Stronger and weaker trends, and stocks
As we said before, the stock market consists of a diverse variety of stocks, some slow and sluggish, some fast and virile.
It is paramount to understand here that if the general market is healthy and stock indices are trending up, there are those stocks that amplify that movement to the upside, i.e. they move faster, and those that under-perform the market, i.e. they move slower.
For the purpose of stock speculation, there is always a very small subset of select stocks, that can magnify this up-trend by 2-,3-,4-,5-fold or more over a given time frame. As such, their price change can outperform the stock indices and the slower stocks by many hundreds of percent, and any money put into the stock magnifies in a similar manner.
Leading stocks attract the largest money inflows
Why is it that some stocks trend stronger and farther than others? Quite simply, there is more institutional money chasing the stock – relatively more institutional investors (the “Big Money”) is putting relatively higher amounts of capital to work to acquire the stock, and thus relatively more money is flowing into the stock. Because there is relatively higher buying demand, everything else being approximately equal, these stocks will appreciate quicker and further than others in price, leading to stronger & longer trends and out-performing stocks.
In bull markets, stocks do not all rally in price in the same way. In fact, every market “rally” (a time period when stocks move up as a group) is led by a smaller number of leading stocks, just like a marching medieval army is led by a small group of agile cavalry.
These stocks are called the leading stocks of a market.
Leaders are followed by laggards
These leaders are followed in their price trends by the much larger amount of lesser stocks (though not necessarily lesser companies!) – the common foot soldiers, if you want. These slower stocks in their role as followers, under-perform the leaders – they are often referred as “also-rans”, or “laggards”, because they are lagging the leaders, and some even the general market. They are not as heavily bought by large swaths of institutional money, at least not when compared to the leading stocks, and they are being dragged along by improving market sentiment, shifting interests by the crowd, or speculators’ faulty ideas and expectations that lagging stocks will at some point catch up with the leaders. This is very often a fallacious expectation.
Why the laggards won’t catch up
You might have come across the mentality of buying cheap and avoiding expensive stocks, or even thought to yourself: “This stock is too expensive. Buy one of the other stocks in the same industry, they just haven’t started to run up like the expensive ones have, but they will, and will produce even more returns if you get in now”.
It’s very important to realize that this mentality is faulty and will lead to severe under-performance. The answer to the question of why laggards won’t catch up to the leaders in a given cycle 98 out of 100 times lies in the answer to the question of why leading stocks outperform at all in the first place. This is an almost trivial, but also deeply insightful question – Why do some stocks outperform, becoming leading stocks of the market? Well, think about what causes trends – thus, by extension, you can ask yourself what causes the difference between stronger and weaker trends. Of course, the answer lies with Institutional money.
Big money managers are not interested in any and every stock in the market, buying indiscriminately and driving up prices of all equities without discernment. They are interested in a certain type of stock that displays certain criteria that suit their goals – which we will discuss later.
For the type of stock that lags the leaders or even the general market, institutions are not just interested in buying, or buying a lot. They might become a “safety diversification” to them with a little bit of money, and they might attract some money from small private speculators … but the large money is going elsewhere. You need to understand that although you might personally like the company, its products/services or even its financials, there is some reason why the institutional money as a group is not touching it. And thus you shouldn’t either. The actual ‘Why’ doesn’t matter. Price is not moving much or at all, and thus you can’t make reasonable, or any, money in the stock.
The leading stocks are those stocks that institutions are almost gang-tackling each other to get the best bid in (remember the auction analogy?). Also in these stocks, other institutional managers who already own them from lower prices will outright orchestrate a big trading buzz around them to raise interest (demand) and thus try to “mark up” the price of the stock to be able to sell it at higher prices. More on this later.
Follow the money
Overall, institutional money causes up-trends in the general market and in stocks. But overwhelming institutional buying demand entering a group of certain stocks causes this group to rapidly appreciate in price and outperform, leaving the average and laggard stocks and indices in the dust. These are the stocks that we want and need to identify, the leading stocks.