Buy the leaders, not the laggards
Stocks shook off early weakness
yesterday morning to finish with another session of gains across the board.
After beginning the day with an opening gap up, stocks trended lower throughout
the first ninety minutes, but the bulls seized control at mid-day, sending the
market higher in the afternoon. Strength in the biotech and internet sectors
helped the Nasdaq Composite show relative strength for a change. The Nasdaq
rallied 1.0%, double the 0.5% gain of the S&P 500. The Dow Jones Industrials
ticked only 0.2% higher, but the small-cap Russell 2000 and S&P Midcap 400
advanced by 1.2% and 0.9% respectively. Each of the major indices finished at
their intraday highs, a sign of institutional support into the close.
Total volume in the Nasdaq increased by 11% yesterday,
enabling the index to register its second straight “accumulation day.” Volume in
the NYSE was 5% lighter than the previous day, but still well above its 50-day
average level. The gains on higher volume confirmed the relative strength in the
Nasdaq, whereas the tapering of turnover in the NYSE matched the more subdued
action in the S&P and Dow. Market internals were firm in both exchanges.
Advancing volume exceeded declining volume by a margin of 2 to 1 in both the
NYSE and Nasdaq.
Our long position in the Oil Service HOLDR
(
OIH |
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PowerRating) continued
to move higher yesterday and is now showing a gain of 6.5 points. The long
position in the StreetTRACKS Gold Trust
(
GLD |
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PowerRating) also moved further into
positive territory, but we stopped out of the iShares Russell 2000
(
IWM |
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PowerRating)
when it rallied above the high of its consolidation. We initially sold short IWM
when it broke support of its hourly uptrend line on October 24, but it promptly
snapped back above it the following day. We also made a decision to close the
position in the StreetTRACKS Capital Markets
(
KCE |
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PowerRating) ahead of its original
stop.
The Biotech Index ($BTK), which began a steady uptrend about a
month ago, zoomed 2.9% higher and closed at a fresh multi-year high for the
first time since February of 2006. The last time the index closed above its
current level of 756 was way back in November of 2000. The $BTK index is now
only 7% below its all-time high, but there has been quite a bit of divergence
between the various Biotech ETFs. The biotech sector is showing more strength
than the tech stocks lately and is clearly a good place to be positioned, but
it’s important to make sure you are in the ETFs with the most relative strength.
Vastly different percentage weightings in the leading biotech stocks has caused
major price divergence within the different families of Biotech ETFs. There are
presently five different biotech ETFs, but how is one to know which is the best
one to buy? The answer lies in using a special kind of chart known as a
“percentage change chart.”
Rather than charting the price of a stock or ETF, a
“percentage change chart” simply shows the percentage that an equity has gained
or lost within a certain period of time. When overlayed with more than one
ticker symbol on the same chart, it becomes a great way to quickly and easily
compare the relative strength of several different equities. In the chart below,
we took all five biotech ETFs and overlayed them with the actual $BTK index. The
percentage gains are measured since the close of trading on September 22, as the
following session is when the current uptrend began. Match up each line with the
color-coded legend on the top left side of the chart in order to see which ETFs
have shown the most relative strength over the past month:
As you can see, the actual $BTK index (the thick black line)
has gained 16% since September 22. Therefore, if looking to buy one of the
biotech ETFs, we ideally would want to buy one that has gained more than the
index itself. Curiously, only one ETF, the First Trust Biotech
(
FBT |
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PowerRating) has
outperformed the index by gaining 16.5%. Relatively close behind is the
PowerShares Dynamic Biotech
(
PBE |
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PowerRating), which has gained 14.3% over the past
month. Curiously, the most popular biotech ETF, the Biotech HOLDR
(
BBH |
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PowerRating), has
been showing the most relative weakness. While the $BTK index has gained 16%,
BBH has rallied only 7.8% during the same period. This is largely due to
disproportionate weightings in a few big biotechs like Genentech (DNA) that have
lagged the market. The chart above proves that the most well-known ETFs within a
particular sector are not necessarily the best ones to buy.
I will conclude with one more important thought about the
chart above. It’s a simple premise, but one that most new traders ignore. . .
Buy the leaders, not the laggards! When I was a novice sector trader years
ago, I often made the expensive mistake of buying the stocks that were lagging
behind others in the sector. My thought process was that the leaders had already
gained too much, so the laggards were bound to “catch up” to the leaders. While
this is a logical theory, I learned the hard way that it rarely works that way.
Time and time again, I watched my laggard stocks go nowhere, while the stocks
that were “already up too much” continued to surge higher. Simply put, stocks or
ETFs showing relative weakness within a sector do so for a good reason —
traders and investors are not buying them. The reason they are weak does not
matter! All that matters is the price action (and volume). Stocks and ETFs with
relative strength are not only the first ones to shoot to new highs when the
corresponding sector index bounces just a little, but they are also the last
ones to fall if the broad market suddenly reverses to the downside. Given how
extended the broad market is right now, buying only the ETFs with relative
strength to the overall stock market is crucial.
Open ETF positions:
Long OIH and GLD (regular subscribers to
The Wagner Daily receive detailed stop and target prices on open
positions and detailed setup information on new ETF trade entry prices. Intraday
e-mail alerts are also sent as needed.)
Deron Wagner is the head trader of
Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com),
which he launched in 2001. Wagner appears on his best-selling video, Sector
Trading Strategies (Marketplace Books, June 2002), and is co-author of both The
Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader
(McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and
Yahoo! FinanceVision. He is also a frequent guest speaker at various trading and
financial conferences around the world. For a free trial to the full version of
The Wagner Daily or to learn about Deron’s other services, visit
morpheustrading.com
or send an e-mail to
deron@morpheustrading.com .