When the market (=index) is strong, a lot of the breakouts tend to have a follow through. And when the market is weak, even uptrending stocks have a hard time sustaining their trend. Do you guys sell a stock which seems to be holding up well just because the market made, say, a lower low or showed signs of weakness?
1) No. An index has to conform to its stocks. 2) A stock doesn't have to conform to an index. 3) Excessive pairs-trading can give lock-step correlation to the stocks in an index creating the appearance of coherent price behavior.
1) The value of the index is derived from the value of the underlying stocks within the index. The market price of the index can't deviate too far from the theoretical value of the index before arbs step in to collect "free money" and bring the index back into line. 2) The index has to "conform" to it's stock components. If it doesn't, then there can be risk-free trade opportunities.
Thanks for the reply. However for a broad index like, say, the S&P 500, there are some index stocks that seem to hold up better than the index itself. If you held one of these stocks, would you sell simply because the index showed signs of weakness or hold on since the stock showed signs of strength?
1) No. Focus on the stock, not the index. That's what your actual position is. Focus on the "hot girl" in the crowd, not her ugly friends! 2) A broadly diversified index can have a greater degree of dispersion in the performance of the underlying stocks. There can be stocks lower, unchanged and higher-on-the-day within the index. They're not likely to be all performing the same. 3) You may be falling into the "deception" of looking for a derivative/lagging indicator that will tell you what something else will do in the future.
As they say across the pond, "too smart by half". Why sell a strong stock from a weak index when you can sell a weak stock from a weak index. What you are suggesting is countertrend trading and unless you know exactly what you are doing, it is asking for trouble.