We regularly receive questions from our followers and subscribers with regard to our trading strategy for ETFs and stocks. Upon receiving a question that we think could be very beneficial to other traders, we post it here on our blog, in the Trader Q&A Archives. Below is a question that just came in today, related to this post from a few hours ago, which explained why we bought a gold ETF for a swing trade, rather than a silver ETF.
Trader Question:
Regarding your post this morning…SLV has achieved only 25% of Fibonacci retracement and you see it as much overhead resistance. Wouldn’t you rather deem that to mean “that much more potential for SLV to run up” instead? As a catch-up play compare to gold?
Our Answer:
Hello,
This is a very good question, one I can personally relate to, and am happy to address it.
When I was a new trader back in the last 1990’s, I was primarily a sector trader who focused on trading individual stocks within the sector that was showing the most relative strength. During this time, I consistently made the mistake of buying the sole stock in the group that had not rallied as much as the other stocks in the group (the weakest one). My thinking was that since it is lagging behind the other stocks in the group, is a good play because it must “catch up” to the rest of the stocks in the sector.
However, what I eventually learned was that laggards are laggards for a reason…Institutional traders such as banks, mutual funds, hedge funds are not buying – plain and simple. The actual reason why a particular stock is not being bought as much is another stock within the same industry sector is irrelevant. The point is simply that the stock or ETF is a laggard. I will close by sharing an actual true story the best relates this example…
I remember one day about 13 years ago, when I was a daytrader, I immediately noticed relative strength in the pharmaceutical sector ($DRG) shortly after the market opened. Most of the individual stocks in the industry sector were already up 2 or 3% on the day within the first 30 min. of trading, so my thought was that I would try to find the one stock that had not yet rallied, the one bucking the trend, and I did. It was Schering-Plough (SGP), which was only up 0.1% (basically flat) at the same time the other stocks in the same sector were already up several percent.
Buying SGP at that time, I felt like a genius who would end up making a lot of money by the end of the day because I had spotted the one stock that nobody was buying it. But as you may be able to guess, the outcome of the story was not at all what I had anticipated. By the closing bell, those other stocks that were originally up 2% or 3% on the open, which I was afraid to buy, were now showing large gains of 5% or more on the day. However, my “genius” SGP play was exactly within a few pennies of where I bought it hours earlier. Why? Because it was a laggard within the sector.
In summary, just remember that cheap stocks are cheap stocks for a reason, and the reason they are cheap is irrelevant. The core of our swing trading strategy is to buy HIGH and sell HIGHER, rather than to buy LOW and hope to sell HIGH if the cheap stocks and ETFs catch up.
With time, I eventually figured out a much more profitable strategy was to buy strength. If you would like to learn more about the details of this, particularly the part about why “Cheap Stocks Are Cheap For a Reason,” please see our recently updated Swing Trading Strategy page by clicking here for more details.
Have you ever bought a weak stock within a sector and assumed it would “catch up” to the rest? How did it work out? We’d love to hear you comments below.
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Great topic, so hard for new investors to buy strength because its natural to think that you have already missed it, and you need to catch the turning point. Good, timeless advice to buy strength