We like to incorporate a top down approach to our analysis, this allows us to view every sector and narrow it all the way down to exactly what we should be trading. When first beginning to trade it is often times confusing all the lingo that is being thrown around – including ‘top down analysis’. So, we are going to show you how we personally use this approach and the basic steps involved.
1. Run through all the sector ETFs. Below is a list of many of them. I would recommend picking the most liquid/followed ones to use.
2. After we run through all these charts (about 20 we use), we write down the strongest and the weakest of the bunch. Meaning, the ones that are lagging behind the $SPX (benchmark) and ones that are out-performing the $SPX (benchmark). This is done so we can get a good overall gauge of where the money is flowing out of and where it is being put to work. Obviously, we want our money to be where there is money being put to work – not where it is being drawn away from (unless we’re shorting).
3. The next, key step we take in the process of initiating a trade is to look up the components of the strongest/weakest sector ETF(s). This is done via a simple Google search ‘XLI Holdings’ for example. We want to know what this sector ETF houses and what the biggest holdings are so we can drill down even further on individual securities.
4. Once we have some of the biggest components written down on a sheet of paper in front of us we head on over to FinViz.com, a website for screening stocks that we use daily. In the search box at the top we type in the ticker of one of the components, click the stocks industry (after it loads), and scroll through all the charts from that particular industry. We do this for each and every industry that has a holding within the particular ETF we derived the security from.
5. As we are scrolling through all these charts we are simultaneously writing down all the stocks that have a potential set up for a trade. This number is dependent on the market condition but it is usually no more than 15% of all the stocks on the scan.
6. Once we have reviewed all the stocks from all the industries from all the ETFs we then nail down and take a closer look at each stock we wrote down as having a ‘potential set up’. This does not take too long as the number here rarely gets above 20.
7. Often times when reviewing the potential set ups, about 50% of them will be crossed out and off the watch list. This leaves us with about 10 stocks. Out of these 10, most of them will not be actionable – yet. Stocks can live on the watch list as a potential set up for days or weeks until the pattern is mature enough to take action.
8. From this point on we review this list of stocks every day to see if any are mature enough in their price pattern to take action or if their pattern is faulty/negated and needs to be crossed out of the watchlist.
9. We then repeat these steps, every day to see if any more stocks are setting up for trades. It is a never ending process, a rotation of stocks on and off the watchlist, many of which never make to the actionable stage.
Feel free to reach out with any questions you may have, hope this helps.