Sector Rotation in Current Markets

10/06/2011 3:30 pm EST

Focus: STRATEGIES

John Bollinger

President and Founder, Bollinger Capital Management

New technology and tools exist that can give traders an edge in sector analysis, says John Bollinger, who tells how to identify the best industry groups for the longer term.

We’re talking today with John Bollinger, and many traders and investors are users of Bollinger bands. John, thank you very much for joining us. I wanted to ask you today about your views on sector rotation in the current market place.

When I started in this business was back in the days of doing technical analysis on mainframe computers. One of the natural applications of a big computing system like that at the time was to deal with this sector and group information.

We had access to a program that used the S&P 500 groups and ranked them according to a number of different technical criteria, and it made trading stocks much easier, because if you wanted to buy a stock that was rising, you wanted to buy a stock that was in a strong group; and if you wanted to sell a stock that was falling, you wanted to sell that stock that was in a weak group.

Prior to that, it had been very hard for technical analysts to track this data. There were a large number of groups, and by hand, it was an arduous sort of thing.

Then, in the middle 80’s or so, we started to get tools that really would allow us to track the group and sector world. I became enamored of these ideas, and one of the first Web sites I ever created is in fact called GroupPower.com, and what it does is it ranks in a number of different ways both industry groups—200 some odd industry groups—and market sectors—15 different market sectors.

This allows the average trader to get a little bit extra “oomph” to the trade. If you think about it, there are really only two ways you can improve your trading performance.

You can improve the number of winners versus number of losers. Say you’ve got 60% winners and 40% losers; you can push up towards 65% or 70%.

You can also improve the relative size of your winners versus your losers. If your winners are twice the size of your losers, you can work on them being two-and-a-half times.

Anything that you can do to increase the odds in favor helps with those ratios. Adding group analysis to stock trading does exactly that: it gives you just that little bit of extra edge.

Where a stock trade placed without consulting the group structure might have a 60% chance of being a winner, you might push it to 65% or 70% by adding some input from industry groups or market sectors.

Now what industries or sectors are you seeing that might have some longer-term potential?

Well right now we’ve been through a very, very volatile time in the markets, and just as the market as a whole has been in a sideways trend with a lot of volatility, a lot of choppiness. Most industry groups and sectors have been in a sideways trend.

So what we’re looking for is not so much what’s doing well now, but as we move toward resolution of this trading range that we’ve been in, we’ll look to see what the early leadership coming out of the trading range is. It’s those groups that we want to be focusing on.

Typically, this will happen in two stages. As we come out of the trading range—either to the upside or to the downside—there will be an initial burst of leadership, and you can trade those groups, but it’s important to note the rotation from there to the sustainable trend.

Often, it will be quite different, so it’s kind of a one, two step: the initial leadership coming out of the trading range, and then the more sustainable leadership.

That’s where so many people get caught in the group sector. They forget, they say, “Oh we’ve been in a long basing pattern coming out of this basing pattern, maybe basic materials and commodity chemicals and insurance companies are some groups that are doing really well,” and they’ll stick with those and they’ll forget to note that weeks into the rally, the leadership has suddenly changed.

It’s no longer those groups, but we’ve had new groups move into leadership, and that’s the really important part. Those secondary groups will likely be the ones that will last into the rally.

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