Sector Rotation: Book Recommendations

Apr 1, 2007: 12:05 PM CST

Sector Rotation Strategy can help you view the larger picture on money flows in the market and possibilities of where strong sectors will emerge.

Regarding sector rotation, probably the best book I read on the issue, which helped me determine my strategy, is Peter Navarro’s “If it’s Raining in Brazil, Buy Starbucks.” Navarro introduces the concept of MacroPlays and contains the best logical description of Sector Rotation, Market Cycles, Economic Cycles/Reports and Interest Rate cycles.

I also recommend Peter Navarro’s “When the Market Moves, Will You Be Ready?” which is just a shortened, easier to understand book like his Raining in Brazil book.

As an aside, studying Intermarket Relationships can add to the larger picture. The aim is to identify relationships (and divergences) among the S&P 500, the bond market, currency market, and commodity market. This is more for the longer term investor, but even short term traders can benefit from studying overall market trends in markets other than the stock market. John Murphy’s Intermarket Analysis is probably the best book to begin.

There are three places I view sector rotation and intermarket analysis at a glance:

Sector Rotation Charts: Stock Charts Sector SPDRs
Intermarket Analysis: Stock Charts Intermarket Study
Prophet.net: Industry Group Analysis (also click on “Historical Trends”)

Position traders, as well as pure swing traders applying strategies that go beyond technical analysis can benefit most from these methods of analyzing the larger market.

Also, technical traders can benefit from assessing how far a trend is likely to continue, provided it has strength from a strong sector and the general market conditions.

Incorporating new ways of analysis can help if you are feeling stagnant in pure technical trading.

2 Comments

How I Trade

Mar 31, 2007: 5:39 PM CST

lthough I predominantly act in the realm of intraday time frames, I use a top-down approach that funnels information down to individual trading decisions and am heavily steeped in technical analysis.My goal is to be a technical purist, yet I let fundamental and economic releases influence my overall bias.

Although I approach my investment decisions within the context of the overall trends of sector rotation, interest rate cycles, market cycles, and economic cycles, I will not discuss those here, but will instead focus on how I trade intraday and hold balanced swing-trading positions to supplement these.

I am heavily risk averse, and this part of my personality influences how I make decisions, how long I hold a trade, and how close to place my stops. I often err on the side of:

  • Stops placed too close to the entry
  • Trades not being held long enough to develop into great profits
  • Entry after confirmation of a move underway

Although I am working on these, it is important to note your personal weaknesses when assessing your strategy. As such, I seek strong stocks in strong sectors (based on sector rotation) and aim to balance these (if opportunity presents with weak stocks in declining or underperforming sectors. Overall market direction will be an indicator of how “imbalanced” to be (which is often to the long side).

No matter what your strategy is, it is crucial to know how you could improve, and this is done with analysis and journaling and studying your trades and whether or not you personally followed your system.

Swing Trading

After obtaining a watch list (study list) of selected stocks, I then use technical analysis on the daily time frame to establish my bias and read of the stock. Once I see a pattern or trade set-up I have tested and identified as profitable, I will determine simple factors from the weekly chart (support, resistance, momentum, trendlines) for possible profit targets OR obstacles my trade will have to overcome.

I further analyze the daily chart for profit targets, price projections (which I actually hand-draw on printed charts – I leave room on the right side of the chart to do this) and stop placement.

I rely heavily on trending stocks (on a particular time frame) and often use moving averages as entry zones, and thus my stop is placed slightly below the entry (moving average). If I am stopped out, I have adopted my own rule that I must repurchase the stock should it rise a set amount above the stop-loss point.

I heavily rely on price swings and swing charts that I create, and am looking to play for small targets based on the price and swing structure of the trend of the stock and the sector, and am always comparing momentum readings to new price highs or lows. I also look for “sweet spots” in various stocks that allow me to play for larger targets. Wealth is built by holding positions longer and taking on more risk when the need arises.

I am learning to enter my trades and walk away and not adjust profit or stop targets unless key information enters the system that compels me to do so. I typically do not hold trades over the weekend unless a strong trend is in force, and will re-buy Monday if no adverse news occurred during the weekend. I like to have my weekends clear of positions so that my analysis can be cleaner and without stress or biases.

Intraday Trading

While I consider myself a scalper, I am not one based on traditional definitions. I am also not your typical day trader, who sits glued to the screen and breathlessly watches news reports and has many watch lists up in anticipation of breaking momentum or increased volatility. I hate volatility and rapid price moves and avoid them if at all possible.

Rather than behave as most people view day traders do, I take my biases from my weekend analysis and try to play them out each day through classic chart patterns, momentum, support/resistance, and trend analysis. I do use margin and leverage on key “scalps”, which are nothing more than playing out the direction of the signal on the daily time frame as it occurs on a key buy signal on the 5 or 15 minute charts.

I seek to play price swings in the dominant direction of the daily trend and exit when a swing is complete. I will avoid the counter swing and will repurchase to play for the next swing, provided there are no warning signs from volume or momentum. I am technically using swing trading tactics on the intraday charts.

I display the 5 min, 15 min, 30 min and daily charts of the stock I am viewing. I use three monitors for my workspace and use TradeStation as my carting software and my broker.

During a typical day, I will have entered and exited 5 or more positions and held each for a maximum time of 20 to 30 minutes to an hour.

Indicators

Moving averages are absolutely essential to my analysis and trading decisions. I cannot live without them. On all time frames, I utilize the 20 period exponential, 50 period exponential, and 200 period simple.

I enjoy reading the stochastic and RSI indicators, but generally use them as confirmation/non confirmation rather than as trading signals.

I view price as king, and study price swings and how price traded around key zones. I use swing charts (color charts) based on an Average True Range function for the colors in my chart.

I also cannot live without the 3/10 Oscillator, which is both a momentum and trend indicator. Popularized by Linda Raschke, the indicator is simply a MACD oscillator with settings 3, 10, 16 and can be programmed into any charting platform. I seek new momentum highs or lows as trade ideas and confirmation of price swings, and I view divergences as trade ideas and confirmation of price.

Volume is crucial for any trader, and I look for volume as a confirmation/non-confirmation indicator. Exhaustion in price often signals the end of a trend, and so I am vigilantly looking for price exhaustion or capitulation.

I use the Breadth (Advance/Decline Issues) as a backdrop for market strength/weakness, and will (often) only take trades in the direction of the breadth unless there is a compelling reason not to do so. I also use the TRIN as confirmation and show the TICK, but make few if any decisions based on it (NYSE TICK).

I used to use a whole host of indicators, but they just mixed me up so greatly and increased my already existing anxiety, that I just wanted to run away from them all. Viewing too many time frames can do the same.

Favorite Set-Ups

I have described my two most frequently used setups in recent posts: The Impulse Buyand the Momentum Divergence play both setup tight risk-reward and allow you to play for high probability small targets.

I have also described The Four Types of Trades and most rely on the Trend Retracementtrades for the bulk of my trading.

Trading Vehicles

I often use major market ETFs (DIA, SPY, QQQQ) for swing plays and individual stocks for scalp plays. If I am feeling particularly bullish or bearish, I will trade the @YM futures (Dow Mini) for increased leverage.

I have also found minor success swing trading oil and gold futures, and probably will be expanding my knowledge and trading into futures more.

(“Optional” section on options)

I also do trade options, but sparsely and in unconventional ways. I will identify larger trends on higher time frames and if I feel like I could benefit from holding a position for a longer time, I will use either bull put (credit) spreads or bear call (credit) spreads. This allows me to collect premium from time decay, and allows me to rise above the ‘games’ of stops and holding individual stocks for a longer period of time than I’m used to.

This is sort of “lazy” trading and I place probably place no more than 5% of the portfolio in these “trades” – they tend to be income producing and have a clear risk/reward… although the risk is always higher than the reward, the probability of achieving the reward (through trend analysis and charting) can offset this risk. Nevertheless, without this edge, this has a negative expectancy (technically speaking).

Conclusion

There are so many more things I could discuss, but this is the most brief description I could provide. Nevertheless, I still advocate simplicity over complexity, and finding a strategy that works for you and you alone. Play around and see what works and above all, have fun and keep your spirits up and actively avoid getting overwhelmed.

I intend this to be a mini-work in progress, as I hear back from readers regarding questions and things I missed in this brief entry.

15 Comments

Dow STILL Trapped!

Mar 30, 2007: 11:56 PM CST

The Dow rose 5 points today, but that headline eliminates all the price action that occurred today.

As mention yesterday, we are still trapped between the 20 and 50 period moving averages as defined support and resistance on the daily charts.

The Nasdaq is also trapped:

The S&P 500 sits comfortably on its moving averages (now support zones):

Now, today was an interesting day from a price perspective. Yesterday, I mentioned that moving averages can be used to generate trade ideas on lower time frames. Today was proof positive of that statement.

However, instead of behaving ‘nicely,’ price penetrated the moving averages slightly in both directions before reversing – in essence, a semi-trap occurred today.

The market is clearly trapped between the buyers and sellers, and both sides today fought a convincing battle, yet neither side won. I personally give victory to the bulls, because analysts keep listing so many reasons why our economy is headed towards a recession, housing is collapsing, oil is rising, yet through it all, the bull market – as of yet – has climbed this wall of worry quite nicely, even despite the recent ‘suprise’ correction.

We are still in a technical uptrend, especially on the weekly charts, and therefore odds do favor trend continuation until proven wrong. Regardless of the news or how you feel, more money tends to be made in the direction of the trend rather than fighting it.

Until proven wrong, and despite how negative other bloggers or the media get, we are still in a technical confirmed (long) uptrend in the Dow and other major market indices.

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Link: Time is on the Trader’s Side

Mar 30, 2007: 11:46 PM CST

Michelle, guest author at TraderMike’s site, posted an excellent observation regarding three different applications of “Time” in her post Time is on the Trader’s Side.

A major quote:

“Regard time, instead, as a wonderful and gracious friend, accommodating your need to focus and execute successful trades.”

She notes that we get so stressed out because there is so much information and so many opportunities, but rather we should focus on what we see and learn and thoroughly immerse ourself in the moment and really enjoy it!

Definately worth a read.

1 Comment

Dow Trapped between Two Moving Averages

Mar 29, 2007: 11:16 PM CST

Believe in the power of Moving Averages!

While no technical indicator is perfect, or gives totally accurate signals, moving averages can provide reliable zones of support and resistance in trending markets.

Today is a unique day in the Dow Index, in that the market tested both the lower 2o period MA (for support) and the flat 50 period MA for resistance.

 

 As technicians, we say “the market is trapped between its moving averages” and imply that a breakout of the “trapped zone” must occur.  At the moment, this signals indecision and no clear direction (at least temporarily).  It is good for the market to pause after rapid mark-ups or mark-downs (recently).

If you don’t use moving averages, or don’t know how to optimize moving averages (which settings work best), then studying how price reacts when it approaches a key moving average can be a very valuable exercise for you.

I live by moving averages for various confirmation or trade entries (or stop placements) and have found the 20 period exponential, 50 period exponential (or simple, depending on preference) and the 200 period (daily) simple work the best.  Feel free to add your own comments if you find others to work.  Many people use shorter moving averages and also use them as signals of trend strength.

However you use them, always know key areas on chart time frames higher than the one on which you are trading.  Post (or interlay) higher time frame moving averages onto lower time frame charts and see how the market trades around these levels.  Often, key tests of moving averages in trending environments (view the left side of the chart) serve as entry points into a trend.

Nevertheless, it is odd that the market (Dow Jones Index) tested both moving averages to the penny today, and I wanted to bring this to your attention.

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