Despite the pullback that kicked off this holiday-shortened week, the current bounce off the September lows in the main stock market indexes has been positive so far, giving investors hope for a potential year-end rally (although “hope” is one of the four emotions investors and traders should always avoid).
Nevertheless, because stocks still have much to prove with regard to overcoming resistance and establishing new leadership, it’s still too early to determine whether or not the recent rally is likely to develop into anything substantial.
But as with every new stock market rally, one of the most useful clues is searching for the emergence of new leadership within specific industry sectors (relative strength trading is thoroughly discussed in Trading ETFs, my most recent book).
When institutional funds start flowing into a particular sector (after a significant market correction), astute traders follow that money flow by riding on the coattails of trading by banks, mutual funds, hedge funds, and other institutional players.
The good news is that we have indeed spotted new leadership in the market, so continue reading to see which industry sector (and a top stock in the group) may provide you with the best potential for outperforming the overall stock market in Q4.
Tune In To Telecoms
In mid-August and once again in mid-September, money heavily rotated out of leading biotech and other healthcare related stocks, which means many of these stocks now need at least several weeks of rest to repair the technical damage done to the charts.
This it is usually best to start from scratch when building a watchlist following a significant market correction.
Although it may be tempting to buy a leading stock from the last market rally that was recently hit hard, these bargain buys often take too long before they bottom out and reverse higher.
Instead, now is the time to seek out and buy fresh leadership in the market.
One industry sector that has been displaying emerging leadership lately is Telecom-Infrastructure, which has gained 14% more than the NASDAQ Composite since the index peaked on July 20.
The comparison chart below clearly shows the impressive relative strength and leadership that is really becoming prevalent in the Telecom sector:
As shown above, the NASDAQ is down 7% since its July 20 peak, while the Telecom sector is up 7% during the same period (bullish divergence of more than 14%).
To take advantage of strength in the Telecom sector, traders might consider trading some sector-specific ETFs.
However, there is much greater profit potential by seeking out the top individual stocks within the sector and trading those instead.
Within the telecom-infrastructure group, there is clear leadership from $DY, $VSAT, and $MXL, as all three of these stocks are either breaking out or in the process of breaking out to new highs ahead of the market.
Accordingly, whenever a stock breaks out to fresh highs ahead of the broad market, particularly when the overall market sentiment is NOT overly bullish, it means the stock has relative strength.
In addition to offering the greatest profit potential, stocks with relative strength are great to trade because they usually decline much less (sometimes not at all) than the major indices when stocks eventually pull back or head lower again.
MaxLinear Is Here
One of the best-looking charts within the bullish Telecom sector right now is broadband chip manufacturer Maxlinear ($MXL), which cleared a three-week high on a pick-up in volume last Friday.
As shown on the daily chart below, the 50-day MA has also turned to an upward direction, joining the 20-day EMA and 200-day MA which were already in an uptrend (it’s a bullish signal when all three of these moving averages are trending higher):
Scaling out to the longer-term weekly chart of $MXL, it is easy to see the relative strength line (on bottom) breaking out to new highs ahead of the price action (which is a bullish sign).
The 10-week MA has turned up the past two weeks, and has joined the already positively trending 40-week MA:
In addition to a bullish chart pattern with relative strength, we also like that $MXL recently posted a 62% jump in quarterly profit (sales revenue doubled as well).
While we never base our trading decisions exclusively off of earnings trends, most leading stocks we trade are confirmed by strong quarterly increases in sales and revenue, so MaxLinear certainly fits the bill.
We will continue scanning the market for additional emerging leadership to buy IF the broad market holds up.
As always, we will report our ongoing analysis and observations to subscribers of our nightly swing trading newsletter.
DISCLOSURE: We are currently long $MXL in the model portfolio of our Wagner Daily newsletter, where we bought the stock at $12.62 after first highlighting the trade setup for subscribing members on October 9.
What other industries and stocks are showing leadership right now? Share your comments below.