3. Is a large number of positions equivalent to portfolio diversification?

One clearly has to pay attention to diversification. Small positions in different stocks don't automatically imply diversification if they're in related sectors that tend to move together. For example, 3% each in Potash (POT), Monsanto (MON), CF Industries (CF), and Mosaic (MOS) sounds innocuous. But collectively, that would mean 12% of account exposure to the agricultural chemicals group (and significantly more when accounting for their recent volatility as discussed earlier). And this is why Toddo often talks about the 4 horsemen: Google (GOOG), Apple (AAPL), RIM (RIMM), and Amazon (AMZN).

Of course, if the intent is to increase exposure to any one sector, then this could be a valid strategy to diversify within one sector.

We should also keep in mind that diversification across sectors only works up to a point. When markets go down in a serious fashion (e.g. in a serious bear market like this one), then most correlations trend to one -- not only between stocks in different industry groups, but also between various asset classes (with the exception of gold and US Treasuries this time around). Cash can be used effectively as an asset class in itself to balance out these converging correlations.

There are many other factors that determine position size, but these form a good starting point. Also, you can come up with rules that are easy to follow -- but to do that, you have to ask the right questions.

This information might feel a bit restrictive at first. Just like, when you're learning to drive, you may simply want to be behind the wheel -- but you have to learn how to confront the various risks you encounter first.

The same is true in investing -- constraints form the basis of a sound plan. Most consistently successful traders and institutions operate under such self-imposed "shackles."

In this context, I'm reminded of Anthony Robbins' words: “Successful people ask better questions, and as a result, they get better answers.”

Sincerely,

- Smita

Smita Sadana offers in-depth research on historical bear markets and provides you with 10 indicators she's found that together confirm the beginning of a new bull market.  Learn them today so you know when it's safe to invest again.  Bull Market Timer - 7 day money back guarantee.