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:

Were there warning signs that you ignored, or didn't know existed?

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."

Ah, but did you look for news on the bellwether stock?

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.

Do all stocks follow the bellwether stock?

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.

So which stock does my stock follow?

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?

How do I use the bellwether or alpha stock?

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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