It’s all relative—strength, that is
07/31/18

Time to play that “stock A…stock B” game.

Stocks A, B, and C are in the same industry, and all three are down around 1% today on news impacting their sector, which has been in a mild uptrend for the past four or five months. During that period, stock A has been trending lower, B has been moving sideways, and C has been trending solidly higher. The intermediate-term sector outlook continues to be positive.

If you had to buy one of the stocks, which one would you pick?

It’s not a trick question. If this was the only available information, most seasoned traders would probably go for stock C—the one that’s been exhibiting relative strength vs. its sector and its industry peers.

Things are never as simple in the real world, of course, but this basic principle brings to mind the recent price action in US stock indexes. All of them have pulled back the past few days after making swing (or record) highs last week: Early yesterday the S&P 500 (SPX) was down approximately 1.3% from its July 25 close, while the Nasdaq 100 (NDX) was down around 4% over the same period; the Russell 2000 (RUT) had dropped around 2% from its July 26 close, while the Dow Jones Industrial Average (DJIA) was off roughly 0.5%.

Some traders may believe that in this type of situation it would make the most sense to buy the market that was pulling back the least (in the case, the Dow), because that’s the one that’s exhibiting the most immediate relative strength.

US index comparison, 12/29/17 – 7/30/18. Nasdaq 100 (NDX), S&P 500 (SPX), Russell 2000 (RUT), Dow Jones Industrial Average (DJIA). Daily price chart. The NDX…and the rest.

Source: OptionsHouse


But the question is whether we define “relative strength” based on just the past few days, or a longer period. In this case, almost any time horizon other than “extremely short” would show the NDX has led its fellow indexes by a country mile. The above chart, for example, shows that as of early yesterday the tech index was up more than 13% on the year—around five percentage points more than its nearest competitor, the RUT (+8%), and waaaay out in front of the SPX (+5%) and DJIA (3%).

Of course, there’s always the possibility that the NDX’s larger drop over the past few days could turn out to be the start of a larger rotation out of tech and into other areas of the market, or the first stage of a market-wide downtrend in which tech leads to the downside.

That said, stock index traders who aren’t ready to declare the end of tech outperformance may see the recent NDX pullback as an opportunity to enter a market-leading uptrend at a discount, regardless of whether they trade E-Mini Nasdaq 100 futures (NQ), NDX exchange-traded funds, or even individual tech names that are themselves showing relative strength.

Nasdaq 100 (NDX), 11/15/17 – 7/30/18. Nasdaq 100 (NDX) daily price chart. Trendline test.

Source: OptionsHouse


The daily NDX chart above shows the current down move has dropped the NDX to a trendline connecting (more or less) the April, May, and June swing lows. There’s nothing magical or absolute about a trendline—this one is likely to be penetrated, at least briefly—but this chart shows that as of yesterday the NDX had yet to pull back to a level that indicated a definitive break in the upside momentum that’s been in force since April.

After all, at their most basic, uptrends consist of higher highs and higher lows; downtrends of lower highs and lower lows. Until the NDX at least makes a swing low below the late-June lows around 6950—and a swing high below last week’s all-time high—it will be difficult for many traders to start writing the eulogy for the tech bull.

 

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