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The Use of Sector Analysis for Swing Trading
10/20/2009 12:01 am EST
Market analysis is an important part of our everyday activity. This means analyzing the market and internals first, then doing the same with the diverse sectors contained in your universe, and ultimately, performing the same analysis on individual stocks. This ensures that you're trading in the same direction as the market, and not against it.
One important part of this process is sector analysis. This analysis allows traders to quickly identify potential trading opportunities in an individual sector of the economy. It's a well-known fact that institutions move their funds from one sector to the next, rather than from an individual stock to another. This is called sector rotation. Sometimes, this rotation occurs because money is moving from assets perceived to be more risky (e.g. tech stocks) to assets perceived to be less so (e.g. gold), and vice versa. But this rotation isn't always intended to be protective in nature. Institutions tend to have a "flavor of the month" approach, where they lock in on a sector of interest and direct all their efforts to invest their funds and sell to their clients the idea of investing in such sectors. This creates an avalanche of funds getting into or out of any given sector, as most institutions will play the same game in order to avoid falling behind the "average" performance of its competitors.
This rotation effect caused by funds being allocated to or from any specific sector will create price movements that often times will be presented as a stage two (up trend) or a stage four (downtrend) in those sectors, as measured by the different sector indexes that exist, allowing for tradable opportunities for the educated trader. This is nothing new, as the sector trading tools and tactics that we teach in our seminars let you trade in the same direction of most institutional traders and market makers.
Here are just a few different ways in which a trader can use sector analysis:
- As a means to quickly search for trading opportunities in stocks within the sector
- As a benchmark with which to measure relative strength and weakness
- As a trading opportunity by using sector following securities
Let’s briefly delve into each of these categories:
One very simple and quick way in which traders look for and find tradable opportunities is by looking at the several sector indexes in their "universe." These indexes, being a basket of the different securities that conform to a given sector, will often show recognizable setups that are formed because many stocks in that given sector have formed such patterns. Thus, a buy setup in a daily chart of the $BTK.X (biotechnology index) should produce several stocks in that sector that show similar price patterns. In this way, traders can quickly focus on opportunity, by analyzing the macro list of sector indexes, and then finding the best setups within that sector.
Sector analysis can also be used as a benchmark with which to measure relative strength and weakness. Within any given sector index, some securities will outperform the index and some will underperform it. This is only natural, as you'll always have leaders and laggards in any sector. Traders can use relative strength analysis to evaluate the performance of individual securities within any given sector versus their sector index in order to determine which patterns present the best odds of a successful trade.
As a trader, you have several options to try to benefit from a sector move. One that is becoming more widely used is trading index-tracking securities. These securities (Holdrs, ETFs, and iShares), traded mainly in the American Stock Exchange (AMEX), are trusts that hold a basket of stocks that mimic the sector index composition. Some of them are liquid enough even for micro trading, even though most are better suited for swing and core trading. Trading these securities is an efficient way to do core trading as it allows you to participate in any sector's potential multi-week move while reducing the risk of any individual stock in that sector gapping down or moving against your position.
By Simon Brad of Pristine.com
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