When a stock market rally becomes obvious, it might already be too late for individual investors to get ideal portfolio positioning. But jumping in at the earliest hint of a market rally can also be a disastrous choice.
"I feel like in the last 10 or 15 years, the indexes have done a very good job of fooling you — and when I say you, I mean me," Scott St. Clair, senior premium product group manager at IBD, told Investor's Business Daily's "Investing with IBD" podcast.
Because stock market indexes reflect an aggregate of stocks, some strong and some weak, index performance may mask how leading stocks are acting underneath the surface. "Any decisions I made based on the indexes, I've almost always come to regret," he said.
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The key to preparing for a potential market rally is to look for quality stocks using portfolio management techniques to manage risk. St. Clair says his techniques fall into three key categories of stock selection, position sizing and making incremental decisions. These tools reduce the chance of taking a big hit to your portfolio when the market is on shaky ground.
Stock Selection In A Market Rally And Market Correction
Selecting the right stock means considering a broad number of traits, St. Clair said. "There's a handful of factors that I think about," he said. "I like a story, I like the narrative and the industry."
Stocks that show strength without the help of a market rally will also exhibit top-notch fundamentals, expressed through things like solid earnings, revenue and margins. St. Clair also says to watch for institutional sponsorship, meaning a stock's shareholders include big fund managers.
"I want the smart, big money to have vetted these companies," he said. "I'm not going to trade it like (institutions), but I know they've kicked the tires, and that gives me a little more confidence in owning the name."
Position Sizing Around Volatility
The early stages of a market rally attempt can be accompanied by heightened volatility, which makes it critical to size your positions carefully, says St. Clair. "You have to have enough of the stock that it makes a difference if you get it right, but not too much that you can't handle it correctly."
A smaller position size can alleviate pressure when it remains unclear when the next market rally will solidify.
Nuclear technology company Oklo is an example of a stock where position sizing is critical. The stock had the a bullish narrative when he was trading it in 2024. AI executive Sam Altman was revealed to be an investor in the company, and St. Clair's entry was timed to around September and October when the stock was just beginning to make a notable move.
But St. Clair says his position size was too aggressive, leading to shakeouts he was unable to weather along the stock's meteoric rise, even though he logged a profitable trade.
Oklo stock is now out of favor and not showing technical strength, meaning it is not a top watchlist stock at this time.
Making Incremental Decisions Ahead Of The Next Market Rally
Making incremental decisions can help traders prepare for a market that can turn instantly from a market in correction mode and a strong market rally. Investors need to consider how much of their portfolio they're risking, says St. Clair.
"I'm big on incremental, probably too big on it," he said. This means continuously balancing, trimming, adding and adjusting portfolio holdings.
St. Clair says traders can adjust their risk appetite depending on how their portfolio is performing, how an individual stock is acting and whether the overall market is showing strength. "(When) you're risking a little to potentially make a lot, you don't have to be right all that often," he said.
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