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By: Chris Rowe — May 31, 2010

Here Are the Pockets of Bull Strength

I'm going to show you exactly which sectors to have your bullish money in, if you must be bullish. 

But first let me say that we've all heard the old adage, "The trend is your friend".  That one rule is probably the single most important one in the trading rule book. 

What does that mean? 

First of all, if you're not a beginner, you know not to think of the market in a way where up = good & down = bad.  You know that strong odds = good, and odds closer to 50% = bad. 

In other words, if odds strongly favor a decline, that's great!  Play the decline and get paid!

If you're not a beginner, you also know that a "buy signal" doesn't necessarily mean it's an ENTRY signal.  Before knowing whether a "buy signal" is an entry or an exit signal, you have to know which direction the next bigger trend is in.

If the trend is down, then a "buy signal" is an "exit signal" telling you to exit your bearish position.  

Okay, now that we got that out of the way, let me tell you that I'm not ready to be bullish yet on the general market.  And when the tide is going out, it tends to bring most boats with it.  I'm always hedged, and these days I'm more bearish than I am bullish because, as of right now, down is the direction in which the tide will most likely move. 

There are a few things I need to see before most of my positions become bullish ones, but I will tell you where to find pockets of bullish strength in this POSSIBLE correction recovery.

Before I tell you where the bullish strength is, let me say that, while I've seen quite a few leading (as opposed to lagging) indications that we could be reversing back up, the fact of the matter is that the big rally we saw on Thursday was on very light volume. 

My personal style is one where I need to see confirmation of reversals higher.  But why should I only help people who have the same trading preferences as me? 

If you're someone who plays the market more aggressively by getting in during what appears to be the early stages of a reversal (which is an approach that leaves you that much more prone to trading false signals that were never confirmed), you will want to focus on the sectors that have reversed their supply/demand relationship back to demand before most other sectors have.  You will also want to be in sectors that have already seen a ton of selling (where much of the stock for sale has already been sold to buyers).  Those sectors are the most likely to show the most strength in an advancing market, or the least weakness in a declining market, in the coming months. 

Among the most oversold are several of the commodity sectors, and many have recently seen significantly more constituents with new buy signals than sell signals.

Three sectors that have been oversold but are now showing demand in control are:

* Metals Non Ferrous
* Oil & Coal
* Steel & Iron

On May 25 the...

...Metals Non Ferrous sector had 78.7% of its constituents on sell signals (only 21.3 on buy signals), but as of now only 67.2% are on sell signals (while 31.8% are on buy signals).  That means there was a net change of 11.5% moving from sell to buy signals. 

...Oil & Coal sector had 81.2% of its constituents on sell signals (only 18.8% on buy signals), but as of now only 73% are on sell signals (while 27% are on buy signals).  That means there was a net change of 8.2% moving from sell to buy signals. 

...Steel & Iron sector had 86.6% of its constituents on sell signals (only 13.4% on buy signals), but as of now only 73.9% are on sell signals (while 26.1% are on buy signals).  That means there was a net change of 12.7% moving from sell to buy signals.  But keep in mind that the steel sector has few constituents, so its sector Bullish Percent Index tends to move way up (near 100%) and way down (near 0%).  Nonetheless, the sector has been whacked and is now showing demand. 

Again, I personally need more confirmation from the general market before getting net bullish in my portfolio, but whether you want bullish exposure to hedge yourself or are a straight-up intermediate early bull, you want to be in sectors that are in demand after already being heavily sold

Other commodity sectors are oversold without yet showing strong demand, but of course, that can change on a dime.  Those sectors include "energy other" which is alternative energy and oil service.  When they show demand again (which they are not too far from showing), they are sectors that will have already been "washed out" (oversold). 

Precious Metals is the one commodity based sector that is not quite oversold and not showing demand taking back control.  I don't know what that says about the price of the yellow metal itself.  Most commodities have taken a beating recently on lower demand forecast in the eurozone, a strong dollar (which has an inverse affect on commodity prices), and speculation of lower demand coming out of China.  But that doesn't mean commodity stocks aren't in demand.  

You might have heard about the idea that China is still showing huge demand for commodities even though some analysts have attributed the declining prices in the actual commodities (as opposed to commodity stocks) to lower Chinese demand. 

Now analysts are saying that they suspect, while China isn't buying as much in the open market, demand is still very strong.  They say the lack of Chinese buying pressure is due to the idea that they have been tapping reserves, and their reserves are deep.  Why buy commodities in the open market if they think prices will come down?  Just tap the reserves and start buying again when prices pull back. 

Even though commodity prices are going lower, many commodity based stocks are moving higher.  If you're going to play the pockets of bullish strength in this recently supply-driven market, be sure to discriminate on which commodity sectors you trade.  I don't think it makes sense to get bullish on commodity funds that include both Non-Ferrous Metals and Oil service, as Oil Service has not yet given the green light.  (Trend Rider members will be bullishly playing that sector as soon as it turns bullish again, along with a confirmed bullish reversal in the general market.)

Although I've focused today mainly on some of the commodity sectors, the non-commodity sectors that are oversold and showing demand include Forest Products, Chemicals, Machinery Tools & Textiles Apparel.

I'll end this rather abruptly, since I can't think of a snappy way to finish...

The End.

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