To be successful in this business, simply getting up in the morning and sifting through your favorite social media sites for the hot trade idea of the day simply isn’t going to cut it.
Sure, this method may allow you to find some trading ideas that work for the day.
But, finding trades that work over several days to weeks takes a lot more time and effort.
Some of this hard work has to do with identifying sector and group rotation.
The group we’re going to examine today, which was one of the strongest groups coming out of the pandemic but has spent much of 2021 digesting those gains in a large downside corrective pattern, is starting to show subtle signs of leadership again.
Stay-at-home stocks are on the rise again
At its core, the price action that develops across the market’s many groups and sectors result from the different viewpoints held by millions of investors around the world.
Throughout history, this crowd wisdom has resulted in the stock market becoming a discounting mechanism that often forecasts the future roughly 6 months ahead of time.
I mention this because I find it interesting that these stay-at-home stocks are just starting to perk up again as the winter months are drawing closer.
Remember, it’s the differing investor views and opinions that cause prices to move in cycles.
Therefore, it’s possible that traders and investors are starting to forecast that the winter months may bring small clusters of Covid outbreaks that cause people in areas not affected by the outbreaks to become a bit fearful and hunker down until the spring.
What are stay-at-home stocks?
Stay-at-home stocks became popular shortly after the stock market found its initial Covid-panic lows in early 2020 after the coronavirus outbreak led to worldwide restrictions.
These companies provide consumers with things like online educational tools, complete in-home fitness programs, and the means to have a pet’s favorite toy delivered with just a few clicks of a mouse.
The technicals also support the case for a tradable bottom in stay-at-home stocks
Love ‘em or hate ‘em, the media can often play a key role in driving industry trends.
This is especially true if the narrative involves widespread fear.
In the case of stay-at-home stocks, just the smallest hint of an early-winter Covid outbreak starting anywhere in this country would likely be something the media would try to blow out of proportion. Why? Because fear sells.
For traders, though, this is a “necessary evil” that drives the kinds of feedback loops among global investors that fuel big trading cycles.
While I am just speculating that the potential for such a narrative exists, the technicals have already shown me that downside momentum in many of these stocks has slowed and looks to be rotating positively.
Peloton Interactive Inc (PTON) and Chewy Inc. (CHWY) are two stay-at-home stocks that I focused on buying this past week.
Figures 1 & 2 below show one of the main reasons why.
Specifically, these charts show that the relative momentum of these stocks, when measured against the benchmark S&P 500, has slowed significantly of late.
Not only that, but these stocks are starting to show subtle signs of leadership against the benchmark.
Correlation is a key concept when focusing on certain groups of stocks
When trading across groups, it’s important to understand the concept of correlation.
Trade Lesson: Correlation
In the investing world, correlation, a statistical term, measures the degree to which two or more instruments (i.e., stocks, ETFs, futures contracts, etc.) move in relation to one another.
Correlation is presented on a scale of 1.0 to -1.0, where a correlation of 1.0 means that the instruments being compared move in perfect relation to one another, a correlation of -1.0 means that the instruments move in a perfect inverse relationship, and a correlation of 0.0 means that there is no relationship at all.
Correlation is a tool many traders and money managers use to diversify their portfolios, especially when there may be an anticipation of increased volatility in certain areas of the market.
As Figure 3 uncovers, at a correlation of 0.80, these stocks trade with a very strong relationship to each other.
While it is no guarantee that the very recent rotation toward leadership by stay-at-home stocks shown here today is going to continue uninterrupted, the supportive momentum signals I showed you give traders the best odds of success when buying stocks that have been beaten up.
When you decide to concentrate on adding exposure to a certain group of stocks, it’s important to understand that group constituents often trade with strong correlations.
Why is this important?
Because having too much exposure to one group can cause losses in your portfolio to become amplified, in the event you are wrong.