On a much needed elaboration of the stock market idiom, "a rising tide lifts all boats," let's talk about how to pinpoint where the best chances for profits are in the overall market. Which sector stocks will be more likely to rise? Will a large cap stock likely outperform a small cap stock? Just keep thinking about that phrase, "a rising tide lifts all boats" as you read the question below.
If you were to invest in a single stock, equipped with no information about that stock but its market segment (shown below), which stock would be more likely to climb?
- Option A: Gold miners
- Option B: Biotech
The answer to this can easily be found in the charts of the groups. Would investing in a single gold mining stock be a profitable strategy right now? It could, but you will find yourself swimming against a tide of bearishness. Here's (NYSEARCA:GDX), the gold miners ETF. Investing in any gold mining stock will likely be akin to trying to catch a falling knife. There could be opportunities, sure, but why take the risk?
Then there are biotech stocks. Take a look at (NASDAQ:IBB), which tracks the NASDAQ Biotech Index, over the last two years.
So, the rising tide among NASDAQ biotech stocks could certainly lift all boats, including the boat (stock) you are planning on trading. This principle can be applied to long and short term trades. A stock in a clear uptrend is more likely to react positively to earnings announcements while one in a downtrend is more likely to react negatively to an earnings release.
One can also accomplish this type of analysis with relative strength charts. For instance, I know that the S & P 500 is in an uptrend; so is the Russell 2000 Small Cap Index. Which index is doing better? If I invest in a stock in the index that is performing better, my probability of having greater profits is likely higher.
So which index is doing better? In this case, a rising line means that the Russell 2000 (NYSEARCA:IWM) is outperforming the S & P 500, and a falling line means that the S & P 500 (NYSEARCA:SPY) is outperforming.
Simply put, don't bother buying into a clear downtrend. You may have the skill to catch that falling knife and make a substantial profit a few times, but eventually, most everybody who fights the trend will lose a finger (or their house if over-leveraged!). In short, here is where it appears easiest to find profitable trades for me, based on this methodology.
- Small cap stocks
- Biotech stocks
- Insurance stocks
- Technology stocks, ex large cap
- Financial stocks, especially regional banks
- Healthcare stocks
- Maybe telecom stocks
Try it. You won't believe how much easier it is to make profitable trades. Good luck!
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.