Sectors' Relative Strength

A look at sectors’ RS reveals a lot about the current market sentiment. In the following charts I am comparing each of S&P 500 main components to SPY itself. When the featured sector is outperforming the broad index, the line is rising.

When the market is in defensive mood, utility companies tend to outperform. Due to the nature of their high leverage, utility stocks tend to benefit during periods of declining interest rates’ expectations.

It pays to highlight that since end of July 2010 $XLF has been underperforming the broad index and leading the way down.

Despite the long bond ($TLT) and Japanese Yen ($FXY) making new 52 week highs on a weekly basis, the material sector (led by gold, silver miners and fertilizer companies) has been outperforming the SPY since mid June.

Market Reaction

I have talked many times here that strong price moves are supported by a sequence of catalysts that change market participants’ perception of value and attract new buying interest. The initial market reaction to a catalyst tells a lot about the future price action in a stock. Let’s take a closer look at a typical setup I am looking for every day:

1) There is a strong catalyst (in this case, earnings’ guidance above the consensus estimate)

2) The stock opens close to a new 6 month high (multi-year high is preferable)

3) Short interest ratio is decent  (5.5 days in the case of $CRM)

4) There is an initial surge in price on very high volume

5) Consolidations are on low volume above the daily vwap

6) There is a second surge later in the day, allowing the stock to closes at the highs of its daily range.

It pays to be underlined that this setup will not work every time. There is no setup or pattern or check list that always works. The success rate is cyclical. This is why risk management is so essential. It takes you out at a minor cost from a trade that didn’t work out as expected. Recent example for me was $FMCN, which I mentioned on the StockTwits stream yesterday. The stock had high short interest ratio and at some point broke out to new 52 week high, only to reverse later in the day. My unrealized profits evaporated and I had to exit at a minor loss. Losses are natural part of the game; therefore they should not be taken personally.

From a 10,000 foot view ,in order to be a consistently profitable market participant, all you need to do is to find one good setup a day ( or a week or a month – depending on your trading/investing horizon).

When there is a fresh catalyst, the overall market weakness is irrelevant for the day. The most recent example is $PAY. About half an hour before market open, I mentioned on StockTwits:

ivanhoff $PAY beat and raised guidance. Close to 52week high; 10d short interest; neutral mkt reaction so far. I will keep an eye on it. Aug. 25 at 7:51 AM


WSM

Williams Sonoma Inc just guided Q3 EPS at $0.26-0.30 vs consensus of $0.21. The company raised its earnings’ expectations range for FY10 from 1.39-1.48 to 1.63-1.70.

The stock tried to break out yesterday unsuccessfully. Due to general market weakness it couldn’t hold above 28.60. I like stocks that shake out weak hands just before the actual breakout.

I will be watching closely this one today for a potential entry. It has a strong recent catalyst behind its back and a 6.3 days of short interest ratio. It could offer good 1-2 days run.

JAZZ

JAZZ  could present a good buying opportunity if it manages to break  and hold above 9.70

They just raised FY10 earnings guidance from .80-.95 to 1.05-1.15

First major raise after missing estimates last quarter. 10 day sma is rising above the 50 sma