Stock Selection

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Stock selection is similar to picking sector strength. As explained in the previous section, the sector that holds up the best going into a low is

FIGURE 2.11 S&P 50 Large Cap Index Shows Rally from April 2005 Low to August 2005 High

Source: Chart courtesy of DecisionPoint.com.

FIGURE 2.12 Major Market Performance Chart Shows Performance of Oil

Services and Pharmaceuticals

Source: Chart courtesy of StockCharts.com.

FIGURE 2.12 Major Market Performance Chart Shows Performance of Oil

Services and Pharmaceuticals

Source: Chart courtesy of StockCharts.com.

one of the strongest sectors. This method also works well to pick strong stocks within a strong sector.

Here 's an example: As noted earlier, the oil service sector was one of the strongest sectors at the April 2005 bottom. The stocks comprising this sector are: Transocean, Inc. (RIG), Cooper Cameron Corporation (CAM), Global Santa Fe Corporation (GSF), Baker Hughes, Inc. (BHI), Noble Drilling Corporation (NE), Tidewater, Inc. (TDW), Schlumberger Ltd. (SLB), Smith Intl, Inc. (SII), Nabors Industries, Inc. (NBR), and Halliburton Company (HAL).

Figure 2.13 shows a comparison chart (found on www.stockcharts. com) that allows us to pick 10 issues and compare them to each other to show which ones held up the best going into a low. (Note: If a sector had 20 issues, then this task would be done twice to compare all issues.)

Figure 2.13 shows that Halliburton and Cooper Cameron held up the best going into the April 2005 low. As of the next high in the market in August 2005 Halliburton was up 40 percent and Cooper Cameron had

FIGURE 2.13 Chart Comparing Performance of Oil Service Sector Stocks Source: Chart courtesy of StockCharts.com.

risen 30 percent. By comparison, the S&P was up 9 percent in this time frame. This shows what a powerful tool stock section is in a trader's technical toolkit.

Now let's take a look at the pharmaceutical sector, which also held up well going into the April 2005 low. However, as we saw earlier, it did not perform as well as oil services going into the August 2005 high. This underscores the importance of trading stocks from at least two top-performing sectors in order to spread the risk. The oil services was profitable. However, the pharmaceutical sector posted a 5 percent gain as of the August 2005 high, compared with the 30 percent increase in the oil services sector.

The stocks comprising the pharmaceutical sector are Schering Plough Corporation (SGP), Abbott Labs (ABT), Bristol Myers Squibb Company (BMY), Forest Labs. Inc. (FRX), King Pharmaceuticals Inc. (KG), Glaxo Wellcome PLC (GSK), Sanofi Aventis (SNY), Merck & Company, Inc. (MRK), Teva Pharma (TEVA), and Wyeth (WYE).

Perf Chart

(SGP,ABT,FRX,KG,CSK,SNY,MRK,TEVA,WYE,BMY)

Interactive Performance Comparison Chart_

B Sphering Plough | M Abbott Labs | Forest Labs | B King Pharma | Chesapeake | M Sanofi-Aventis |

B Merck B Teva Pharma | B Wyeth B Bristol Myers Squibb

B Sphering Plough | M Abbott Labs | Forest Labs | B King Pharma | Chesapeake | M Sanofi-Aventis |

B Merck B Teva Pharma | B Wyeth B Bristol Myers Squibb

FIGURE 2.14 Chart Comparing Performance of Pharmaceutical-Sector Stocks Source: Chart courtesy of StockCharts.com.

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FIGURE 2.14 Chart Comparing Performance of Pharmaceutical-Sector Stocks Source: Chart courtesy of StockCharts.com.

Figure 2.14 shows that Schering Plough and Teva Pharma held up the best among 10 stocks in the sector going into April 2005 low. The stocks were up about 15 percent and 5 percent, respectively, at the April 2005 low.

As of August 2005, Schering Plough was up 25 percent, netting a gain of 10 percent in that time frame, and Teva Pharma rose 10 percent for a net gain of 5 percent. Both stocks did make modest gains and were a profitable investment. But they did not have the performance of the oil-sector stocks. Again, this points to the necessity of picking more than one top-performing sector.

ALIGNING WITH THE MARKET

The top-down approach outlined in this chapter is a three-step process that determines the market direction first, focuses on the strongest sectors second, and then zeroes in on the strongest stocks in the strongest sectors. The purpose is to create greater alignment with the market, and to let the market carry your stock selections higher.

Investment novices think that investing is easy. We 've all heard the stories of monkeys picking stocks by throwing darts at stock tables in the newspaper. If a monkey can do it, the novices tell themselves, then so can I! What the novices don't understand is that those monkeys don't have any outside influences to support or counter their dart throwing.

The rest of us, however, are bombarded with myriad influences. There are the financial television shows, web sites, blogs, and opinions touted by so-called experts, amateurs, and financial journalists alike—who sometimes end up being 180 degrees off the mark!

Information is one thing, but information overload is quite another. To cope, I rely on breadth, volume, and momentum analysis alone to give me an objective view of which way the market is moving. Breadth, volume, and momentum are the facts of the market, and they do not lie. Stay with the facts and you will increase your chances of having a rewarding investment career.

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