Industry Risk Cycle

The rotation of stocks within an industry is as follows as taught by "option addict" found at ibankcoin and trading addicts.

My view is only a little bit different, but it is more complex and thus this method above is probably more practical. The most simple explanation is that sentiment moves from an extreme low to an extreme high and back and it manifest itself in various layers, but the layers get complicated due to different goals and size of capital needed to be moved. Rather than get into the complications right now I better explain this cycle first.
When you expect a rotation into an industry, you should understand there is a bit of an order that TENDS to occur as a result of the perception of risk and other factors. By knowing this tendency you can use it to anticipate movement and provide a bit more focus into a particular name and boost your results.

The market will usually be driven by a leader outperforming and then the trending momentum names will continue their charge strong. The rotation into momentum has a lot to do with liquidity and the largest players providing the positive equity and signalling a more long term sustainable rotation into the industry. This way the smart money can get ahead of the rotation that will take these mega institutions a lot longer to accumulate. The laggards are again an instance of the recognition that the industry will continue its rotation, and that those that lagged the move are relatively undervalued compared to how they were relatively valued before the rotation began. Also, there is a perception that laggards are riskier as those who buy it are more than likely going to have to wait on a loss before the return goes positive. Finally once you have the liquid laggards there is nothing left that hasn't really moved besides the companies that are perceived to be the kind you don't touch with a ten foot pole. Rather than chase these, the peddle goes to the floor as the buyers simply target the high short interest stocks. These are companies that people have been betting against but now as the tide has turned, the shorts will eventually have to cover in and if they get enough capital in there and trigger a short squeeze, they can simply CREATE liquidity through the short sellers margin calls and go for the big short squeezes. Finally, once everyone is starting to become convinced of the move, the short sellers will cover the names they have a profit in that they intended on shorting to zero (as a result of the margin call?) creating the bottom of the lowest quality names and also there will be some liquidity from the retail investor always predictably showing up late to the party chasing performance.

You'll notice that "liquidity" is a common theme I mentioned above. That is because my knowledge of WHY this occurs has a lot to do with my understanding of other principals that I use to infer an entirely new way to look at the cycle as a "liquidity cycle" within an industry and ultimately a more complicated look at the risk cycle. I will save this for another time.

The Anatomy of a Short Squeeze

In the stock market a short squeeze is a fantastic way to make wealth. SHORT squeezes are a situation where a large number of shares get caught short during a price move higher. As a result, many will potentially be forced into a margin call which means they have no choice but to either cover, send money, or raise funds elsewhere. This usually results in forced buying which can result in even higher prices and force even more short sellers to cover.

When it comes to a playing for a short squeeze there are two things you need to know:
1)The short squeeze potential of a stock (i.e. which stocks are most vulnerable to a short squeeze).
2)When a short squeeze is likely to occur in those stocks. (i.e what things can you look for to actually make a purchase in anticipation of a short squeeze).

Understanding the anatomy of the short squeeze is important, for it happens to some stocks more than the others and the underlying fundamentals don't really matter at this point. This article will discuss where it will occur and which stocks are most vulnerable to a short squeeze.

A stock that has zero short positions on cannot see a short squeeze. Stocks with a small number of shares cannot see much of one. So, you should be looking for a HIGH market cap of shares short as a percentage of market cap. You can actually estimate this reasonably accurately.
1)Go to finviz screener and make sure you have Market Cap, Short Float %, Shares Float % and filter it so you don't include any ETFs.
2)Click the "export" button and download the .csv or excel file.
3)Set up formulas.
Step 3 I must explain.

We need to calculate Market cap SHORT as a % of market cap. Float * % of float short * Price= MARKET CAP SHORT. Market cap short/ market cap= market cap short %.

The higher the number the more difficult it will be for all of them to simultaneously cover at current prices. For example, a market cap short % of 50% indicate that IF all those short had to cover at current prices, they would basically need HALF of all owners of the stock to sell to them. That is substantial because it is very unlikely half of the shares can be sold to them at current price. IF those holding refuse to sell, those short must offer a higher price until they can sell.

This gives huge potential power for a short squeeze the higher this number is.

Next we want to look at % of market cap that FLOATS= (Float * Price) / market cap.


The "FLOAT" represents the available shares that are actively traded as opposed to those held by insiders and institutions that HOLD. The fewer that FLOAT, the harder it is to accumulate shares and the more likely a buyer will have to pay a higher price if he wants in since the rest of the owners are likely to either hold or in some cases are FORCED to announce their sale well in advance. So not only if scarcity of shares FLOAT good, but if a large percentage of the float is short, that also signals that of the shares traded, a high percentage of them are short and thus will have difficulty covering.
So we want:
1)Market cap short % to be high
2)Short as a % of float high
3)Float as a % of market cap low

We can do a simple formula.
We want the numbers where HIGH is better in the numerator, and the small to be in the denominator. For those that skipped high school math that means we want market cap short % and short as a % of float divided by float as a % of market cap.
So
((Market cap short %+Short as a % of float)*.5)/Float as a % of market cap.
The higher the number the better.

Now I want to fix up this list and that means I have no patience for erroneous numbers. I will use the sort function in excel and eliminate these.
Things like market cap short over 100%, short as a % of float over 100% and float as a % of market cap over 100% or error messages for dividing by zero I delete. I also want to delete individual categories near the worst of that stat. For example the market cap short % I want to be around 5% or higher. The short as a % of float I want to be maybe 5-10% or higher. The float % as a market cap I want to be less than 90% (that represents at least 10% held between insiders, major owners and institutional holders). Then the final metric I will use as the determiner how to rank stock's short squeeze potential from there and get rid of the worst and focus on the start of that list.

This only tells you that ONCE a stock starts being bought aggressively AND the shorts start to cover that the potential for a short squeeze exists and is large. It does not give you any clue as to IF/WHEN this short squeeze will occur which is why it is also important to recognize and adjust.

With that being said here is a list of all those remaining with a formula that says they have a ratio equal to at least .15 or more.

ATLC
SCLN
SNTA
FMD
BTH
VRA
SWFT
SPWR
NQ
JAKK
JASO
CSUN
XONE
TTS
CALL
GTXI
SODA
AFSI
CAS
PHMD
EBIX
USNA
ANGI
TITN
RES
VHC
LQDT
NGVC
UNIS
ALJ
BRLI
WNR
TSLA
GMCR
MILL
SCTY
LF
WRLD
BONT
BBRY
CLNE
CLNT
PAMT
NEON
BKS
RATE
SPPI
IPGP
TEAR
PACW
IMAX
GNK
TPH
END
KIOR
KWK
VRNG
CONN
KBH
RVLT
MFRM
IOC
YGE
NLNK
Z
BKE
MITK
HOV
MELI
IRWD
TRIP
MOH
IPI
OPK
HLF
AFOP
MNKD
APP
ROIAK
CNS
MNI
GPRE
RBA
HXM
FRO
WPRT
DANG
CBZ
CHCI
ECHO
SA
IRDM
ETM
HGG
CAB
SUSS
WTI
VPRT
OLED
GOL
VCLK
SHLD
DLB
CCXI
AMRN
KNDI
MR
LULU
STSI
HK
CRR
JBLU
KEYW
EAC
MUX
PSUN
CVC
GTI
SZYM
QDEL
WBMD
ZUMZ
AXDX
ENPH
DGIT
MLNX
AMKR
TFM
RAX
USG
AXL
SVU
CNQR
ELLI
DHI
OSIR
ATRS
CWTR
DWA
MBLX
SIGA
AH
ARCO
MANT
BPZ
SOL
FWM
SD
HNSN
FSLR
GRMN
SAM
BYD
MACK
PRLB
MEET
YELP
FRP
CCBG
MTZ
AKRX
PATH
IMH
GLNG
AMRI

Individual Stock Selection Trend Trades and Investments

For trend trades and indivudal investments I want a sector theme that makes sense with my understanding of risk and an industry that makes sense as well. So I will look through the sector "basic materials" and look for industries within it that have done well. These are likely the "leading industries" as we are anticipating a rotation. However, it is important to understand that often times those that peaked first and have performed the worst will eventually lead and often times really early in the rotation.

In this case, "chemicals" are vaguely in the materials sector and have performed the best.
http://finviz.com/screener.ashx?v=111&f=ind_specialtychemicals
http://www.barchart.com/stocks/sectors/-CHES?f=ind
And I look on a weekly chart this time
http://finviz.com/screener.ashx?v=211&f=ind_specialtychemicals&ta=0&p=w&o=-marketcap

I see an established trend by many names. I believe a lot of the momentum names have had their runs as well. But If I am right about the rotation into the space, I want laggards on a weekly basis. These are ones that should be near support and more of a sideways trend than vertical. I also want medium risk names so not the lowest beta and highest market cap. This isn't an exact science here and involves more of an "art" in assessing risk tolerance of the masses, so I may also be interested in looking at more severe laggards (those in more of a downtrend to sideways trend) and "potential short squeezes" . Technical analysis still matters but it's much different when you are anticipatory and trying to pick a bottom. If you pick a bottom you are looking for a consolidation and accepting of price. The only "severe laggard" I really like is HWKN. There are plenty of other what I would consider "laggards" because they are near a trendline and showing a temporary pause in an uptrend and near support. But I would lean towards the earlier stages of the rotation as a sector, even if specialty chemicals are really more likely to be among the early stages of the rotation and thus that particular industry may be in it's mid stages.

SHW,SXT,KRO,HWKN. If I choose one of those names I may keep an eye on some of the higher risk short squeezes and high risk small and micro cap stocks.

I will also glance at the monthly chart. If I am willing to do some more due diligence into the fundamentals of the company, I really love the looks of HWKN and KRO on the monthly chart. I would really have to determine whether or not I think Specialty chemicals as an industry could be likely to pan out for a significant length of time as well.

Also keep in mind that this type of analysis applies to all different ways to slice up a market. For example, you might identify that Technology is ready, specifically search engines are ready for some quality and momentum names while simultaneously China is looking like it is receiving a rotation of capital and ready to rotate into quality and momentum. BIDU at that point may be the best of all worlds and could possibly receive multiple inflows of capital. Your odds go way up that Bidu will be the recipiant of one of those flows of capital and if it is all it could skyrocket quickly.

So, now you know a methodology towards selecting individual stocks while being mindful of the big picture, the next step is knowing how to properly manage a trade and analyze risks/rewards.

Individual Stock Selection - Swing Trades

There are many layers that go into individual stock selection.
I like to be in the right sector, and from there identify some of the best industries and from there, identify the right stocks within the industry. I like to be anticipatory rather than a trend follower, but at the same time, I still need to see the initiative strength out of a sector/industry.

The sector analysis is about recognizing the sector rotation that goes on long term and really trying to identify where we are in the cycle, and what's next. I believe we have seen industrials rise and thus should see some material related as the next to move followed by energy.

I also believe at looking which individual industries are hot as information that can be useful on it's own, but can also confirm a sector rotational theme.
http://www.barchart.com/stocks/sectors/industry.php

This cycle is all about a rotation in sentiment of "risk" and actually goes through somewhat of a predictable cycle that is "fractal" and overlaps on many time frames. For example within one large wave there are a few sub-waves which have their own set of sub-waves.
The engine of the economy is the banks that lend, that allow transportation companies to transport the needed raw commodities, that allow companies to run that get the industrials going that allow energy and raw material businesses to work off their excess inventories and start growing and producing profit, and the profit of those businesses first fuel a boom in demand for raw commodities as maximum business activity takes place creating an over saturation in business, an eventual oversaturation in energy prices (which lag the rest of the economy) and then capital rotates into defensive names that isn't as correlated with the economy and that can produce when the economy is bad. So you have staples, drugs, and utilities and finally the financials lead again.
This cycle makes no sense until you understand the WHY it occurs and it occurs because of how the economy functions and how capital moves according to their tolerance for risk and outlook for the economy.

The same rotation of risk happens within individual industries although since there are hundreds of industries it is difficult in really developing an understanding of the rotation. I can tell you though that many industries will lead well ahead of the broad sector rotation either because of their ability to grow quickly as a small industry, or as a real leader and more stable idea in the field. Within the industries you also have a rotation among individual stocks according to the same concept of outlook and risk.

The cool thing is, that you can select names as a trend trader looking at a weekly chart to trade the trend at support and get the full scope of the rotation of large institutional funds (or monthly and get the rotation of the pension funds, sovereign wealth funds and largest mutual funds). But you can also look at the daily chart and recognize the wave like nature as these same institutions look to accumulate a position in a particular orderly fashion that while ultimately could take weeks, could have predictable 3-5 day swings upwards, followed by a pause for a couple weeks.

The thing to really understand is that which particular stocks the mutual funds and all others will get a position in also depends upon their appetite for risk. They will NOT start buying the first stock in an industry they see, but instead are not going to immediately start buying the stocks that are declining because they don't want to sit through declining accounts while they wait for it to catch on. Instead they will pick the stuff that is liquid. If their thesis and rotation into the industry, sector, or stock is wrong, they want something they can get out of. If they are going to wait on it they probably will want a dividend yield, and they want a stock that has some relative strength.

The primary line of thinking when you first rotate into the sector/industry or the market is first just shorts that cover and decide to take profits and look elsewhere, along with contrarians and deep value investors that represent the minority. This will set up conditions where some of the higher quality companies typically will begin to form it's first bottom and a higher low in which NOW the major mutual funds and such can actually begin to consider a rotation into quality first. But they are thinking about preservation of capital and it is really not their primary investing thesis right away. So they are not at all aggressive. They want strong fundamentals and technicals in high market cap companies with a dividend yield. IF some of those stocks start doing well, THEN they might look for some of the higher risk momentum names that can trend for weeks and that may be a bit over extended and may be considered more vulnerable. It is now when the "chase" mentality in the industry kicks in IF the thesis works. If everyone else begins to follow through and position into the sector, their will suddenly be an appetite for risk in the industry and this causes some stocks to take off that are capable of producing more substantial returns.  Ahead of this, the SMART money decides to look for the bargains. This is followed by the rest of the money managers wanting to get in the industry but not dumb enough to chase. As a result they begin to find anything that isn't moving yet that has lagged. The buying frenzy really begins to kick off in the industry and the thesis is more widely recognized. At this point the shorts get nervous and the aggressive investors and traders smell blood. They go after the stocks that have large short positions,thin float, and large short as a percentage of the overall float as they recognize it is only a matter of time before some of the shorts will have to cover. When they do, they will be forced in many cases to buy at the market and push prices much higher. The short squeeze is capable of even more dramatic returns, and the appetite for risk represennts the market going into even that which some "smart money" is actually or has been bearish on. This starts to become slightly "irrational" at this point, but is not without it's reasons.

Finally, the riskiest stocks start taking off. The bankrupt, penny stocks. Desperate buying and short covering takes place and the speculation of buyouts. When the buyouts on a large scale start occuring and the penny stocks start rocketing higher, be ready for a correction on whatever time frame you are observing this cycle. Get into the defensive names in the sector, if any at all. Many mutual funds want to be diversified and thus want to remain in the sector but will reduce their size and rotate into real defensive names. Then if the industry is to get going again, it will start with the quality and start over. If not, it could enter an industry/sector bear market.

The other col thing is that you can look at this sector and apply it to an individual industry, or you can look at the market as a whole as going through this process if you want a wider view and to look for "short squeezes".

Also, there is a more simple rotation into and out of risk that can often be measured at looking at the relative daily and multiday performance between the dow/S&P (quality, lower risk) vs the nasdaq and russel (growth, higher risk), and look for divergences. This gives you a clue as to where the rotation will take place, into risk and stocks, or not.
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So the hottest industry right now according to barchart is solar which does correspond somewhat well to the eventual sector rotation into energy as it is alternative energy and is more about the industry being small and having long term potential to become a more dominant player in the sector than it is about large and liquid. As a result, I may be less likely to use this as a reason to rotate into the sector, and more willing to look at it as taking a swing at a hot industry with potential and large moves being made, by identifying select individual stocks according to the cycle..
So we can look at this particular industry more in depth.
I like reinforcement by another site, so I will take this list from barchart:
http://www.barchart.com/stocks/sectors/-SOLA?f=ind

and plug it into finviz
http://finviz.com/screener.ashx?v=111&t=CSIQ,JKS,CSUN,SCTY,SPWR,TSL,SOL,YGE,FSLR,JASO,ENPH,FNRG,LDK,RSOL,STRI
I can see that many of these have different industries listed, but most are in the "specialized semiconductor space".
I will set those that are not aside and take a look at the industry.
http://finviz.com/screener.ashx?v=111&f=ind_semiconductorspecialized
So if I want to be thorough, I can compile a list of these and combine it with the others above and get a list which I like to sort by market cap to help identify where in the risk cycle we are.
http://finviz.com/screener.ashx?v=151&t=ACTS,ALTR,AOSL,ARMH,ASTI,CEVA,CRUS,CSIQ,CSUN,DSTI,ENPH,FNRG,FSLR,GTAT,HIMX,HSOL,IXYS,JASO,JKS,LDK,LLTC,LSCC,LSI,MCHP,MPWR,MX,NVDA,NVEC,RSOL,SCTY,SIGM,SLAB,SOL,SPWR,STRI,TSL,UCTT,VIMC,YGE&o=-marketcap

From here, I manually scan the charts.
In this case, I can also look at the solar ETFs for a broad look at the industry. Recently, there has been a pullback in the sector on a swing trading basis. There are plenty of individual "quality" names that are strong, and a few that have yet to move. I put my focus on that. I look for quality technical setups as well, and I also am willing to consider momentum names while also paying attention to laggards and short interest in the back of my mind for the next potential play afterwards.
So FSLR,SCTY are good plays YGE was a couple days ago but has started to move since then. CSIQ is not bad but has already moved quite a bit longer term and I think there are better setups for now, yet if it works sideways a bit longer could work.  After that I might be ready to try to pick a bottom in some of the laggards which will likely have better setups by then.

So Now I add FSLR and SCTY to my list and then move onto the next sector. Once I have a large list I may decide to filter it down a bit.

If I was looking at solars for a longer term play to get ahead of a sector rotation? Well, we will cover that later.