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Back on September 17th, when the equity market was two weeks into what has now become the largest correction for the S&P 500 since November 2020, I alerted Total Alpha readers to leadership that was coming from the energy sector at the time, and introduced two stocks, CPE and REI, that have exploded by roughly 50% and 40%, respectively, in just the 2.5 weeks that have passed since.

When I look across the energy complex, it looks like this sector is only just starting to awaken from the 3-month correction it underwent this summer.

Today, I am going to show you how to spot this leadership and how to play it with a potentially explosive trade idea.

The energy sector is full of stocks showing strength

From an absolute price perspective, Figure 1 shows that the S&P 500 Energy Sector has not looked back since exploding out of a 2-month bottoming pattern during the 2nd half of September.

Figure 1

With RSI above the 70 level, you might be asking yourself, “isn’t the energy sector overbought now?”

While that is technically true, remember that RSI is also a trend strength indicator.

Therefore, with RSI confirming the rally by making higher highs along with price this week, the potential for momentum conditions to remain overbought longer than anticipated is high.

Fundamentally, this is because of OPEC and their plan to maintain output levels the way the policy is already defined.  

Also, the oil price rally has been fueled by an even bigger increase in gas prices, which have spiked by 300% or more depending on the area of the country you are in.  

From a relative perspective, the energy sector has shown the greatest improvement vs. the benchmark S&P 500 over the past several weeks, and that leadership doesn’t appear to be anywhere near complete.

How can traders see this leadership? By using Relative Rotation Graphs (RRG).

Relative Rotation Graphs are readily available on a number of charting platforms these days. Today, we’ll be using the version provided on the Stockcharts.com website.

Stockcharts.com describes RRG charts as follows: RRG® charts show you the relative strength and momentum for a group of stocks. Stocks with strong relative strength and momentum appear in the green Leading quadrant. As relative momentum fades, they typically move into the yellow Weakening quadrant. If relative strength then fades, they move into the red Lagging quadrant. Finally, when momentum starts to pick up again, they shift into the blue Improving quadrant.

The clockwise rotation that occurs on these charts is very effective when prospective buyers of stock are trying to find the early stages of a leadership cycle, or when prospective sellers are trying to identify early signs of deterioration.

In both cases, the comparisons are made relative to some benchmark, which in many cases is the S&P 500.

For today’s example, Figure 2 shows all 11 S&P 500 sector ETFs relative to the S&P 500 ETF (SPY).

Figure 2

Figure 3

Though not visible on Figure 2 above, the S&P 500 ETF (SPY) is positioned at the origin (where the X and Y axis meet).

The long tails left behind by each sector are meant to help the viewer track each sector’s relative path over the past 4 weeks of trading.

The message that is being signaled by this graph right now is that the energy sector is still showing the best pace of improvement vs. the broader market.

Here’s how I want to play this leadership momentum

NextDecade Corporation (NEXT) is a development and management company of land-based and floating Liquified Natural Gas (LNG) projects primarily in the global integrated natural gas industry. It principally focuses on land-based projects on the U.S. Gulf Coast.

It’s no surprise that I hate chasing stocks.

Over the years I’ve developed the patience to either wait for stocks to come to me, or to do a little extra work to find stocks that are on the verge of a breakout.

NEXT is in the former category.

After slipping below the all-important 200-day moving average and filling the powerful 06/04 to 06/07 gap three weeks ago, Figure 4 shows that the stock has begun to rotate back above and use the 200-day line as support.

In the process, momentum, measured here by the default 14-day RSI indicator, has begun to rotate into bullish territory above the 50 level.  

Figure 4

While this is all very constructive, NEXT has yet to break out in a manner that can start to cause the 13% short base enough pain to have to start reversing their positions.

Here’s how I want to play it from here

The other key item I like about this setup is how close by and how well-defined the stop protection is at the most recent pivot low of $2.70.

I want to build my long position above this level, because this level MUST hold in order for the uptrend originating at the 09/20 low to continue to develop.

The initial target is the $3.50 area, which, as the chart shows, is thick with prior price history (i.e., resistance).

HOWEVER, if the stock happened to close above this area, I believe this would be the trigger for a short squeeze that can force prices much higher in a short period of time.

Author:
Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

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