The Best Investing Bet to Make Right Now
Tuesday, March 10, 2009 | Chris RoweRating:
My last weekly contribution to The Tycoon Report was an article titled "How to Profit From the Decline Using These ETFs!" In it, I talked about the importance of focusing primarily on sector activity in the stock market, and I gave you a few ways to profit from it.
The one ETF that I specifically highlighted for you, which was the triple inverse Russell 1000 Financial Services Index (Symbol: FAZ), proceeded to gain 43.7% in just one week. And that goes to show how important it is to stick with the weakest sectors for bearish positions, and the strongest sectors for bullish positions (if you dare take any here).
The major trend is still down, and everyone wants to try to figure out which sectors to take the bearish bets on for the biggest possible gain.
Last week the financial sector lost another 10% (depending on which financial index you look at).
Who knows what it will be next week?
Well, you don't necessarily need to know the answer to that, because typically the best bet to take, assuming we had no information at all except what has already happened, is to bet on the recent trend continuing.
However, it makes sense, since you're working with your hard earned cash here, to do a little more homework or use a service that gives you the best sector signals there are. So that's why I really gave the new Sector Hunter a big plug last week in the process of making my point. Instead of just taking me for my word or experience when I tell you to focus hard on sector action, it would help if I addressed exactly why it works.
Today I'll let you read a few paragraphs of the Internal Strength System book that I wrote to help you understand exactly why it's important to focus on the sector level ...
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Institutions obviously control the movement of the stock market. Institutions generally trade sectors, not just individual stocks. Shifts in the economy stimulate entire sectors, which results in virtually all stocks in a given sector acting in unison. And when institutions are moving billions of dollars into or out of different sectors, they’re forced to spread the huge amount of money among a large number of stocks within that sector.
This is called sector rotation, and since institutional action can be like a bull running through a china shop, it’s easy for knowledgeable individual investors to recognize this event and profit by piggybacking the resulting move.
The question is: How quickly will you be able to recognize it?
For example:
When energy stocks are attractive, institutions might focus on buying 5-10 or many more different energy stocks. It might take several months to purchase all the stock that they have to buy, but the idea is to benefit from a huge, long-lasting trend caused by a major economic shift.
On the flip side, when institutions don’t like a particular sector, such as Regional Banks, they might sell out of, or sell short, 15 or 20 different Regional Bank stocks, which can take months of selling.
[Remember] that there are four basic stages to the stock market’s cycle. The same is true when it comes to sector rotation. Here’s how it works ...
1. When a sector is oversold and undervalued, it’s because it’s been out of favor for a while. Therefore, most individual investors aren’t focused on that sector.
Institutions, however, start to plug billions of dollars into that sector, literally changing the supply-demand relationship of the stocks in that sector, and therefore the sector itself. This change is usually not visible to most individual investors at first.
2. As the sector starts to move higher, other institutions start to join the party, and start plunging money into the stocks within the sector, pushing the sector noticeably higher.
3. The financial media starts to highlight the sector’s strength on television and in articles. Since the financial media is paid to play on your emotions, it hypes up the sector and gives the impression that there is virtually no stopping the strong sector. At this point, individual investors hear about the sector’s strength and start buying. At this point, too, there is only a little bit of room left for demand.
4. The last stage occurs when the general public jumps in. The signs of this are looked at as a contrary indicator. This stage is usually stimulated by financial magazines like Barron’s Magazine highlighting either the hot sector or the best performing stock within the sector. An even bigger red flag is when we see the sector, stock or general market on the cover of mainstream magazines that don’t focus exclusively on the financial markets (like Time Magazine).
This is when Bob Jones sees the magazine cover and calls his broker and tells him to buy the stock or sector. Mr. Jones and his neighbors and friends make up the final demand left for the hot sector.
Usually, the advance in that sector will continue for another 3-6 months before tanking.
The "magazine cover indicator" is usually a strong long-term indicator of saturation. At this point, anyone who’s going to buy has already bought, leaving nobody left to buy from the sellers. That’s why we see such a swift drop soon after that magazine cover is printed.
Bottom line ...
You can buy the greatest company on earth. If it’s in a declining sector, you’re going to have trouble making money. On the other hand, you can own stock in a “piece of garbage” company. However, if it’s in the strongest performing sector, then you are still likely to make a profit.
Even when the general stock market drops, taking most stocks down with it, it’s likely that the strongest sectors would be resistant to decline which means they may not decline by nearly as much as the rest of the market, or they may even advance. In a market that so many people are calling "oversold" it's hard to take a bearish bet because people are afraid to have a strong rally destroy the bearish positions. But when you are bearish on the weakest sectors, it's likely the sector won't rise as much as other sectors do. They’d likely either move lower, but by a smaller percentage than the market did, or move even higher as the market moves lower.
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So that's it for this week. Congratulations to those who have gotten on board with Sector Hunter. In light of the recent launch, I'll probably write another article on sectors next week, too.
In the meantime, I invite everyone reading this to leave a comment if you feel sectors are at least tied for first in your stock market investment decision-making considerations. Until next time, "Profit From The Trend."
(Please let us know what you think about Chris Rowe's article.)
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“Profit from the Trend”
Chris Rowe
Chief Investment Officer
The Trend Rider
