Find the Leaders

5.1 - Leading Stocks are Leaders for a Reason

The stocks outperforming the market tend to continue performing well, while lagging stocks are likely to remain underperformers. Here, you'll see why this is an important lesson for investors and how to identify the leading stocks.

5.2 - The Best-Performing Stocks Continue Performing Well

Stocks that are doing well, tend to keep doing well.

How many times have you concluded that a stock's best days are behind it, only to watch it soar as you stand on the sidelines? This assumption has often come back to haunt investors. In reality, the stocks that are doing well, tend to keep doing well, while those slumping will, in all likelihood, continue to do poorly. Why? Well-performing companies manifest their strength through superior performance in terms of earnings, sales, profit margins and, yes, even the performance of their stock.

• Choose the leaders (even at a higher price)
• Ignore the laggards (even if they are available cheap)

A study of the greatest stock market winners found that all-star stocks had, on average, outperformed 87% of the market before they began their most dramatic price advances. In other words, they were already in leadership positions. This concept is contrary to the popular bargain-hunting mentality, but is based on historical facts.

5.3 - How To Find The Leaders

Use the StockAxis Technical Rating to identify today's leaders.

If you want to find next year's winning stocks, look at the better-performing stocks today. Remember, the biggest winning stocks historically have been, on average, in the top 13% of stocks at the time they began their major advances. To help you identify today's leaders, we have developed the Technical Rating. This rating compares the price performance of each stock over the last 12 months, with extra emphasis on the six most recent months. Stocks are rated on a scale of 1 to 99, with 99 representing the top 1% in terms of price movement. So a Technical Rating of 85 means that stock is outperforming 85% of all stocks in terms of price performance.

A good starting point for stock selection is identifying the top two or three stocks with the highest Technical Rating in an industry group that's leading the overall market.

5.4 - Evaluating Potential Leaders

Following StockAxis’ Technical Rating, consider for investment stocks with its rating of 80 or higher.

Any stock worth considering should have a Technical Rating of 80 or higher. This way, you're concentrating on the top 20% of price performers. In fact, the most successful stock selections generally have Technical Ratings of 90 or higher just before breaking out of their first or second base structure.

Any stock below a Technical rating of 70 is not in leadership territory. If you consider any stock with a Technical Rating of less than 70, keep in mind that you're automatically ruling out the top 30% of the market. It's possible that these stocks will still go up, but it's more likely they'll have only lacklustre performance. Bottom fishers, those investors looking for a bargain among down-and-out stocks, are tempted to buy stocks with low ratings. But history proves that the most powerful stocks have shown prior strength and aren't rebounding from last place.

5.5 - Another Useful Tool: The Relative Strength Line

It's best when the relative strength line moves up at a sharp angle, showing the stock is outperforming the market. A line moving down indicates the opposite: a weakening stock. The relative strength line offers other clues:

• It's a positive sign when the line begins moving higher before the stock price itself does. A rising line indicates underlying strength in a stock; frequently, it's just a matter of time until the price itself begins moving higher.
• If a stock's line stays on an uptrend, that's positive. It shows the stock is keeping ahead of the overall market, acting as a confirmation of the stock's uptrend.
• If a stock's relative strength line fails to follow along with a new high in price, that's a warning signal. This shows the overall market is moving up faster than the stock. This may signal the stock is weakening, though the price may not reflect it immediately.

Relative strength lines that start drifting lower over a period of time, even if prices remain steady, indicate the stock is weakening. This also shows the stock is slipping in comparison with the rest of the market.

5.6 - Avoid competitors available for cheap

Another common temptation among investors is to seek out stocks that resemble leading stocks in terms of having similar products or services, but are trading at lower prices than the leaders. You're better off sticking with the leader of the industry, even if its share price is higher. Take the IT industry. Wipro, after the 2000 crash, fell about 90% from the peak of Rs. 1700; the price of the stock was only about Rs.350 in early 2008 after 8 years of the crash. On the other hand, infosys made a new high and rallied higher sending its stock price up during the same span of time. This is not a rare example, for any industry. The moral: stick with the leading stocks in a leading industry group.

5.7 - Assess all parameters before making your selection

No investor should pick stocks based on a single factor. You must weigh the full picture, including a company's earnings, industry group performance, institutional sponsorship and chart patterns. (Institutional sponsorship, chart patterns and other important elements will be explained in detail in subsequent lessons).

5.8 - Key Points To Remember

• Relative Price Strength Rating measures a stock's price move over the last 12 months compared to all other stocks.
• Look for stocks with high Relative Strength. The better-performing stocks tend to go higher, while the lagging stocks tend to lag even more.
• The Relative Strength line helps confirm a stock's upward price movement. You want to see the RS line moving in a strong uptrend.

Next: Avoid ‘Bargain’ or ‘Cheap’ stocks