How most traders trade without an edge and don't even know it

There are two mistakes most traders make when building a basket of trading setups.

1. They trade setups without and edge.
2. They trade the setup in the wrong market.

Your trading "edge" gives you a reliable idea of how much you can expect to win with your setup over time. A well tested setup gives you a a predictable probability rate.

This seems counter to my article titled "the fallacy of backtesting".

It is not.

While I find backtesting in the way most do it a waste of time, it is not because the past is not reliable. It is because most do not backtest correctly.

Most backtests plug in the parameters of the setup and test over a given period of time. This type of unrigorious testing is worthless.

To properly test a setup you must account for how a setup reacts to different markets.

A common trading cliche is that 70 percent of a stock's move is related to the market and it's sector.

If  gold is getting crushed odds are so will the gold related stock you are trading, regardless of the setup.

I wouldn't touch a breakdown short setup in a ramping market.

So you decide to test breakdown setups going back 7 years. I'm willing to bet your stats for this setup will be horrible, considering the market has gone up over that time frame. You'll think the setup is worthless and discard it.

However, now test for that setup when the market is below it's 50 day moving average and you might have something.

Never forget how important the market and sector is to the stock you are trading. As a swing trader, you are not just trading stocks and setups. You must be in tune to the market and sector you are trading.

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On the Radar: Residentials

Residential Real Estate and homebuilders is one of the hottest sectors right now, showing strong accumulation, price patterns and relative strength. One of my favorites is DHI. The chart speaks for itself . . .

Education Stocks Showing Accumulation and Relative Strength

A few sectors asserted themselves during last week's market up move. Education stocks are on fire and showing buying interest from the big boys. While most stocks are coming off bottoms and nearing resistance levels, education stocks are near recent highs.

Focus list stocks include EDU, DV, CPLA and APOL.

Airlines

I have been saying almost non-stop over the past couple of weeks that airlines are in a short to intermediate term bottoming formation!!! Take a look at the capitulation day in mid-July, followed by that purdy volume pattern. Does it get any better than that?

As noted earlier today, I exited UAUA, for a gain, but not as big of a gain as I could have had if I had held it to the close. Going into the fed announcement I felt I was over exposed on the long side and I was holding two airline stocks.

I did hold onto CAL. I took partial profits at the close, but am still holding a nice sized position going forward.

CAL was first mentioned as a bottoming setup in the Trade Report on July 21. It was trading at $9.25 at that time and is now trading 58 percent higher, closing today at $15.91.

Staying Away From Steel

While I am decidedly bearish on most commodity sectors, the one sub-sector I am staying away from is steel. Steel stocks are all over the place.

Take a look at the sampling below. Two steel stocks have made huge upside moves and could be reversing the recent topping pattern (AKS and X). MTL, ZEUS and RIO are in ugly downtrends. Then there is MT, which is caught in the middle.















I'm going to stick with the easy commodity trades. I feel much more comfortable trading a sector where a majority of stocks are headed in the same direction, like indpendent oil and gas.

Overbought Sectors

Here is a list of sectors with the highest stochastic readings. I use this information for three setups:

1. To find sectors with good chart patterns and await a pullback for entry

2. Find sectors with bad chart patterns that are bouncing to resistance and ready to short.

3. Find topping patterns in overheated sectors.

Sector Analysis: Discount Variety Stores

As many of you know, I usually spend Sunday evening analyzing sectors and the hot stocks within those groups. Due to time constraints I've been skipping this watchlist ritual, instead only trading stocks that I find through my scans.

I had some free time today and was surprised to see Discount Variety Stores among the top of "sectors making 52 week highs" list. I should not have missed this and will go back to my Sunday ritual this weekend. Now lets look at Discount Variety Stores:



The sector action looks great. Price is pulling back from all time highs in an orderly fashion. The moving averages are all moving up and, not seen on this chart, volume is confirming the trend.

There are twelve stocks in this group, and nine are within 70 percent of their 52 week highs. Here are my favorites:

BJ: Stick with the trend and buy pullbacks



COST: It's dropped below the 50 day moving average, so I would not buy here. However, a dip to the 200 day MA would provide a low risk entry. I haven't shown it here, but Costco has been an excellent deep pullback play since 2004.



BIG: Watch for a pullback to the 30 breakout level.



WMT: Already pulled back to support. Low risk entry with good volume pattern.

Sectors Analysis

The 20 most oversold sectors:



The 20 most overbought sectors



How do I use this information? In the overbought sectors, I look for charts where stocks are near highs and wait for a healthy pullback. In oversold sectors, I look for stocks oversold near support that have good risk-reward potential.

Sectors Nearest New Highs

Here is a list of sectors ranked according to "percent of 52 week high".
























Most sectors on this list will come as no surprise. However, "regional southwest banks" threw me for a loop. I dug deeper and looked at individual stocks and did not find one that I'd put on my watchlist. Some had decent price patterns, but not enough solid volume.

I still like many of the commodity sectors that top the list, but won't get involved until there is a pullback (which some sectors, like steel, seem to be starting).

Today's Entry: CSX, DZZ and MTL

I bought 100 shares of MTL at $143.46. The strong broke out over $140 yesterday on strong volume. It's one of the strongest stocks in a strong sector showing loads of accumulation. I may be a bit early on entry (I usually don't enter at overbought stochastic levels), as the stock could pullback to $140. That's why I went with a small position size and may buy more at $140.



I bought 300 shares of CSX at $56.10. Another strong stock from a strong sector at the bottom of a high tight flag pattern.



I bought 500 shares of DZZ at $26.55. This ETF is 2X short gold. Gold has setup nicely as a broken momo that is retracing weekly to resistance levels.

Industry Strength

Here is a list of the top performing sectors of the past week. My favorite technical pattern is Steel.

Time to Reload Shorts?

Some beaten sectors have retraced to levels that make for attractive short entries. High on my list is education services.














As for individual stocks, my watchlist includes CPLA, APOL, DV, EDU, LTRE and CECO.

The Ag Gap

I sure am glad I decided to wait for more of a bounce to short ag. Geez. All of the ag stocks are making big moves based on this headline, "Monsanto ups profit view on corn, herbicide strength," and a few other headlines.

I'm going to take a step back and just watch ag this week. The overall pattern is still toppish, but today's gap over resistance puts this theory in question.

Sector Volume and Market Notes

One of two things will happen this week. Either we get a major decline or that capitulation move that everybody has been waiting for will lead to a nice bounce. I have no idea what will happen, but I am positioning myself for either outcome.

Here is a list of sectors showing strong positive volume. A few surprised me.

6 Bullish Metal and Mining Stocks

Surveying the top sectors over the past week, I see a number of bullish charts in the metal and mining complex. The six charts that I will be watching next week are CLF, MTL, SID, ZEUS, CENX and JRCC.

Today's Hot Sector: Agriculture

Yesterday it was the financials and real estate, and today the hot sector was agriculture. Great move if you caught it. Now the million dollar question is whether this move was due to short covering or the start of a reversal that will resume the sector uptrend. More to the point, should we hitch on for a ride, short or just stand back and watch.

There are too many "ifs" to make a convincing long or short argument. The longs can say that most stocks have remounted the 50 day moving average and still remain in a long term uptrend. However, bears can point to volume and short covering.

That's why I don't plan to make any trades in this sector. However, if the stocks breakout to new highs, I will likely enter. And if they break down below the 50 day moving average, we will have a short signal.

I was going to post charts of my favorite Ag plays, including MON, CF, AGU and TRA, but there is no need to post more than one. They all look almost exacly the same.

Sector Review

Here are the top performing sectors last week. There isn't much that has me excited here. Most of them were bounces from some of the worst industries over the past few months, like mortgage, cement and building materials.



One sector I do like is Ag Chemicals.

Sector Review: Where Have the Momentum Sectors Gone?

As usual, I went over the this past week's top and bottom peforming sectors. Most of the sectors that performed well do not look good as longs. This is not a good sign for the market. At best, it signals new leaders are emerging. Worst case scenario is that most sectors, along with the market, are rolling over and ready to make another leg down.

Regional Airlines is an example of a sector that performed well last week, but is not a long candidate. Not much to look at, eh? It actually looks good as a short, with price pulling back up to resistance in the nidst of a downtrend.



Here are the top performing sectors for the week:



And the worst, which features many of the year's best performers:



Don't forget, I'll be posting answers to your questions later this week. Ask me anything. Send your questions to: SinghJD1@aol.com

High Flyers Have Lost Their Wings

My focus list, which is mostly comprised of momentum stocks, looked ugly today. Not only was there a lot of red, but many stocks have broken major support levels. Because of this, I cannot play a bounce in these stocks. I never play bounces when support has broken. Many of my favorites have now made it to my short term shorts list.

For example, LFC, BHP, FXI, AAPL, RIMM, DE, RIO, FLR, VMW, FCX, DRYS and many others now look like short candidates on a near term bounce towards old support levels. Only a few stocks are on my long list. These stocks are mostly recent breakouts that are still acting strong, such as DCO and HMSY.

Looking at today's sector action, the bottom performing sectors have been the darlings of the market the past few months (and in some cases, much longer). Industrial Metals, Gold, Silver, Copper, Tech, Ag, Chemicals, Energy, Industrials, they all got hit hard. What does that mean? There are two theories. The first is we had our capitulation move and can expect a resumption of trend. The second is that now that the high flyers have also broke down, we can officially expect a bear market.

I can't make a prediction, other than to say I am now more inclined to add a few shorts. I added a few today, and may add more if we get a weak bounce.

Sector Review

This was not a great week for the market. We still don't know if the character of this bull market has changed or it was just a natural correction. Either way, after a negative week, it pays to make note of what is working.

During a week where every major index was significantly down, lead by the Nasdaq at -6.5 percent, only 24 of 239 Industry groups were positive. My current favorites are Internet Providers, Oil and Gas, Industrial Equipment, Dairy Products, Silver, Gold and Ag Chemicals.