting your portfolio too much.

Deciding what to buy

By now you should be tracking various investing strategies on a spreadsheet. When it’s time to buy a stock, look at the best-performing strategies in your spreadsheet or portfolio and choose a stock from one of those strategies.

Deciding what to sell

After a year and a half, we’re going to start selling stocks. Selling stocks replenishes your cash supply so you have money to continue investing in new stocks.

After a year and a half, you’re going to start selling a stock each time before buying a new stock. When deciding which stock to sell, only sell stocks that you have owned for over a year. Any stock you’ve owned for more than a year is fair game for selling.

I like to sell the stock that had the biggest gain to take profits and allow other stocks more time to fulfill their potential. Don’t worry about selling stocks that you think are still good long-term investments. You can also buy them again later as part of your stock buying rotation.

Adjusting your position size and frequency

As your financial situation changes, you may find it beneficial to adjust your position size and/or frequency. Maybe you started out with only $2,000 to invest and you decided to invest $200 every two months. But then you took a new job that paid better and reduced some of your spending, so now you anticipate having $12,000 to invest over the next 18 months. In this situation, you can increase your position size to $300 and invest more frequently—perhaps every two weeks instead of every two months.

The end of each year is a good time to look into your finances and adjust your position size and frequency. Simply go through Steps 1 and 2 above to find your optimal position size and frequency.

Honing your strategies

Once a year, it’s also a good idea to audit your strategy tracking spreadsheet. Purge the strategies that haven’t been working and come up with some fresh ideas to test based on all the new knowledge you’ve gained over the past year.

You might find that some services or newsletters you pay for are actually performing terribly. You can go ahead and cancel those subscriptions. Use the money saved to invest or try new subscriptions to different services.

Investing is a constant learning process that you will likely continue for the rest of your life. That’s the beauty of the Stock Market Rotation: it only works better with time.

Resources

Spreadsheet and Portfolio Software

You can use one or more spreadsheet or portfolio software to track your investment strategies. I personally use a combination of Google Sheets (free), Yahoo Finance Portfolios (free), and Tradestops to track my strategies (Tradestops is a bit pricey, and perhaps overkill for beginning investors). Some other popular spreadsheet software include Microsoft Excel, LibreOffice, Zoho Sheet, and OnlyOffice. Morningstar also has a robust free portfolio service that I have tried before, but stopped using because I thought it was difficult to use.

Stock Picking Strategies

My stock picking strategies are constantly evolving as I learn more about investing, so I’ll just give you a few of my favorite links.

Financial newsletters typically cost money, and I’ve found that spending more on a newsletter usually doesn’t yield better results. My favorite sites offering lower-priced newsletters include The Motley Fool and Curzio Research. These sites also have many free articles and podcasts that will teach you a solid foundation in investing. For more, check out 12 Best Investing Newsletters For Buying Stock.

Stock screeners are tools that don’t recommend stocks, but attempt to filter out the garbage and show you only stocks worth your attention. My favorite screener is MagicDiligence (their free screen is okay, but for $8 a month you get a couple of exceptional ones). For a few more options, take a look at 5 Best Free Stock Screeners for 2020.

There are also an infinite number of stock picking strategies you could use. People write entire books about stock picking strategies, so I’ll just point to a couple of articles to get you started: How to Make a Winning Long-Term Stock Pick, and How To Pick Stocks Using Technical Analysis.

Books

There are so many great books on investing. Two of my favorites are The Little Book That Still Beats the Market, by Joel Greenblatt, and The Essays of Warren Buffett: Lessons for Corporate America, by Lawrence A. Cunningham and Warren E. Buffett.

Podcasts

These days I only listen to two financial podcasts. Wall Street Unplugged, with Frank Curzio offers solid stock market investing advice and insights. ChooseFI, with Jonathan Mendonsa and Brad Barrett deals more with personal finance than investing, but they often touch on the broader big-picture topics of investing.

The 1K Bets Way

Each person has a different financial situation, but you might be wondering what I do personally.

I buy $1,000 worth of a stock once a month… hence, “1K Bets.”

I aim to keep each of my investments for at least five years before reassessing. That’s because I pick stocks for their long term prospects, and setting a minimum of five years helps prevent me from selling too early. After all, we’ve all heard of investors who claimed to own Wal-mart stock in the 90’s, Amazon stock in the 2000s, or Bitcoin in the 2010s… but sold their stakes before they really took off.

As for information sources, I subscribe to a number of financial newsletters from The Motley Fool, Curzio Research, TradeSmith, and Paradigm Press. Besides the financial newsletters, I also rely heavily on personal experiences and instincts (do I LOVE the company’s products?).

Other than that, I suggest that you keep an eye on technology news and take note of any technologies that get you excited, particularly the technologies that you would be willing to pay money for.