Believe it or not, there are some stocks that have continuously been trending higher and higher. One might not think that's true based on the way the general stock market has been trending lately. But not all stocks are performing the exact same way the general market indices are performing.
For the last four or five months, we have seen the general market trade sideways. In fact, when you look at a one-year chart of the stock market, you'll see that we're at just about the same place that we were a year ago. It seems like each month the market either trades up or down by 10 or 15%. Even when we see the market appear to be breaking out, it often just sucks in new buyers only to sell off again.
So considering the fact that individual stocks don't all perform exactly the same way the general market indices are performing, it's more important now than ever before to be very selective about the stocks that you choose to buy.
I don't know if the general market will break out from here with a sustained rally, or if this will just be another one of those times where the market sucks in buyers and then sells off again.
So what I've been doing is hedging myself by trading both the bullish and bearish sides at the same time. But that doesn't mean I don't still have to be very selective with my picks.
What are some of the things that you should look for when taking long positions, or positions that will profit as the stock moves higher?
Size Does Matter
It's important to focus on the market cap of the stock that you are considering. If you take a look at the stock market, you'll notice that small-cap stocks have not broken their horizontal resistance levels. Small-cap stocks have been lagging behind mid-cap and large-cap stocks. If you look at the NASDAQ 100, which is the 100 largest stocks in the NASDAQ, you will see that they broke out of their horizontal resistance over a week ago.
What About Breakouts?
Some investors tend to ask a very good question: "If this market broke out already, does that mean it's too late? Shouldn't we be buying the ones that didn't break out yet?"
The answer is you want to stick with the stocks that have already shown strength. You want to buy stocks that have proven themselves already. Typically, the stocks that break out first are the stocks that will sustain their rally. Typically the stocks that are lagging the rest will continue to lag until the trend changes. If they are overbought, it might pay to wait until they pull back to buy your position. But nonetheless, the stocks that broke out early are still the ones we should focus on in a pullback.
The S&P 500, which includes many of the stocks in the NASDAQ 100, just broke through its horizontal resistance yesterday. This was pretty much a triple top breakout. The high in August pretty much matched the high made in June. Those two highs are the ones that we just broke out of.
The Dow Jones industrial average also just broke out of its horizontal resistance level. That marks the second higher high since the early July bottom. In other words, the high made in August was significantly higher than the high made in June -- as opposed to the S&P 500, which made even highs in June and August.
Growth or Value?
It's also helpful to figure out whether growth stocks are outperforming, or value stocks are outperforming.
Currently, we know that growth stocks have been outperforming value stocks. There are many stocks that are considered to be a blend of both growth and value stocks. We know this because we do a relative strength comparison between growth stocks and value stocks, and one way to figure this out is to compare the Russell 3000 growth Index to the Russell 3000 value index.
I can't possibly overstate the importance of using relative strength when picking your stocks.
You want to buy stocks that have already proven themselves by outperforming the general stock market, and also by outperforming their peer group. For example: if I was looking to buy Starbucks (symbol:SBUX), I would look to make sure that it's outperforming the general stock market, such as the S&P 500, and I will also make sure that it's outperforming restaurants in general.
It's important to understand that there is short-term relative strength and then longer-term relative strength. Short-term relative strength might show that a stock such as Starbucks outperformed the S&P over the last few days.
The S&P 500 might have traded 3% higher in one week, while Starbucks traded 10% higher in one week. That is short-term relative strength.
But what happens if, in week two, the S&P 500 traded 3% lower while Starbucks traded 5% lower?
In this example, in week one, Starbucks outperformed the S&P 500, but in week two, the S&P 500 outperformed Starbucks. But you might have already noticed with that equal 3% move lower instead of higher (on the S&P 500), that Starbucks only moved 5% lower as opposed to 10% higher.
Now let's say, in week three, the S&P 500 moved up by 3% again. At the same time, Starbucks moved up by 10%.
I'm sure some of you are already realizing what's happening here.
S&P starts at 1,120
Moves up 3% to 1,153
Moves down 3% to 1,118
Moves up 3% to 1,151
Total move up 2.8%
SBUX starts at $24.00
Moves up 10% to $26.40
Moves down 5% $25.08 (in week 2, notice Starbux is profitable, while the S&P is slightly lower)
Moves up 10% to $27.56
Total move up 14.83%
In the example above, we showed you that Starbucks is outperforming the market. But it's outperforming the market on a longer-term basis, as opposed to a short-term basis. We call that a relative strength Buy Signal.
As I mentioned above, you want to be long stocks that are on relative strength buy signals versus the general stock market, but also on relative strength buy signals versus their peer group (in this case, the restaurant sector).
This is very basic but incredibly important: You don't want to buy stocks that are in negative trends.
In other words, don't buy stocks in downtrends, or when they're below their downtrend line. You want to buy stocks that are making higher highs and higher lows. In other words, stocks that are in positive trends.
Stick with stocks that are on buy signals, but don't think just because a stock is in a positive trend, that means it's on a buy signal.
A stock might have just broken through an important horizontal support level, and still be above its upper trendline. If the stock is in that position, I would rather wait to see if that stock finds support at a lower price, preferably near or at its uptrend line.
Bullish Percent Index
You can find sector bullish percent indices for free if you Google it, but you are only going to find bullish percent indices for the 10 major S&P sectors. I don't like to use those bullish percent indices because they are too general, and because there are usually not enough stocks in that group to make a valid study.
If you sign up with TycoonU's Sector Hunter by Teeka Tiwari, you'll gain access to 45 broad sector BPIs.
The bullish percent index tells you how many stocks in the group are on Point and Figure buy signals. You want to be in stocks that are in a group that have their BPI moving higher. That shows that more and more stocks in that group are moving to buy signals. In other words, more stocks in the group are moving to buy signals than are moving to sell signals. If 15% of stocks in a group move to buy signals, while 10% move to sell signals, then net 5% of stocks in that group have moved to buy signals.
Individual stocks within a sector tend to move in unison. They move like a school of fish, mostly at the same time, with some stragglers of course. You want to use a sector's momentum to help you make money in the stock.
Putting it All Together ...
It may seem sort of overwhelming to know that you want to try to find stocks that fit these criteria. Add to that the confusion of not knowing in which direction the general stock market is moving, and one might feel lost.
Obviously it pays to be positioned to take advantage of the direction of the general stock market. You want to use the momentum of everything you possibly can, including the general stock market's direction, followed by its "peer group" (or sector's) direction.
Like I said before, I don't know if the stock market will resume its uptrend, or turn around and move lower like it has been over the last four or five months. Again, I have both bullish and bearish positions open at the same time.
But below I've listed 10 stocks that fit all the criteria that I just mentioned. In other words, all of the stocks below are:
- Either large-cap growth (or blend) or mid cap growth (or blend) stocks
- On relative strength buy signals versus the general stock market
- On relative strength buy signals versus their peer group
- In positive trends
- On buy signals
- In sectors that have their bullish percent index moving higher
Linn Energy LLC (Symbol: LINE) -- Utilities and Gas Sector
Starbucks Corp. (Symbol: SBUX) -- Restaurants Sector
Chipotle Mexican Grill 'A' (Symbol: CMG) -- Restaurants Sector
Cummins Inc. (Symbol: CMI) -- Machinery and Tools Sector
Equity Lifestyle Properties Inc. (Symbol: ELS) -- Real Estate Sector
MSC industrial direct Co Inc. (Symbol: MSM) -- Machinery and Tools Sector
Millicom International Cellular S.A. (Symbol: MICC) -- Telephone Sector
Silver Wheaton Corp (Symbol: SLW) -- Precious Metals Sector
Nordson Corporation (Symbol: NDSN) -- Machinery and Tools Sector
It's up to you to pick the timing on when you want to enter into any of these positions.
While some of these stocks look like they can afford to correct a little bit before moving higher, the reality is that if the market explodes to the upside the overbought stocks will probably outperform all the other ones.
I hope this helps those that are considering taking bullish positions in this market. My only advice is to stay hedged, and trade safely. Until next week...
Chief Investment Officer
Technical Analysis Millionaire