Use Rotation to Profit from Missed Opportunities
September began with a bang.
But you were sitting on your hands…
You wanted to buy stocks, yet you weren’t sure if it was safe. And as the uncertainty over the market’s fate began to recede in your mind, stocks were already breaking out. You missed the initial move that sent the S&P 500 4% higher over the past 10 trading days.
Fortunately, these last few weeks weren’t the only opportunity you’ll have to make money in 2012. Far from it…
In fact, if you learn to prepare a trading plan after a significant market breakout, you will greatly increase your chances for success as stocks consolidate their gains.
The first thing you need to change is your mindset. As a trader, you should not concern yourself with missed opportunities. Even skilled traders can look back on dozens of trades that might have netted significant gains on any given week. The truth is you can’t possibly trade every single favorable setup that flashes on your screen…
Lamenting every stock you failed to see breaking out will do nothing except raise your anxiety level. Constant second-guessing will pull you out of the moment, potentially causing you to make rash and potentially harmful decisions.
Instead, you should work on approaching the markets with an open mind. After all, there are no missed opportunities. That’s because there’s always another trade setting up right around the corner.
To combat these potential mistakes, you should concentrate your energy into the planning process. If you’re constantly planning for the market’s next move or your next trade, you’ll have little time to sulk about money you could have made if only you were paying attention to a completely different play the previous week.
To do this, you have to think rotation…
Rookie traders tend to chase new highs. They get caught up in the excitement of a big move and zero-in on every overextended stock on the market. Some of these trades start out as winners. But over time, chasing highs quickly becomes a losing strategy.
Instead of getting light-headed during a major market move, you should concentrate on sector rotation. Ask yourself the following questions:
What types of stocks are moving significantly higher right now?
What stocks are overextended and due for a pullback?
Finally, what lagging sectors are improving?
This is the information you need to decide where spend your trading dollars. Avoid buying into names that have moved straight up. Instead, look for strong or improving sectors that are fighting to catch the leading names.
Let me show you what I mean with a couple of examples…
First up are energy stocks:
Looking at the chart, you can see that the Energy Select Sector SPDR has been very strong since it posted a double-bottom in July. XLE continued its strong run into September, breaking out to new 2012 highs within the past few days.
In short, it’s a strong chart that could still have room to run…
Turning to homebuilders, you’ll notice a different story:
After breaking out in August, homebuilding stocks have gone on an absolute tear. But look at how the chart is now overextended. RSI—our gauge of momentum—has quickly moved into the overbought range.
And the price have moved well beyond the August breakout zone with absolutely no downside or sideways action. This is the perfect example of sector that will probably need a breather before it can move higher.
Remember, every market will have leaders and laggards. If you miss an initial breakout, you should have plenty of opportunities to jump on stocks in strengthening sectors that are working to “catch up” with the high-flyers.
Greg Guenthner, CMT
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