12/10/2007

How to make money by monitoring sectors

Sector monitoring is useful if it gets you in to sector at beginning of sector trend. By the time sectors reach at top in sector ranking lists, bulk of the move is over. So most sector rankings have that problems.

Sectors are often based on historical classification, which often mislabels new companies or subsector. e.g. Ethanol stocks were under Chemical sector in most classification , when they started rallying and had big rally some time back. Solar Sector stocks are currently under other energy in some cases and under electronics in some cases but it is a subsector by itself from trading usefulness perspective. The exchanges (CME, ICE, NYX, NDAQ and likes ) are under Diversified Investments in Telechart. Does that make sense. I can go on and on with such examples. While broad sector categories like
  • Basic Materials
  • Capital Goods
  • Communications
  • Consumer Cyclical
  • Energy
  • Financial
  • Health Care
  • Technology
  • Transportation
are correct classification on a practical terms you want to isolate a subsector or more specifically a "industry" trend. Now this means having sectors classified in more smaller industry groups. That is what Bullsector does to certain extent. That is also the reason IBD has created its own sectors.
Another problem with sector ranking is sometime the stocks in sector are weighted by market cap and so if smaller caps are moving, it may not get reflected. Also when you are tracking a sector you are averaging it can give you a misleading picture. For example AAPL in many sector classification is in Hardware, now when AAPL was rallying in beginning of its move, rest of the stocks in the sector were going down rapidly. So the sector ranking may not truly reflect such things as it is average. As they say averages hide more that they reveal in most cases.

So considering all these limitations, a sector tracking system should give you actionable information from trading perspective. As a trader the only reason to monitor sector is to make money from it. Fortunately there are some very good sector tracking ways readily available :
The best option according to me is the IBD Industry Group Page. To use it to make money you have to study it in detail and understand the logic and thinking behind it. It has following things:
  • 197 Group Rankings
  • Leading Sectors Graph
  • 52 week high and low
  • Groups with highest % of stocks making new highs
How does one use this information. The 52 week high and low section and Groups with highest % of stocks making new highs tell you very critical information. They tell you where the next set of sector leaders are going to be coming from. In the book 24 Essential Lessons for Investment Success, William O'Neil talks about how to use that page :


The top 20% of the 197 industry groups are usually best, and I recommend avoiding the bottom 20%. IBD’s main stock tables include the stock’s Industry Group Relative Strength Rating on an A to E scale, with A being highest. A and B rated stocks are preferred. This detailed information can’t be found in any other publication.
A second and even better place to find the market’s leading industry groups is Investor’s Business Daily’s “52-Week Highs & Lows” feature on the “Industry Groups” page.
It’s organized by sectors with the most stocks making new price highs. When you’re in a positive market with numerous stocks making new highs, the top five or six sectors on this list will be your leaders. I check this list every single day so I’m always aware of what the top groups are and can spot when a brand new group shows up in the top part of this innovative list. Use of this list should increase most investors’ performance at least 10% to 20%.
The retail group popped up near the top of the list at the beginning of 1998 for the first time in several years. Any time you have 30 or 40 stocks in a sector making new highs, that’s a powerful clue you can’t afford to ignore.
Another special list entitled “Groups With The Greatest % Of Stocks Making New Highs” also provides valuable clues. It’s in a somewhat smaller box located below the “52-Week Highs & Lows” feature. (page 35)
If you daily track that list, you will see new sector trends before they hit the 197 Sector list top. For example currently the top six sectors are:

  1. Medical (26)
  2. Energy (13)
  3. Retail (12)
  4. Utility (9)
  5. Finance (8)
  6. Business Services (8)

That tells you in near future Medical and retail sector might move up the 197 sector ranking. Those are the sectors to focus on. Also if you look at individual 26 stocks in that Medical Group , you will see they are ranked by volume change and stocks with good EPS are boldfaced. So it also tells you which stock amongst these sectors to focus on.

How do I use this information is by looking at other stocks also likely to break from that sector. I also look at IBD 200, DT and EP scans and see if there are any medical stocks in it and if there are prefer them over others. This kind of sector monitoring is actionable. You can actually find trades using this approach.





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10 comments:

Pete said...

excellent post.

recently found ur blog- going thru alot of previous post- excellent thinking here. fan of the zanger/minervini/ibd/momo/et all methods.
pete

Pete said...

excellent post

Pradeep Bonde said...

Thanks.

bluebird said...

Great post and very usefull one.

What I didn't undestand is how you can drill down strong IBD sectors to the individual stocks? Stocks on new highs are listed on new highs sectors list but what if I want to check othes stocks in those sectors?
Thanks in advance,

Pradeep Bonde said...

Thanks.
For that you need to subscribe to IBD Industry Group Service or use the IBD Custom Screen Wizard.

Prashant said...

Excellent post. I was, in fact, looking forward to your views on how to identify the new leading sectors and the leading stocks from those sectors when a new move starts. Thanks.

Zack said...

Excellent post describing the problems and solutions to following sectors. I noticed some of these problems myself when trading, but seeing it explicitly described here so well, really helps a lot. thanks

Pradeep Bonde said...

Thanks all

Ram said...

Hi,

I have been reading your posts from the beginning and it has been an AHA.. experience for me.

Thanks for all the great work you have been doing.

I trade in NSE/BSE and currently we don't have something similar to IBD to track sectoral performance. What would you suggest in this case? Will finding out the 10 day ROC and sorting it based on high values help?

Pradeep Bonde said...

ROC of a 40 days or a quarter would be better. 10 days is too noisy.