How to find strong and weak sectors when investing

For a trader, picking the right stock is as important as his decision to either go long or short on the market. A sector or stock, which barely moves or moves slowly, is of little use for a trader whose outlook for profit can be measured in minutes to days.

A trader likes volatility. The more volatile a market - where stocks rise and fall fast — the more the opportunity it throws up to trade. A fast moving market gives immediate results compared with a slowly trending one.

A regular problem faced by most  traders is that though they get the direction of the market right, they end up holding the slowest-moving stock.

There are various ways in which the strongest and the weakest stocks to trade can be filtered. One of them is to measure their distance from weekly, monthly or yearly highs and lows.

Those stocks or sectors that are closest to say, their weekly highs, are the ones that will move up faster than those which are near their lows.

Similarly those sectors and stocks are likely to fall the most in a bear market, which are near their lows.

A sector’s strength need to be looked at on a weekly, monthly and yearly basis. For example, a sector may be looking strong on a year scale, but might be consolidating on a weekly or monthly basis. Thus, all three time scales are important, depending on the trader’s time horizon.

A topdown approach is generally helpful in filtering out stocks that can be picked up for trading.

First, the strongest and the weakest sectors are classified based on their distance from the two peaks (high and low). Within them, one can repeat the same exercise for picking up the best stocks to go long or short.

Previous month’s peaks (high and low levels) are taken and the current position of the sector/stock between these peaks is marked.

The distance of the current position between these peaks (calibrated between 0 and 100) gives an indication of the strength or weakness.

A value close to 100 signifies more strength, while a value closer to 0 signifies weakness.

DNA will be carrying the monthly sectoral strength charts given below every week, within which the stocks can be identified based on volume criteria.

The chart below is in descending order, with the strongest sectors on top.