One Right-Sized Tech Stock

04/28/2011 10:21 am EST

Focus: STOCKS

Thomas Aspray

, Professional Trader & Analyst

Rely on relative performance, or RS analysis, to stay invested in stocks that are leading the current market, and consider this tech stock, which looks poised to outperform now. 

Many traders and investors pick a stock to buy based on their analysis of its fundamentals, the stock’s chart, or they read something about the company that piques their interest. However, many do not pay enough attention, in my opinion, to the size of the company and how companies of the same capitalization are doing relative to the broad market.

One of the methods I use to find the strongest sectors—and the strongest stocks in those sectors—is relative performance, or RS analysis. This can be done on may free Web sites, and basically, you create a ratio of a market average like the S&P 500 to an individual market sector.
 
This type of analysis can provide a great advantage. At the start of the current bull market, the RS analysis revealed an upside breakout in the technology sector, as I wrote here on March 4, 2009, which suggested that tech stocks would lead coming out of the bear market.

On a regular basis, I look at the RS analysis of the mid- and small-cap sectors because being in the right-sized stocks can be quite important.

For example, the iShares S&P MidCap 400 Growth Index Fund (IJK) is up 47.6% from the August 2010 lows versus just 33% for the Spyder Trust (SPY). The iShares S&P SmallCap 600 Growth Index Fund (IJT) is up 44.5% during the same time period.

Of course, since the March 2009 lows, the numbers are even more dramatic, with IJK up 162% versus 104% for SPY.

Let’s take a look at whether mid- or small-cap stocks look best now and take a look at one Canadian tech stock that may be just the right size.

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Chart Analysis: The iShares S&P MidCap 400 Growth Index Fund (IJK) has closed well above the early-April highs over the past two days, as IJK made new all-time highs early in the year.

  • There is initial support at $112.30 and the April highs, with stronger support at $110. The daily uptrend, line b, is currently at $108.40

  • The RS broke through its downtrend from the December highs (line a) in early February, signaling that the mid-caps were once again ready to outperform the S&P 500  

  • The RS has continued to make new highs and shows no signs yet of topping out  

  • The daily on-balance volume (OBV) broke out to new highs in early April and has confirmed the recent price action with initial support now at line c  

  • Using the rally from the March lows to the early-April highs, we can derive an equality target at $117. This is about 3% above current levels

The chart of the iShares S&P SmallCap 600 Growth Index Fund (IJT) also looks strong and has initial support in the $80 area. The daily uptrend (line d) is now at $78.33.

  • Further support corresponding to the February highs is in the $77.50-$70.70 area with major support at $71.50-$72.50  

  • The RS line broke out strongly to the upside in March, and while it made marginal new highs on Wednesday, it is slightly lagging the action of IJK’s RS line

  • The daily OBV confirmed a new uptrend in March when it surged through resistance at line e

  • The equality target for IJT (100%) is now at $85, which is about 4.5% above current levels

NEXT: A Tech Stock That’s the Perfect Size; How to Profit  |pagebreak|

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Celestica Inc. (CLS) is a mid-cap, cash-heavy, Toronto-based manufacturer of printed circuit boards. Its main competitors are Flextronics International (FLEX) and Jabil Circuit, Inc. (JBL). The daily chart of CLS shows that it broke through resistance going back to October 2006 in February (line a).

  • In March, CLS dropped back below the breakout level and may be completing a short-term double bottom on the daily chart in the $10.40 area

  • The decline has so far held above the 50% support level at $10 with the uptrend going back to the 2009 lows (line b) now at $9.70

  • Daily OBV surged to the upside in mid-December, overcoming resistance at line d. Both the daily and weekly OBV measures confirmed the new highs with the daily OBV now just below resistance at line c

  • A strong close above $11.60 should signal that the uptrend has resumed with the 127.2% retracement target at $13.15. Longer-term resistance is at $15-$16, and keep in mind that CLS was an $87 stock in 2000

What It Means: Investors and traders should not only look at the sector of the stocks they are considering for purchase, but also look at how stocks of the same capitalization are doing.

In any stock market conditions, there are periods where the small- or mid-cap companies either outperform or underperform the S&P 500. Of course, there are also times when the large caps do better. I have been expecting the tech sector to catch up for the past few weeks, and I still like its chances.

How to Profit: Given the dramatic rally in stocks over the past couple of weeks, I do not see favorable risk/reward opportunities in either IJK or IJT at this time.

CLS does look more interesting, but I would advise a two-stage buying strategy. Go 50% long at $10.94 and 50% long at $10.78 with a stop at $10.18 (risk of approx. 6.3%). On a move above $11.50, raise the stop to $10.66, and sell half the position at $12.12.

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