By all accounts, it's been a very difficult year. There were plenty of stock market warning shots fired in December 2021 and we're now paying seeing the carnage. While the current environment is dangerous, it's no time to rest on our laurels. There's work to be done. We need to be prepared for the next advance and, to me, that means find relative strength and improving relative strength.
So how do we do that?
Well, there are plenty of options, but StockCharts.com makes it very easy. I'll use this article to take one approach. First, let's identify sectors that are improving "under the surface." We know there's been a lot of weakness throughout the year and the weakness in the past couple months has seen our major indices return to new year-to-date lows. But where is money rotating TO? Well, here's how the sectors have performed over the past month:
Every sector is down, but clearly energy (XLE) and health care (XLV) are the two best relative performers. So while there's plenty of selling taking place right now, these two groups are favored by the big Wall Street firms. We should take notice. Energy has been a leader throughout 2022, so I'll focus this article on the improving health care group. To further break down health care, let's pull up a chart of the XLV and then, in the panels beneath, highlight the relative strength of each of its industries to try to zero in on the best area(s) of health care. Here's what that looks like:
This is a 6-month daily chart and highlights the fact that health care providers ($DJUSHP) and biotechnology ($DJUSBT) have been the two strongest industries within the health care sector. From there, we can further break down this group by running a scan to find the strongest stocks within these two industry groups. Here's what a simple scan using SCTRs (StockCharts Technical Rank scores) looks like:
I used a few filters to limit my results. First, I wanted only "liquid" stocks, so I added a filter for stocks having at least 500,000 shares traded daily over the past 50 days. I also wanted to eliminate low dollar stocks, so I added the filter for closes to be at least 5 bucks. Obviously, I added an industry group filter since I only wanted to see biotech stocks. And my final filter was relative strength, looking only at biotech stocks that rank in the top 5% of SCTR scores. Here were my results:
There were 28 biotech stocks returned and I've shown the top 18 SCTR scores on stocks returned. This is a solid starting point. Just please keep in mind that biotech stocks, in general, can be extremely volatile - and especially small cap biotechs dependent on just one or two drugs. Invest or trade with appropriate caution.
There are a TON more biotech stocks than health care provider stocks. As a result, I lowered the filtered SCTR score from 95 to 80 for my next scan. Here were the results, again in SCTR order:
These two scans would be a great starting point for individual stock review. If you want more stocks to consider, simply lower the SCTR score filter. There could be plenty of stocks in these two industry groups consolidating in bullish fashion with slightly lower SCTR scores.
One last thought. October options will expire this Friday. Because health care has been one of the stronger industry groups and options expiration week is usually "Opposite George" week (Seinfeld reference), pullbacks in these stocks to reduce net call premium could produce excellent reward-to-risk setups.
At EarningsBeats.com, we send our members a Max Pain report each month the weekend before options expire. We will send this October report out to all FREE EB Digest subscribers on Monday morning, highlighting the stocks that we believe could rally strongly into Friday's expiration due to heavy net put premium. Also, there'll be health care stocks on this report with net call premium, where you should be extremely careful and use any weakness ahead to potentially establish positions. To receive this report for FREE, simply CLICK HERE to enter your name and email address to subscribe to our EB Digest newsletter, published 3x per week on Mondays, Wednesdays, and Fridays.
Happy trading!
Tom
