Leadership Rotates…So Rotate With It!

November 11, 2000
Tsutae Kamada

Which
is the best baseball team today? I believe many baseball fans would
pick the New York Yankees. As we know, the Yankees recently captured their third
straight World Series title. When a team is in a winning streak, it’s almost unstoppable. Winning streaks are like strong uptrending stock sectors,
and their trends last a long time. We can say the same of downtrending sectors.
Once a sector begins a downtrend, it tends to remain in the downtrend for a long
time.

We often hear investors talk about “sector rotation.“
Why is it so important to pay attention to stock sectors? In general, when
mutual funds invest their money, their decisions are based on economic
forecasts.
Analysts are constantly looking for which sectors or industries will benefit from
upcoming economic environments. If fund managers see the semiconductor sector
looking attractive in coming months, they will shift or rotate money from weak
sectors to semiconductors.Â Â

Back in May 1999,
the semiconductor sector
began an uptrend which lasted till March 2000. We saw the
semiconductor sector index
(
SOX |
Quote |
Chart |
News |
PowerRating) rise from 370 to 1360 in this period. As I
mentioned earlier, once a trend begins, it will last long time. Also in this
same period,Â the telecommunications sector was experiencing a strong bull
market, and its index
(
XTC |
Quote |
Chart |
News |
PowerRating) ran up almost 60%. As long as business environments
and economic conditions are favorable to certain stock sectors, fund
managers will not shift money to other sectors. That’s why we keep hearing
the same sectors’ names over and over as strong performers.Â

As semiconductors and telecommunications were peaking in March 2000, one
sector slowly began to come out of its bear market — the
utilities sector. Since March, the Utility Sector Index
(
UTY |
Quote |
Chart |
News |
PowerRating) climbed up from
240 to 380, almost 60%, and its uptrend is still intact. This is one actual
example of how yesterday’s loser becomes today’s hero. By reviewing and studying each
sector’s chart every day, we can see signs of technical weakness, such as
a violation of long-term trendlines which may be signaling that a
sector rotation is in progress.Â Also, periodically checking TradingMarkets.comÂ
Uptrending and Downtrending Indicators can give us valuable
information about which sectors are strong or weak. Â

Let me give you two actual examples. Exchange Traded Funds (ETFs are like mutual
funds but are traded in major stock exchanges) provide us with excellent pictures of hot and
weak stock sectors. According to TradingMarkets.com
Funds Indicators, the best 12-month performing fund at present is the Utilities Select
Sector Fund
(
XLU |
Quote |
Chart |
News |
PowerRating). It has a strong three-month RS (relative strength) of 98,
a six-month RS of 97, and a 12-month RS of 96. As you can see on the daily chart, the
stock has been uptrending since February 2000 and it still looks strong.

On the other hand, the worst 12-month fund
at the moment is the Internet Holders
(
HHH |
Quote |
Chart |
News |
PowerRating). It has an extremely low
three-month RS of 4, a six-month RS of 1, and a 12-month RS of 1. The issue
has been declining since the beginning of 2000, and this downtrend is still
intact.Â

If you look at these two charts again, you will notice how money shifts or
“rotates” from a weak sector to a strong sector. I cannot stress enough the
importance of following strong sectors. Let me add that sector funds
are a wonderful way to capture long-term profits from uptrending sectors.Â

A stock sector can be divided into several sub-sectors or industries. For
example, the utilities sector comprises three industries: electric, gas, and water utilities. You can find profitable opportunities in the
strongest and the weakest sub-sectors, just as you can in sector funds. According to Dow Jones & Company, the best-performing industry
of 2000 is Biotechnology (a sub-sector of the
healthcare sector), up 69.84% (YTD), and the
worst is Office Equipment ( a sub-sector of the technology sector), down 48.32%
(YTD).

Biotechnology
IndexÂ Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â
Office Equipment Index

Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â

As you can see, the Biotechnology Index is challenging its resistance level near
700, and it may be setting up for a breakout. On the other hand, the Office
Equipment Index is still in a clear downtrend.

Our next task is picking potential buy candidates from the
Biotechnology
industry and choosing issues for
shorting from the Office Equipment industry. You can find those stocks easily by
utilizing our TradingMarkets.com Stock
Scanner. You
can set your own criteria, but I would like to show you how I use the scanner.Â

Letâ€™s start with Biotechnology.Â

First, I set the Sub Sector
to Biotechnology. Usually, higher-priced stocks give you better results
because they have a wide daily
price range, so I put 30 or higher into the Closing Price section. Next, I
insert “3000” (3000 equals 300,000 shares — the last two 0s are
omitted) into the 50 day avg.
volume section. I want stocks to have good liquidity. Next, I put 80 or
higher into the RS(3MO) section. If my stock has a RS of 80, that means the
stock belongs to the top 20% of the group. Lastly, I insert greater into the 50-day MA and
200-day MA sections and hit the START SEARCH button. Thatâ€™s it.

I study each daily chart and look for stocks with excellent
tradable patterns. Four stocks look interesting to me: AMRI and AVIR are pulling
back from recent highs and we can expect them to resume their uptrend. MYGN
and GENZ made strong breakouts to new highs. Their breakout volume was big,
and their upward move will probably continue for a while.

This time, I will choose potential short-selling candidates from the
Office Equipment industry, again using TradingMarkets.com Stock
Scanner. I start by setting the Sub Sector to Office
Equipment.Â My scanning criteria are: Closing price of 30 or
higher; 50-day average volume of 300,000 shares or higher; ADX value of 30 or
higher; Negative DMI value; and closing price of below 50-day moving average.
(You can study more on ADX indicator in Dave Landry’s Finding
The Strongest Trends With ADX.)Â

In general, the higher the ADX value, the stronger
the trend of the stock. This time, my scan produced no potential short-selling
stocks. I decided to remove closing price and 50-day average
restrictions but this still did not give me any stocks. My conclusion is that
although this industry is downtrending, no individual stock is declining
strongly enough.

Let me show you a different approach to find potential short-selling candidates.
TradingMarkets.com has several downtrending indicators. The one I am interested is
New Low RS Sub-group Concentration,
where you
will find Telecommunications Services as the one of the weak
industries. After scanning this industry using the same criteria as those used for the Office Equipment
industry, I have now two stocks
for potential short sale:
(
TBH |
Quote |
Chart |
News |
PowerRating) and
(
TEF |
Quote |
Chart |
News |
PowerRating). TBH is bouncing down from its 20-day
moving average, and TEF is failing to break above its 50-day moving average.
Both stocks look ready to test their prior lows.

Summary

The strongest industry group is an excellent place
to
look for potential buy candidates. Make sure your scanning criteria are strict
enough, so you can get only the strongly uptrending stocks. On the other hand,
finding stocks for shorting is tricky, because the worst-performing industry does
not always give us good prospects. However, one of the downtrending indicators, New Low RS
Sub-group Concentration, can provide us with some stocks for potential short
sale. Some days, of course, scanning the strongest industry may not produce any
good candidates for buy. Eventually, stocks will form a peak and begin to
decline. That will cause decrease in the ADX value. We have to be flexible and sensitive
to changes in market conditions.

Finally, let me show you a short cut, so you can automatically find stocks from the strongest
sector:

In his book, Hit and Run Trading,

Jeff Cooper writes that you should pick stocks with a RS reading of 95 or higher,
and choose stocks preferably above $40 a share. I scanned for stocks that fit
his criteria (I also added 50-day average volume of 300,000 or higher)Â and
received 49 stocks as a result. Amazingly (or as expected), 11 stocks (22.4%)
were from the biotechnology industry, followed by four stocks from the business
software industry. A word of caution, Mr. Cooper says, ” My only
criticism of RS is that it will not allow you to create a short-selling list.
Unfortunately, extremely low RS readings usually are associated with stocks that
are trading for $2 or $3 a share.”Â

Good luck, and happy trading.Â

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Leadership Rotates…So Rotate With It!

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