The biggest change in the stock market over the last decade has been the tremendous growth in the use of Exchange Traded Funds (ETFs) and computerized trading. Some of this growth has been driven by the popularity of indexing but now the great bulk of volume in the market is a product of trading a large basket of stock rather than buying specific stock.
The huge impact of ETFs and computerized trading on the character of the market is seldom discussed in the business media. The focus is still on the indices and the DJIA in particular, but the underlying action has shifted in dramatic ways.
The essence of ETFs and computerized trading is to trade large baskets of stocks without regard to their individual merits. When you trade the Nasdaq 100 ETF (QQQ) you trade all 100 stocks that it contains to various degrees depending on their market caps. There is no distinction between good and bad fundamentals or charts
Recognition of this dynamic is extremely important because it changes the entire nature of trading. In the past trading was largely a function of stock picking. Investors looked for great stocks with good fundamentals and favorable technical patterns and were paid nicely if they made good selections
In a market that is dominated by ETFs and computerized trading, stock picking becomes secondary. It is all about market direction rather than the merits of any particular stock. The trading of market direction takes various forms such as reaction to news events like China trade or the Fed, but the essential point is that large groups of stocks are traded in tandem without any regard to their individual merits.
This sort of 'basket' trading eventually leads to greater mispricing in individual stocks and that leads to periods when stock picking reasserts itself. Traders can do very well finding the mispriced stocks that are being repriced to better reflect reality but these periods may not last for long.
Once you understand this dynamic the key to effective trading is to determine if we are in a directional market or a stock-picking market. In a directional market, stock picking is going to be much more difficult but not impossible. Your carefully chosen stocks that are going to trade based on other considerations and their technical setups may not work well but good stocks still will receive attention even when market direction is the dominant market force.
Many traders complain about how much of trading now is about riding a small group of big-cap names rather than picking stocks. The ETFs and computerized traders are forcing a focus on market direction and the best vehicles for that are the ETFs themselves or the dominate big-cap names.
The key thing to be aware of is that stock picking goes through cycles. When headlines, like China trade, are dominating the news then directional trading will drive the action, but when there is less macro news and flatter action in the indices then individual stock picking will work and can work exceptionally well after a period of being jerked around as part of a big basket of names.
It is easy to complain about how the nature of the market has changed over the years but our job is to adapt to the change. The most productive change that a trader can make is to simply understand whether the market favors directional trading or stock picking.