V.6:11 (408-410): Technical analysis of industry groups by Richard K. Carlin, Ph.D.

Technical analysis of industry groups by Richard K. Carlin, Ph.D.

Stock market analysis is usually done in one of two ways: either on the market itself to predict whether stocks as a group are in an uptrend or downtrend, or on individual stocks to discover undervalued issues. No one, however, has consistently outperformed the market using these two approaches. Why? The one thing in common to both strategies is diversification of the investment portfolio.

Since the market is nothing more than an average return on many stocks, it acts like a diversified portfolio. Thus, no matter which investment approach you use, the more diversified your portfolio, the more it will act like the stock market over a long period of time.

There is a third type of analysis which can outperform the general market and still provide you with a diversified portfolio — industry group analysis.

Each industry group index is a composite of many individual stocks and thus acts like a separate, miniature stock market. Because industry-related stocks tend to move together, there is always a bull market in some industry group regardless of what the general market may be doing. For example, during 1973-74, the market fell about 50% yet gold stocks continued to hit new heights. By diversifying a portfolio within an industry group, you may not outperform the industry index, but you may significantly outperform the market as a whole.

If a stock is not in an industry group you can compare it to the Dow Jones Industrial Average. You might also compare indices made up of each group of stocks, but here I want to focus on five indicators helpful with industry group analysis: Advance-Decline Line, High-Low Index, Overbought-Oversold Indicator, Diffusion Index and Absolute Breadth Index.