Comparing Strength and Weakness: Group Averages

[DbPhoenix]

We seem to have entered the subject of groups by the side door. As mentioned elsewhere, Wyckoff counsels the trader to go through several steps in order to find the most attractive opportunities: (1) determine the trend of the market, (2) find those groups which are most in tune with that trend, (3) find those stocks which present the best short or long opportunities within the group. One can skip the group step and go straight from market to stock, but the odds of finding the right stock are far better if one knows what the stock's group is doing as well as other, comparable stocks within that group. (He'll explain in more detail below.)

The following is an edited excerpt from Wyckoff's original course: "Comparing Strength and Weakness: Group Charts" (Sect. 8M). This is only about a third of it. The rest is devoted largely to detailed explanations of charting and compositing with examples of stocks and groups of the time. Today we don't have to go through all that work. In addition to the "mother" averages (the DJIA, DJTA, and DJUA), we have the Nasdaq, the S&P, the NYSE, and a vast array of other averages and indices, all available at a click. BigCharts even goes so far as to arrange all of them for you, from the nine basic sectors (plus Telecommunications, which is highly specialized) to 25 groups to dozens of subgroups and sub-subgroups.

I won't go any further into the process. Wyckoff does a much better job of it, as one might expect. However, one example of the process is provided in the EOD thread, linked in the first sentence, top. Following, I'll provide charts of the nine sectors as of yesterday with simple annotations. I'll try to update these charts when there's something worth updating, but I'm not promising anything. One can do this quite easily for himself. The symbols are in the upper-left-hand corner of each chart and can be plotted anywhere. But they do provide a starting point, and one can explore each sector all the way down to the bottommost levels at BigCharts.

COMPARING STRENGTH AND WEAKNESS

GROUP CHARTS (Sect. 8M)

After we have determined the position and trend of the market as a whole, we next must determine the position and trend of the various groups and, finally, select from the best situated Groups those Individual Stocks which promise the best moves.

One of the best indications of the future course of a group or a stock is its comparative strength when the rest of the market is weak, or its comparative weakness in a strong market.

James R. Keene used to say: “Watch the stock that shows strong resistance to pressure when the market is weak, and buy those stocks for all you are worth.”

The reason for this: Someone is trying to buy while the market is weak. He would not do this unless he has reason to believe that he can sell it later at a higher price. So he takes advantage of the weakness in the rest of the market by holding the bag for all the offerings of other people who are prompted or compelled to sell. When a stock is exceptionally weak in a strong market, we conclude that somebody knows something to its disadvantage and is forcing his offerings on a market that is otherwise strong. This may indicate need for urgency, based on fear or necessity; or it may signify the taking advantage of a strong market.

Large operators often test the market for a stock by buying 5,000 to 25,000 shares in order to see how easily they can buy it, or by selling a similar quantity to ascertain how well the market will absorb their selling. Thus they are able to decide which side shows the least resistance. If they find other people are trying to buy it and that the stock is rather scarce, they regard it as a bullish indication and take a long position. However, if the price yields easily to pressure, they regard it as a bearish indication and take a short position.

A small operator is unable to test the market in this way before he takes a position, but by a close study of his charts, he is able to estimate the comparative strength or weakness of a stock and thus reinforce his judgment as to whether, considering the trend, it is time to buy or sell it.

When large interests are planning a campaign in a stock, they “lay the foundation.” That is, they accumulate or distribute a quantity of stock according to the size of their venture and the anticipated profit to be derived from it. This quantity bears a relation to the estimated number of points profit. (Figure charts afford a means of judging this relation and hence frequently indicate the approximate objectives of such campaigns.)

If a stock is below value, and these interests see a large potential profit ahead, they will take all they can buy at certain levels, then gradually raise their bid prices until they get all they want. They buy preferably on reactions until such time as they are ready to mark up the price. Or if a stock is above value, and they see trouble ahead, they will sell all they can at certain levels, supporting the price on reactions and unloading on rallies until they are read to let it drop. This is why these supporting levels and the levels of resistance (a phrase originated by me many years ago), are so important for you to watch.

In brief, when you see strong support in a stock, with the rest of the market weak, you know the buying is better than the selling -- that insiders are probably doing the buying because they believe they can sell out later at a profit. And when you see the reverse, that is, strong resistance in a stock with the rest of the market advancing, you know the selling is better than the buying -- insiders are selling because the outlook for that stock is turning sour, or because they believe they can later reaccumulate at a lower level.

Likewise, when an individual stock in any group is stronger than the Average of that group, this is an indication that such a stock is likely to move sooner and faster than the Average, provided its behavior otherwise confirms the indication. If it is weaker than its group, this may signify that the stock is preparing to decline more rapidly than the Average.

The fact that an individual stock may be moving against the trend of its group does not destroy nor impair the value or effectiveness of the indications given by the Average in which it is included. On the contrary, such action, of itself, frequently conveys significant information which should not be ignored with respect to the behavior and position of that stock.

In like manner, by comparing the behavior of the various Group Averages with the action of the whole market — the way they respond or fail to respond to advances and declines, rallies and reactions in the Composite Average [the Dow, S&P, etc] — you may gain valuable additional information on which to base your stock market campaigns.

These comparisons are especially important because they help you to select the best opportunities and to avoid the slow movers (“sleepers”) -- thereby keeping your capital working at maximum efficiency.

Bear in mind that all stocks do not move at all times in harmony with the prevailing trend; nor do they all rise and fall together. Bull markets usually begin with advances in the leaders, that is, the seasoned, higher grade, and higher priced issues. This is so because the big interests, who are best informed as to prospects for approaching recovery dominate these stocks and hence reflect their sentiments toward the market by their operations in the leaders. As the rise in the leaders continues, large independent operators, taking their cue from the action of the leaders, are encouraged to begin bullish operations in the secondary issues and specialties, In due course, the public is attracted by bullish demonstrations in various parts of the list and by the revival of market activity, whereupon the lower priced and more speculative stocks come into line. This demand rotates from group to group as, for instance, from Steels to Rails to Coppers, etc., and from one stock to another.

As the rise progresses, individual stocks and groups of stocks that have advanced too rapidly may rest and react while other stocks and other groups are brought forward. Thus bull markets are built up by a Process of Rotation. That is, demand shifts about from week to week, day to day and even from hour to hour.

Price movements tend to become increasingly selective (mixed) after a prolonged advance because when the big fellows see that some industries have about attained maximum prosperity, they will wind up their speculative campaigns in those groups and turn to those laggards in which there is still room for improvement.

When large interests are distributing at the tops of the intermediate or maJor swings (or on the way down from the extreme highs), they sometimes fool the public by rapidly marking up the prices of a few easily influenced stocks, or by applying hypodermics to a few of the leaders. These whooping up tactics maintain the atmosphere of bullishness so essential to keep the public in a buying mood while other stocks are being unloaded.

An indication that demand is being exhausted may be given when the majority of stocks respond sluggishly to such whooping up maneuvers; or when they tend to fall back quickly on repeated attempts to continue the process of rotation, or when the leadership of an advance shifts from the recognized leaders to the secondary issues and to the “cats and dogs”; or when representative stocks fail to follow the strength in a few hypodermically stimulated fast movers.

The Process of Rotation operates in much the same manner at the beginning and during the course of a bear market. That is, supply rotates to break down prices in one section of the list after another until offerings are finally exhausted. Likewise, selling pressure rotates while the market is in process of forming a bottom. Hence some stocks may reach their downward objectives sooner than others. Therefore, when we see that the early leaders of a decline are refusing to move materially lower, while supply is still rotating to other stocks, we have an indication that demand is overcoming supply. This helps us to determine the levels at which accumulation is taking place.

Supply in a falling market rotates more rapidly than demand in a rising Market. This is explained by the fact that there is seldom (if ever) sufficient buying power to lift all stocks at once in bull movements; whereas, in bear movements, fear, necessity, or both, eventually compel holders to liquidate all stocks without regard to value. This characteristic difference may easily be seen by reference to the accompanying charts.

Another reason why stocks fall more swiftly and uniformly than they advance is that the public long interest is always greater than the public short interest. Most people are willing to buy stocks but fear to sell short, although intelligently conducted short selling operations often yield more substantial profits and involve no greater risk than commitments on the long side. At any rate, those who are long of stocks greatly outnumber those who are short. Consequently, upward price movements are retarded by frequent profit-taking on the part of the numerous bulls, especially in stocks below the $50 class which attract the largest outside following. But downward movements are not so effectively retarded by profit-taking on the part of the relatively few bears.

And, because the public’s attitude is unbalanced (leaning always toward the bull side), actual and potential demand for stocks is greater when the market goes up than when it goes down. In other words,the majority will buy while the market is strong but this demand fades away when it is weak. In fact, the untrained trader and investor hangs on to his stocks through falling markets until prices reach a point where hope suddenly evaporates. Then he sells out in a panic. The herd psychology that characterizes the Wall Street public often causes unskilled investors to reach this panicky state of mind simultaneously. Thus there is a concerted rush to sell which cleans out all of the weak holders at about the same time, relieving the market of pressure and reducing the supply quickly at that point.

The Principle of Rotation is operative also in group movements. Thus, strength or weakness in the leading stock of a group influences traders to buy or sell other stocks in the same group. This helps those who are conducting a campaign of accumulation or distribution to work their stock to the lower or the higher level at which they wish to acquire or unload their line. At the turning point in a falling market, the continuing weakness in other stocks creates the atmosphere of general pessimism which induces the public to go on selling around the bottom. This affords large operators an opportunity to buy what they want without bidding prices up. Similarly, at the turning points in a rising market, the rotation of strength to other stocks in a group enables the large operator to unload the one he has marked up to its objective under cover of the activity and strength in the other issues, without forcing his offerings upon the market.

This explains why you so often see individual stocks in a group topping out, or rounding out a bottom, one after another and why all stocks do not necessarily touch their highs or lows together, on the same day or in the same week, or perhaps the same month. It likewise explains why some of the leaders of one phase of a bull market may not lead nor actively participate in its later stages.

You must strive to take advantage of the above principles. Seek out the stocks in the strongest position when buying and the weakest to sell short. Aim to pick the leader of a group for your operations.

It is a mistake to ignore the laggards in a group simply because the leader “is too high.” Some of these other stocks may be in preparation for moves which will come after the leader is finished. That gives you an opportunity to switch from the leader (when you see it may be near the end of its swing) to the next best issue or issues, that is, to those which may not have come fully into line with the advance in the leader. But in searching out these opportunities, you must be sure to weigh each situation carefully. The fact that a stock is moving sidewise around a low point, while others in the group are going up, is, by itself, no assurance that this laggard must be under accumulation. Study its volume behavior. Note particularly whether the price shows a tendency toward rising supports after it has been in the range for some time. If it does not show such a tendency, better leave it alone. A stock that persistently hugs a low line of supports (stays near the bottom of an apparent range of accumulation) and refuses to rally well when the rest of the market is strong, is very apt to be subjected to a shake-out, or it may be in a weak position.

Therefore, bear in mind that even though a group may be in a strong position, every stock in that group may not be desirable nor in a position to move aggressively. Vice versa, in a weak group, some stocks may be in a relatively stronger position than others, while some may be neutral.

Judge the progress of stocks and compare strength or weakness directly from your charts. From your vertical charts you can see immediately, by casual inspection, how a stock is behaving in relation to the general market averages and in relation to its own group. Changes in its action become apparent at once so that you can adjust your conclusions promptly.

--Richard D Wyckoff

[Trader333]

Great post DB. I have used something similar to this to trade US stocks on an intra-day basis. Basically taking a top down approach and buying the strongest stocks when INDU rallies or shorting the weakest stocks when INDU falls.

Of course when doing this on an intra-day basis the way in which INDU is determined as strong or weak and the key measure of which stocks are strongest and weakest by comparison is of prime importance to enable to be traded profitably.


Paul

[Copycat]

Anyone willing to help me anwering these 2 questions?

In Comparing Strength and Weakness (sect. 8M) Wyckoff wrote:

"The fact that an individual stock may be moving against the trend of its group does not destroy nor impair the value or effectiveness of the indications given by the Average in which it is included. On the contrary, such action, of itself, frequently conveys significant information which should not be ignored with respect to the behavior and position of that stock."

I can't figure out what kind of siginificant information it conveys. Isn't this the same as:
Market (averages) weak - stock strong = market trending down - stock trending up.
So buying would be better?

My other question. Should the effect of news be taken into account in your analysis? For example: If a stock is not reacting bullish to bullish news, could this be indicating weakness? More combinations possible.

Ugh, wrong thread. Could this be moved to the: Ask any Wyckoff related questions thread?

[DbPhoenix]

Originally Posted by Copycat Ugh, wrong thread. Could this be moved to the: Ask any Wyckoff related questions thread?

Since this was related to Section 8 in particular, I moved it to this thread. And since this thread is much shorter, your question is much more likely to be noticed.

Originally Posted by Copycat Anyone willing to help me anwering these 2 questions? In Comparing Strength and Weakness (sect. 8M) Wyckoff wrote: "The fact that an individual stock may be moving against the trend of its group does not destroy nor impair the value or effectiveness of the indications given by the Average in which it is included. On the contrary, such action, of itself, frequently conveys significant information which should not be ignored with respect to the behavior and position of that stock." I can't figure out what kind of siginificant information it conveys. Isn't this the same as: Market (averages) weak - stock strong = market trending down - stock trending up. So buying would be better?

It depends (but you probably expected that answer). First, don't forget to include the paragraph following what you've quoted:

In like manner, by comparing the behavior of the various Group Averages with the action of the whole market — the way they respond or fail to respond to advances and declines, rallies and reactions in the Composite Average [the Dow, S&P, etc] — you may gain valuable additional information on which to base your stock market campaigns.

When W refers to the "Average" in your quote, he means the Group Average. So, yes, barring all other considerations, if your stock is among the strongest in its group, it becomes a prime candidate for purchase.

However, the market holds the trump. One always begins with the market, then the group averages, then the stocks. If both the general market is weak and the group average is weak, then you are swimming against the current by trying to profit from a particular stock, regardless of how strong it seems to be. This is not to say that obtaining a profit is impossible, but doing so is so much easier when trading with the general trend.

Incorporating the trend of the market, the trend of the group, and the trend of the stock become more beneficial to you at or near turning points. For example, when the market appears to be approaching a bottom, or is already in the bottoming process, which groups are already showing signs of exiting that bottom? And out of those groups, which stocks are the strongest? Or at tops, which groups are weakest? And out of those groups, which stocks are in turn the weakest? And if the market happens to be "rotating" or "churning", not moving significantly one way or another, turning to the groups can tell you whether leadership is moving from one group to another, and, if so, which are the leading stocks in those groups which are assuming leadership.

Applying all of this to the current market, you have to decide whether we are topping or rotating. One way to look at this is to incorporate the Wyckoff Wave. Or you can monitor the nine major sectors, as I've posted above (far easier to do now than in W's time). If there is observable weakness in most of the sectors, then we are likely topping. But if there appears to be a hand-off, with some sectors weakening while others are strengthening, then we are more likely rotating. If we are topping, then buying is not the best idea. If we are rotating, then assessing the relative group strengths can put you at the front of the line for taking a position the best stocks in the strongest groups.

Originally Posted by Copycat My other question. Should the effect of news be taken into account in your analysis? For example: If a stock is not reacting bullish to bullish news, could this be indicating weakness? More combinations possible.

No. But it depends (again) on what you mean by "not reacting bullishly" and "indicating", which in turn depends on your strategy and your goals. If, for example, any weakness at all is going to push you out of the stock, then your expectations may be too high. On the other hand, if you're willing to hang on as long as the stock maintains its overall trend and it hasn't, for example, dropped below the last important swing point, then its temporarily bearish behavior in the face of bullish news may be irrelevant. But how you behave in this situation will also depend in large part on where you entered and whether or not that entry was timely or late. If you entered late and the stock's behavior puts you underwater, then you may not be willing to give it the room it requires to adjust to the news. That, however, is not the stock's problem, but yours. If the stock's behavior makes you so nervous that you can't be objective about it, get out. It's easier to be objective when you're out and trying to decide whether or not to get in than to be in and try to decide whether or not you should get out.