Industry Groups

At this point in your investment research you should be able to answer the question: "What state is the market in?"  Assuming the market is in a confirmed rally, you are ready to find stocks that are part of a an industry group leading the market.

Finding Industry Groups Leading the Market

Generally speaking you want to locate industries that are leading the market higher and pinpoint the leading stocks in those industries.  That is where the big big money will be made.  The sooner you can spot these trends the better, so I try to use a hybrid approach of pure price movement performance of industries over 10, 20 and 30 days as well as analysis of exchange traded funds (better known as ETF’s) which also allows me to see the volume movements as well. 

Price Performance

In the members area I display a list of the top 20 performing industries over 10, 20 and 30 day time frames in order to track those industries that are moving.  Here is a screenshot a copy of the list found in the Top Industries area of the members section:

Rank 10 Day Performance 20 Day Performance 30 Day Performance
1

Electronics Stores (0)

Catalog & Mail Order Houses (1)

Catalog & Mail Order Houses (1)

2

Home Furnishings & Fixtures (0)

Semiconductor – Memory Chips (0)

Semiconductor – Memory Chips (0)

3

Processing Systems & Products (0)

Major Airlines (0)

Networking & Communication Dev (0)

4

Investment Brokerage (12)

Processing Systems & Products (0)

Office Supplies (0)

5

Residential Construction (0)

Electronics Stores (0)

Processing Systems & Products (0)

6

Pollution & Treatment Controls (1)

Semiconductor – Broadline (2)

Internet Software & Services (7)

7

Appliances (0)

Appliances (0)

Semiconductor – Integrated Circuit (3)

8

Apparel Stores (3)

Food Wholesale (0)

Semiconductor – Broadline (2)

9

Catalog & Mail Order Houses (1)

Toys & Games (0)

Internet Service Providers (2)

10

Recreational Goods – Other (0)

Internet Service Providers (2)

Semiconductor Equipment & Materials (1)

11

Food Wholesale (0)

Auto Parts Stores (1)

Sporting Good Stores (1)

12

Major Airlines (0)

Residential Construction (0)

Drugs – Generic (0)

13

Apparel Footwear (2)

Recreational Goods – Other (0)

Food Wholesale (0)

14

Internet Service Providers (2)

Home Health Care (0)

Printed Circuit Boards (1)

15

Department Stores (1)

Lodging (0)

Department Stores (1)

16

Sporting Good Stores (1)

Specialty Eateries (0)

Semiconductor – Specialized (2)

17

Dairy Products (0)

Apparel Footwear (2)

Electronics Stores (0)

18

Industrial Equipment Wholesale (1)

Department Stores (1)

Application Software (3)

19

Movie Production – Theaters (0)

Networking & Communication Dev (0)

Diversified Computer Systems (0)

20

Home Improvement Stores (0)

Broadcasting – Radio (0)

Apparel Stores (3)

Important Note: Industries in bold with a number next to them indicate that there are stocks in the SelfInvestors Breakout Tracker from that industry.  The number indicates how many.  Stocks in the Breakout Tracker are the fastest growing companies in the world that are near a breakout from a base or they have already broken out from a base.  These companies are the leaders of their industry.  So this table provides a great way to find the leading stocks of leading industries in just minutes each day.  Very powerful indeed! 

When I’m scanning this list, I’m looking for two things in particular – an overall theme and industries with lots of leaders.   By theme I mean  broader sector such as technology, medical, commodities or financial.  What is the theme for this market currently?  Well, it’s certainly not oil anymore!   For the past couple years this top performing industries list was dominated by oil related industries, metals and heavy machinery.  It was a commodity boom.  A couple of months ago the commodity related industries slowly started disappearing from this list until eventually there were none.  What I began to see was were more technology related names popping up.. something that had not been happening for a long time.  It prompted me to bring it to the attention of my subscribers on August 20th, 2006 in the Weekly Market Report (Sign up for it in the upper left hand corner of the this page – it’s free!):

August 20th 2006
"The market has a way of pulling off surprises and a surprise is exactly what we got last week as inflation came in much cooler than expected which contributed to 5 straight days of market gains.  Taking a look back, two big themes come to mind.  First and foremost has been the lack of buy volume during the 2 days of big rallies.. it’s something I mentioned on a few occassions in the MidDay Market Updates last week.  It looks like institutions are being very cautious here and rightly so.  One good economic number doesn’t make a trend and by jumping in prematurely can be a recipe for disaster (remember, institutions can’t unload positions quickly like the small investor).  The second big theme of the week was the shift of money from commodities to tech.  Many tech companies began to emerge from the dead last week and may prove to be the backbone of any new rally.  Pay close attention to technology shares in the coming weeks.  It’s still too early to start seeing a barrage of high quality tech breakouts, but in a few weeks this may be where the big money is made.  As far as economic numbers go, it’s going to be a light week but Iran’s formal response to the nuclear incentives package may be a market mover on Tuesday.  I’d expect to see the market digest recent gains and possibly retrace the entire move.  Look for decreasing selling volume on down days as a sign that the market continues to get more bullish."

In order to find out where the big money is flowing I prefer to look at the 20 day time frame first and then branch out to the 10 and 30 day time frames to confirm.  The 10 day is a bit short and may just indicate an oversold bounce while the 30 day may be a bit long and you may have missed the bulk of the move.  So, the 20 day provides a nice starting point, then I can look at the 10 and 30 day performance to see if it’s performing well on those time scales too.  If it is, even more reason to focus your attention on that particular industry/sector. 

So in this example, looking at the 20 day performance I’m not seeing a dominant theme such as mostly retail or mostly technology, but there are areas of strength worth noting.  Since nothing is really jumping out at me on the 20 day timeframe as far as an overall theme, I’ll scan the 10 and 30 day timeframes as well to help put together an idea of where money is flowing right now.  Here are some notes I would be taking:

  • There are two semis industries in the top 6 of the 20 day time frame – Memory Chips & Broadline.  What really jumps out is that several semiconductor industries appear in the top performances over the past 30 days as well – Memory Chips, Integrated Circuit, Broadline, Equipment & Materials and Specialized.  Clearly, semis are showing considerable strength, so I’d be looking for the leaders in this industry and putting money to work at some point.  However, considering that many appear in the 30 day performance, may need to pull back some.  The trend may be a bit overdone in the short term.
  • There are quite a few retail, consumer related industries in the table.  With commodity prices plunging, rate hikes on hold and evidence of a soft landing in the economy the market probably feels that the housing downturn won’t destroy consumer purchasing power too much.  In the Top 20 column I see Catalog & Mail Order Houses, Appliances, Toys & Games, Auto Parts Stores, Recreational Goods, Specialty Eateries, Apparel Footwear and Department Stores.  This trend also appears on the 10 and 30 day time scales as well. 
  • Housing Related stocks are coming back.  It’s very early in the trend, but housing is emerging as a sector of strength with Residential Construction making an appearance at position 12 in the 20 day time frame for the first time in probably a year.  Notice in the 10 day time frame that Home Furnishing & Fixtures (2), Residential Construction (5) and Home Improvement Stores (20) appear.  With 2 consecutive pauses in rate hikes, the market is putting some money to work in this sector.  However, keep in mind that past leaders will rarely lead the market again.  This is probably an oversold bounce and not much more than that.
  • The Investment Brokerage industry contains 12 leading stocks that are near a breakout or have already broken out!  It’s number 4 in the 10 day performance table but doesn’t appear anywhere else, so it’s an emerging trend that may be too early to jump into, but absolutely worth looking at.  I’ll go ahead and do that now and see that it may not be too early to nibble a bit in this industry.  The top rated stock in this industry is Blackrock (BLK) and it already broke out on September 13th and is pulling back into a buyable range.  A couple others worth taking a look at include Knight Capital (NITE), TradeStation (TRAD) and Charles Schwab (SCHW).  I’ll put these in a watchlist and look for a good entry.

So in summary, based on the performance tables I’d be focusing on technology (particularly semis) and retail in my overall strategy for initiating long positions and nibble a bit in the leading brokerages.

Using ETF Analysis to Guage Leading/Lagging Industries

Using pure price performance can no doubt be valuable as we’ve seen by the amount of information that can be gleaned from the simple table above.  However, pure price performance doesn’t quite give the whole picture.  Without studying the volume behind those price moves, we have no idea how much momentum is behind the move. This is extremely important because the amount of volume behind a price move validates the move in that an unusually large number of traders are willing to pay increasingly higher prices.   

So how can we study the volume moves in an industry?  Through the analysis of Exchange Traded Funds (ETFs) which trade like individual stocks and provide volume data throughout the day.  Unless you are brand new to the investing world, you have no doubt seen the explosive popularity of this type of investment.  Simply put an ETF is like a mutual fund that can be traded on the open market throughout the trading day.  By tracking the price and trading volume movements of ETF’s that seek to emulate an industry or sector, I can get a decent picture of just where in the market the big money is flowing to.  There wasn’t enough trading volume in these instruments for an accurate analysis just a couple years ago, but now they provide an accurate representation of the health of industries and sectors.  By using a fairly simple formula (which I call the Demand Indicator) that awards points for high volume buying and low volume selling and subtracts points for high volume selling and low volume buying, I’m able to see where the money is flowing.  Here at SelfInvestors.com I track this demand over 15 and 30 days which I believe provides a good time frame for tracking trends.

Registered members of SelfInvestors.com (just a name and a valid email address in the upper left of the page gets you access!) now have access to a new feature called Market Snapshot which tracks leading and lagging industries as well as emerging markets using the Demand Indicator I just mentioned.  Here are a couple screenshots:

This shows a portion of the Market Snapshot page showing the top 5 leading industries according to demand (measured through price and volume) over 15 and 30 days.  Industries are ordered by the combined DI score over 15 AND 30 days (the higher the scores, the greater the demand).  The table also shows the price % change and the volume % change from the average for today as well as the % from the 50 and 200 day moving averages.  The table confirms what we saw in the price performances table above in that technology and consumer related industries are leading this market higher.  While retail isn’t shown here, I have a suspicion that it’s ranked 6 or 7 (it has appeared on this list at times in the last couple weeks). 

While this article focuses on finding industry strength for investing long in a bullish market, the lagging industries section provides a look at industries traders are dumping en masse which may provide fertile ground for short opportunities.  Here’s a screenshot showing the lagging industries on September 21st:

Not much surprise here.  The oil and gold industries have been getting crushed and those industries have appeared in the lagging industries section long before the meltdown actually began.  Yes, price and volume movements are a leading indicator!  Notice the DI scores for the Ishares Global Energy.  Typically, the DI scores will range between -20 and +20 so that is some mighty heaving selling going on.  Granted it’s a thinly traded fund so is prone to more wild movements, but still a good indicator of the amount of money pouring out of oil stocks recently.  However, there are strong technical support levels on the horizon and you have to believe that OPEC will step in at some point and do all it can to halt the plunge.

So there you have it.. my characteristically wordy (not in a nutshell) explanation of how I go about tracking industry and sector rotation.  This is a process I’ve been honing for awhile now and believe it’s important for all traders to have their own "process" for researching the markets, but hopefully you can take away some ideas and hone your own for an even better tracking method :)

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