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Apprenticed Investor: Tracking Elephants, Part 2

Relative Sector Strength

A company's performance is determined in large part by the sector it is in. (The health of the overall market is just as important.)

Sector charts clearly reveal whether an entire sector -- or the overall market -- is in an uptrend, a downtrend or merely going sideways.

Good advice: Even the best company in a sector trending downward has a tough time rallying.

I believe a bad stock in a good sector can go higher and do so more easily than a good stock in a bad sector. The PC business was awful after the Y2K upgrade. Even Dell (DELL) got killed in 2000.

Consider also the online colleges in 2003. It wasn't just Corinthian Colleges (COCO) -- they all screamed higher, even the lousy ones. That's sector strength at work.

Knowing this can help you decide whether to avoid a stock --or jump on board.

Charting History

A weekly three- or five-year chart gives you a broad historical overview of a stock or a sector. It provides an immediate snapshot of a firm's earnings history, both good and bad. Sure, you could read five years of 10-Ks and analyst reports, but why waste all that time? The picture is worth many thousands of words.

You can easily see how volatile a stock is with a quick glance. A chart showing wild intraday swings and sharp reversals might raise suitability issues for more conservative investors. A more measured, gradual chart might not fit the goals of short-term, more active traders. Either way, the chart provides some insight as to whether this stock is for you.

Reality Check

How often has a piece of fundamental data or a tidbit of "unknown" or hot information induced you to buy a stock? The chart lets you know whether that data point is baked "in the cake" already.

If someone tries to convince you to buy a stock because of the hot news he has, a quick glance tells you how warm or cool the news really is. A stock up significantly over the past three months implies that the hot tip you just got ain't so hot -- lukewarm is probably more like it. As my head trader is fond of saying, "Last man in pays for the beer."

Buying a stock based on an analysis that is not fresh or advantageous is a recipe for losing money.

Charts have more to offer than patterns and predictions. Savvy investors learn how to use them for recognizing warning signs, managing risk and selecting stocks. Over time, you will too.

1. Expect to Be Wrong 2. Your Fault, Reader
3. The Wrong Crowd 4. Bull or Bear? Neither
5. Know Thyself 6. Prepare for Battle
7. Bite Your Tongue 8. Don't Speak, Pt 2
9. The Zen of Trading 10. The Folly of Forecasting
11. Lose the News 12. Tracking Elephants, Pt 1
Check back for more of Barry Ritholtz's
Apprenticed Investor series
Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback; click here to send him an email.

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