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.
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