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May 28, 2004
Finding the "Bellwether"
Stocks that Matter
By John Brasher, CallWriter Publisher
Among the hardest things
for traders to learn are the things that are not covered in
the books. Everyone teaches technical analysis and strategies,
but seldom does anyone teach the core knowledge that is necessary
for trading success. This article will touch on one of the
most helpful tricks a trader can have: learning to find those
"bellwether" stocks.
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Those of you trained or experienced in
technical analysis know the basics: support and resistance,
trendlines, moving averages, oscillators, continuation and reversal
patterns... all the things a good technical trader is supposed to
know. You use those analytical tools to get into a trade, only to
watch as the stock takes a battering for no discernible reason.
Maybe the entire industry or sector sold off. You want to scream
as you watch your hard-earned money fly away. You think to yourself
that Wall Street is a dirty rigged game, one in which the powers
that be regularly upset the applecart so they can screw the public
and pocket big profits.
Could be, but when a stock makes a large and unexpected
move, there are winners and losers in Wall Street, not just winners.
But the real question is this:
One of the core things CallWriter
teaches is to watch out for earnings announcements or other news
expected on the company before option expiration that could cause
the stock to sell off. The likelihood of a sell off is increased
if the stock has run up in anticipation of the news, or if the stock
has a history of selling off on the type of news expected. But you
say, "Wait a minute - that didn't happen on this trade.
I looked carefully and no such news was expected."
The fact is, a stock can sell off based on news
or an event concerning a different stock. You see, almost every
stock follows another stock in its industry. Bellwether
stocks are those in each industry whose fortunes drive
the industry. When these stocks take a hit, or miss their earnings
target, the entire industry (or entire sector) can go into rotation,
meaning that it sells off.
Finding them: On the CallWriter
Research Page, go to the Snapshot page, then
click the pulldown menu and select the Industry Snapshot
page. The bellwether stock will be the one on top with a market
cap and revenues that are commandingly larger than the others.
Examples include Intel, Microsoft, Cisco and similar
household-name stocks, each of which is the 800-lb. gorilla in its
industry. When they sell off, the industry tends to go with them.
If the bellwether stock for your trade is expecting important news,
such as earnings, be aware that a pullback in that stock probably
will pull your trade down.
The answer is no, except when a stumble in the
bellwether stock causes the industry to sell off or run up. As you
might expect in the market, it is always more complicated than that.
But unless your trade is the bellwether stock itself, it will track
another major stock in the industry. So DO NOT assume that your
stock follows the bellwether stock.
Example: Intel, NSM and Texas
Instruments are in the same industry, generally, but NSM does
not follow Intel, while Texas Instruments does.
However, most small- to medium-cap stocks follow
a larger company in the same industry, which we at CallWriter
refer to as an alpha stock.
You can find out whether your stock follows the
bellwether stock by simply overlaying price lines for the two companies.
That is, lay the price lines for both stocks across the same chart
to see how they move together, or IF they move together.
How to overlay: If you use a
charting service, it should permit one or two overlays. If you
are using the CallWriter Research Page, first open a page for
the stock you are considering trading. Click on the News
link in the top navigation bar, which takes you to a Yahoo page.
Then click the Technical Analysis link on the
left-hand frame of the Yahoo page, which will open a Yahoo chart.
Right above the chart is a fill-in box that allows you to Compare
the stock charted. Enter the symbol of the other stock you would
like to compare, and click the Compare button.
This will overlay the second stock's price onto the chart. You
can then see how, or if, your stock moves with the bellwether
stock.
Another tactic for finding the bellwether stock
is to go into the chat rooms and ask if there is a particular stock
that your stock follows. Persons familiar with the stock will know.
This kind of detailed knowledge about a stock and how it trades
is one advantage of concentrating your covered call efforts in stocks
you know well, or at least are familiar with. There is nothing
wrong with writing a few stocks over and over as they hit the Real
Time Lists™! We are not looking for trading glory,
but income.
Your stock may not usually move with the bellwether
stock, except for moves that take the entire industry up or down.
If not, select several other major stocks in the industry
and compare to each of them to find its alpha stock. The
larger stock that your stock tracks is its alpha stock. Unless the
company you are thinking of trading is an oddball, you will usually
be able to find the alpha stock whose movements it tracks.
A stock is said to track another stock when their
respective charts are very similar. There is a certain amount of
"know it when you see it," of course, but this is not
a statistical analysis - - it is a common sense analysis. Is the
congruence great enough that your stock is likely to track the other?
When they are so similar that they are virtually the same line (this
isn't common, but it happens), you've got a solid tracker. When
the congruence is less than 75-80%, or when your stocks makes major
moves in "defiance" of the alpha stock, there is not true
tracking. The occasional move together is not meaningful. Ask yourself:
is the congruence great enough that your stock is likely to track
the other?
When writing covered calls, it is often helpful
to find the bellwether or alpha stock. The smaller the company written,
the more important this can be to trading success.
Example: Let's say you have
thoroughly researched XYZ Corp. (XYZ) and like its potential for
a covered call. No earnings or other major news is expected before
option expiration, or you have concluded that XYZ does not normally
react adversely to earnings reports and are comfortable with it
even though it will report earnings before expiration. But suppose
that XYZ very closely follows another stock, which IS expecting
earnings news. If the news on the alpha stock is adverse, a sell
off may likely take your stock with it. You have to reconsider
whether you are writing the proper strike - should you write deeper
in the money. You may want to reconsider writing it at all.
Obviously, the larger the company you write, the
less its likelihood of being affected by another stock's fortunes.
And many large companies track no alpha stock, because they are
the alphas. This is why many experienced covered writers stick to
larger stocks: it eliminates one trading variable. Experienced traders
well understand the bellwether stock dynamic and will refrain from
entering a stock if worried about the bellwether stock. Conversely,
the expectation of a positive move in a bellwether stock is more
reason to consider trading a stock that moves strongly with it.
This is one of those subjects that makes traders
wonder how much one must know about trading to be successful. Looking
for the bellwether stocks is primarily important if you are not
writing the big stocks. If you are writing large companies,
such as the S&P 100, this exercise is usually not necessary,
because the stocks on our Real Time Lists™ usually will BE
the bellwether stocks.
Consistent trading success is what CallWriter
is all about. We not only show you the fattest trades on our Real
Time Lists™, we teach you how to analyze them and pick the
ones with the highest combination of return and safety. We also
show you how to manage your trades for maximum profitability, as
this newsletter indicates. We hope this one has been helpful!
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