How to spot leading sectors and stocks
Hello everyone,
Spotting leaders is an important exercise, as it ensures that your capital is always on the fastest racehorse out there.
If the fastest racehorse on the racetrack is unable to hold up, then it is very unlikely that other more sluggish racehorses will be able to.
It is also probable that the fastest racehorse will be able to win the race ahead of its competition on the racetrack.
I like to think of this analogy: if I have limited resources (capital) to feed the racehorses, would I want to feed the fastest or slowest one?
The answer seems obvious, but when it comes to the markets, the majority of participants prefer to “buy low” or put their money in beaten down names. Suddenly, the “slowest racehorses” become the most attractive to investors / traders.
How to spot a leading sector
The first part of the exercise is to identify a leading sector. These are some of the characteristics I look out for:
Stocks within a particular sector trade near their highs within an overall bear market
Stocks within a particular sector are able to rally on days when the broad market is selling off
Stocks within a particular sector are on uptrends and are above their 10, 20, 50, and 200 day moving averages. This holds more weight if these are achieved within an overall bear market
Stocks within a particular sector are breaking out of big, long-term bases at the same time
Stocks within a particular sector are not selling off even though they are supposed to, based on the leading narrative out there, or despite them breaking down via bearish technical patterns. This characteristic is the most difficult to spot, but the other 4 will work fine enough.
How to spot leading stocks within a particular sector
After identifying a leading sector, we want to stack probabilities, which means focusing on the strongest stocks within the strongest sectors. This raises the probability of the trade working out in our favour.
What I do after I identify a leading sector is to extract as many stocks as I can within the sector.
Some ways I do so include finding all the underlying stocks within a sector ETF. ETFs publicly disclose their holdings, so this is a pretty efficient method.
I also have access to Tradingview and MarketSmith tools, and I use their stock screener tools to look up all the stocks within a particular sector.
I then place all the stocks within a list. For example, my Tradingview list looks like this for the shipping sector:
Now that I have organised all the stocks within a particular sector in a single list, the next step is manual work.
I plough through the charts of all these stocks individually, and then shortlist the leaders.
The characteristics of leading stocks include:
Trading at more elevated levels compared to their same-sector peers
Having better-developed bases compared to their same-sector peers
Breaking out of bases ahead of their same-sector peers
Having cleaner uptrends (e.g. price sits better above the near-term moving averages, no red flag gap-down price action or big bearish candles) than their same-sector peers
Enjoying positive price reaction (read: explosive) to recent positive earnings surprises
Example: HK / China casino stocks
I will use HK / China casino stocks as an example, as I have been writing about their strength of late.
The first question to ask is whether the sector is a leading one. Below are 4 charts of HK / China casino stocks.
They have all broken out of big multi month bases and are showing huge upside momentum. Try to remember how the charts look as we will compare them with the broad HK / China market later.
Daily Chart: MGM China
Daily Chart: Galaxy Entertainment
Daily Chart: Wynn Macau
Daily Chart: Sands China
Okay, now we will look at the charts of the broad HK / China market.
Daily Chart: KWEB
Daily Chart: Hang Seng
The broad market charts pale in comparison compared to the charts of the casino stocks. As such, the casino sector is the leading sector within the market.
The next step is to identify the leading stock. Which of the four is the leader?
It will have to be the first chart (MGM China). Notice how MGM China never retested the breakout zone of its big base, while the other three did? This is a sign of strength, as buyers are stepping in to buy the stock aggressively, without even waiting for a technical retest.
Which is the laggard stock within the sector?
It will have to be the third chart (Wynn Macau). Notice how price has yet to clear the December swing high, while the other three have already done so.
Zooming into the daily chart of MGM China, we can see that the stock broke out from a tight consolidative pattern on 3 January. If we missed the breakout, the next step would be to wait for the stock to set up again. Technical setups and entries will be covered in future posts.
Daily Chart: MGM China
