The Dangerous Day Trading Myths About “Industry Type”

The Dangerous Day Trading Myths About “Industry Type”

The Dangerous Day Trading Myths About “Industry Type” 1024 576 Steven Dux

A question I’m often asked is… when choosing the right stocks, does the industry matter?

Intro

It’s amazing how many people seem to get this all wrong, it’s one of those day trading myths I’d love to debunk. The short and simple answer is… NO, the industry does not matter. But there’s a little more to it than that, which is why I decided to write this article.

When it comes to day trading, so far we have discussed the fundamentals, the importance of strategies, how to choose stocks to trade, tips and tricks to stay profitable et al. Another important thing that we must cover is the importance of industry when it comes to stock selection.

As a beginner,

…there are a number of things you constantly think of.

Are you working with the right mentor?  

Are your strategies working?

Are you choosing the right stocks?  

While you are selecting stocks, should you look at the industry type? 

It is a good and important question, so let’s dive into it… 

Does The Industry Matter In Day Trading?

Again, the short answer is no.

You shouldn’t choose stocks based on their industry type. You can’t keep choosing technology company stocks just because you’re a techie, for instance, and you can’t choose textile companies stocks because you like fashion. Your personal preferences have no bearing here. Each stock has unique characteristics that are often independent of what industry it belongs to.

So choosing a stock based on its own characteristics is a better approach, something I’ve discussed in-depth in this article on how to go about choosing stocks.

Penny Stocks, in particular, involve stocks of companies that have a small market cap and trade at a relatively low price (regardless of the industry the company falls in). 

Such stocks usually belong to smaller, newer companies and as such, exist in their own bubble. So while these stocks themselves are highly volatile and therefore give good chances at a return on investment, they don’t get affected by market events and therefore are not reliant on industry type — under most circumstances.  

Besides, day trading happens in too short a time span for industry type to matter too much. One trade lasts for less than six and a half hours, before that market closes you’re in and out of that position. 

Blue-chip stocks, on the other hand, get impacted by market conditions rather frequently, which makes industry type more significant in their case.

A blue-chip stock is generally the market leader or among the top three companies in its sector, and is often a household name. 

Having said that, the industry type of a stock is something you should keep in mind to get a holistic idea of how the stock will perform in certain economic conditions. A major change in economic conditions was caused by a global pandemic last year, affecting various industries.

major changes in

economic conditions

In such a scenario, while some stocks gained, many others dropped. The travel and tourism industry turned out to be one of the worst-impacted sectors. On the other hand, companies involved in eLearning, home entertainment, and virtual healthcare saw a boost.

This is why, when it comes to industries, what you should keep in mind is a diversified portfolio. It’s good practice to diversify your investments and have stocks from varied industries in your hand, to get balanced opportunities. With a diverse portfolio, it’s possible to level out the impact of various economic changes that affect different sectors, because a diverse portfolio means you’ll have more than enough gainers to mitigate the losses.

The idea of spreading your capital across various sectors aims to balance risk and reward. Any kind of asset will carry inherent risk but some stocks succumb to that risk factor during certain situations, whereas others won’t.

That is just the way probability works.

Staying away from

Certain industries

However, it’s also important for me to mention that there are certain industries you NEED to stay away from. These are the sort of life lessons I share with my students inside The Freedom Challenge because I’ve seen too many failures when people deal with these stocks.

01.

Biotech

Biotechnology companies are the ones that do research and development of new drugs. Their main focus is treating diseases and medical conditions. In most cases, they remain unprofitable. There is always a huge likelihood of their experiments failing, as 90% of all prospective new drugs do not get approved. 

For these reasons and more, BioTech companies are not bankable and do not have good odds. I recommend avoiding their stocks. 

02.

Commodities

A commodity is something like oil, gold, and silver — and that is interchangeable with other goods of the same type. A barrel of oil from one producer is the same as a barrel of oil by another producer so they can be interchanged. I recommend my students avoid commodity stocks as, again, they have not shown good odds for shorting.  

In general, commodity trading is better suited for the longer-term, and because day trading typically lasts a day, it just doesn’t make sense to get involved in commodities. Besides, because commodity prices tend to be more volatile than stocks, commodities trading is generally better suited for those with higher risk tolerance.

Again, it’s an industry I don’t get involved in, and I recommend my students avoid it too.

The Importance of a Diverse Portfolio

One of the biggest mistakes beginners tend to make when it comes to industry type is that they pick a stock from one industry, and if they take a loss on that trade, they’ll want to make up for that loss with the same stock (or stocks from the same industry), and keep doing this over and over again until they lose their account.

It becomes a constant cycle where they are trying to chase back their losses.

You cannot expect a different outcome by doing the same action over and over again. You need to learn to let go. Sometimes losses will happen and you have to accept that as a part of day trading. Just move on and choose another stock from a different industry.

Although sometimes the opposite of this is true...

Sometimes you might avoid a sector because you previously made a loss. Well, this is crazy. Just because one trade brought a loss doesn’t mean every trade you make in that industry will lead to the same result.

You cannot let your losses scare you.

Be prudent about it and see the bigger picture. A one-time loss does not indicate you need to avoid that sector altogether. If you do that you might be missing out on some potential wins. Focus on your strategy and try to make your accuracy better next time.

This is why a diverse portfolio is so important...

So you don’t get stuck in a constant loop of chasing stocks that are in the same industry/sector that leads to the same outcome.

Without a diverse portfolio, you might end up blowing your account. As the saying goes, never put all your eggs in one basket. Diversification is something you must strive for from the very beginning. A variety of investments will provide more opportunities for profit and keep losses limited.

It also ensures there are chances for wins even during economic downturns, as not every industry will take a hit.

Some will see an uptick and with a diverse portfolio, you will get the advantage of that. Therefore you must diversify your portfolio in order to protect yourself in the case of a market crash.

A lot of people are afraid of investing money in day trading because of the fear of losing their entire investment. And yes, if they put all their eggs in one basket, these losses can add up. But if you diversify, you better protect your investments.

What To Consider Instead Of Industry

(And Why)

If we should not keep industry type at the forefront while selecting stocks, then what are some things we should look at instead? Here are 3 things I consider when picking stocks:

01.

Top Percentage Gainers In The Premarket

The stock market opens up for its regular hours of trading at 9:30 a.m ET. Pre-market is the name given to the time before that i.e. 8:00 to 9:30 a.m. ET. Premarket time is tracked to gauge the market outlook ahead of the actual open.  

Stocks that increase the most in price during the premarket hours are said to be top gainers in the premarket. Top gainers often continue to climb to new highs because they start strong. Pay attention to top gainers of the premarket and focus on them while picking stocks. This will increase your chances for profits and also keep you away from the duds of the market.  

Stay focused on the ones that gained 20% or more. 

02.

High Volume Stocks

Stocks that trade the most volume are always on my radar. 

Volume can be a sign of market strength because rising markets on increasing volume are characteristically seen as strong. That is why I most suggest purchasing stocks that are high in volume. It shows there is more demand for that stock, whereas low volume stocks carry liquidity risk. 

03.

High Float

Float is the number of shares a company has made available to the public, effectively making these the number of shares a trader can actually trade. This is an important number to note because it gives you an indication of how many shares you can buy and sell.  

If a stock has more than 20 million available shares for trading, it is known as a high float stock. A stock with less than 10-20 million available shares for trading is known as low float stocks. 

I tend to avoid stocks with low float as it’s hard to sell them at a desired price. Since low float stocks have fewer shares available, it can be tricky to find a buyer or seller for them. They also tend to be extremely volatile owing to the lower supply of shares. 

In a past article on how to go about scanning and finding stocks, I go into more detail about the things you must take care of so check it out here.

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