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One way that major financial institutions go about their stock selection is to employ a process known as top down analysis. Quite simply, decisions are made upon the possible trends and direction of the entire economy, before specific sectors are identified as benefiting or struggling from the current and near future economic environment. Companies that exist within those sectors are then reviewed as relatively strong or weak and positions are implemented accordingly.

It is an easy proposition for any retail trader to model this style of investment and trading strategy. By using technical and fundamental analysis it is possible to profit from the higher probability opportunities top down analysis reveals. A sprinkling of additional economic and seasonal analysis of markets can help massively in order to produce solid trading results. If we review an example, it is easier to put the current context into perspective.

Through the latter parts of 2007 it was evident that the Sub Prime issues in the US were spreading to global markets and that the financial sector in Australia was starting to suffer. Comparing a sector to the overall market is easy using the Relative Strength Comparison [RSC] tool in your software and can demonstrate which sector is displaying strength or weakness, regardless of the overall market direction.

Chart 1

 

click here to enlarge

Although the top 200 shares in the ASX were falling, the rising red line in the lower chart clearly displays that this particular index was massively outperforming the XFJ (the financial sector). Over this period and in this circumstance it becomes a simple case of running scans for short trading opportunities over individual companies that lie within that sector. Hence it is possible to identify those that are most likely to drop from a technical perspective.

If we move to the same charts over the current period there is a different story playing out. Of course, you can also do this to assess the strength of any sector (e.g. the materials or energy sector the XMJ or XEJ respectively).

Chart 2

 

click here to enlarge

Evidently, the most recent price changes would suggest evidence that the XFJ is beginning to outperform the ASX top 200 shares. This signifies a reversal of the predominant share market action of 2008.

Now would be a perfect time to look for short-term reversal trades (such as those supported by Elliott Wave 5 set ups) on shares of companies that are involved in this sector or are perceived to benefit from a rise in this part of the economy. Profits from any potential run up into Christmas period in line with the potential Santa Claus rally seem to be on offer over the next few weeks.

Stay sharp,

John Jeffery
Trading Tutors Team

 

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