Top-Down Trading

Trade the Right Stock in The Right Sector

 Top-Down Trading

Contents
Intro ............................................................................................................................................................. 3

Sector Defined ........................................................................................................................................... 4

Sector I Agricultural, Drilling, & Mining........................................................................................................... 4

Sector II Manufacturing & Construction........................................................................................................ 4
Sector III Consumer Services ............................................................................................................................... 4
Sector IV Information Services............................................................................................................................5
I. Understand The Money Flow .............................................................................................................. 6

II. Understand Sector Analysis ............................................................................................................ 10

Industrials/Basic Materials......................................................................................................................................11
Consumer Non-Discretionary.................................................................................................................................11
Consumer Discretionary ...........................................................................................................................................11
Energy ............................................................................................................................................................................... 12
Financials ........................................................................................................................................................................ 12
Healthcare ...................................................................................................................................................................... 12
Services ............................................................................................................................................................................ 13
Technology ..................................................................................................................................................................... 13
Transportation.............................................................................................................................................................. 13
Utilities .............................................................................................................................................................................. 13
III. Understand Sector Rotation .......................................................................................................... 15

Three Approaches to Sector Rotation .............................................................................................................. 16

IV. Get in, Watch, Get Out .................................................................................................................... 18

Conclusion ................................................................................................................................................ 21

2
 Top-Down Trading

Intro
Simple is as simple does worked for Forest Gump, and it can work for you in trading.
Keeping it simple means not making your trades complex; rather, more pointedly, it
means keeping your trading strategy simple. One such simple approach is top-down
trading, trading stocks in sectors that are moving because of identifiable forces.
These sectors comprise all parts of an advanced economy, and at the top are four
main sectors.

3
 Top-Down Trading

Sector Defined
Sector describes an area of the economy in which businesses share the same or a
related product or service. As it relates to the stock market, it is a basket of companies
in a specific industry that share common operating characteristics. Dividing an
economy, or the market, into identifiable pieces allows for more in-depth analysis of
both. And when trading sectors, you need an understanding of both to ascertain
movement. Having solid trading software and other technical tools are also required
to develop a sector strategy.

Sector I Agricultural, Drilling, & Mining

In sector one, you will find companies that participate in the extraction and harvesting
of natural products from the earth, such as oil and coal production, agriculture,
mining, and forestry. Yes, there are giant bellwethers within this sector (Rio Tinto, for
example) that signal global economic expansion or decline, but overall, this sector as
a group provides clues as to economic/market movement.

Sector II Manufacturing & Construction

Sector two consists of processing, manufacturing, and construction companies. True,
lots of big companies and bellwethers here as well (Caterpillar, for example), and as
a part of an economy, particularly the US economy, the sector is quite huge. Since
many of the companies in this sector operate internationally, this sector is a good
indicator of global economic activity.

Sector III Consumer Services

One of the largest sectors in terms of participation, Consumer Services includes the
giants of real estate, utilities, retail sales, entertainment, and the infamous yet
necessary financial industry. When you are analyzing economies to ascertain
movement, sector three is key to understanding a simple reality economies move
on consumer spending and consumer spending relies on credit. Now much of that
spending is non-discretionary, such as housing costs, energy costs, and food, but a
lot is discretionary, meaning folks have a choice on what they spend their money,
which makes this sub-sector an important indicator of economic/market movement.

4
 Top-Down Trading

This is not to say the non-discretionary sector of the economy is not an indicator; it is,
especially when you look at the financial sector in conjunction with the non-
discretionary and discretionary spending.
If the Consumer Services sector of an economy is doing well, it means consumers have
discretionary income, which means they are spending money on homes, movies,
toys, sports, clothing, theme parks, and new cars, which then connects back to Sector
Two. The financial aspect plays into this as well. If consumers are spending lots of
money, they most likely are utilizing credit to do so. Keep this is mind as we move
through the sectors.

Sector IV Information Services

The Information Services sector is comprised of a somewhat diverse population of
companies. Still, there is a common theme in that these companies provide valuable
and practical information to end-users. The Information Services sector is the leading
producer in US economic activity and what it produces is information and products
that deliver that information. In this sector, you will find companies that focus on
developing knowledge for sale, information technology, information generation and
sharing media, R&D, consulting services, education services, and financial planning.
Now, the four large sectors above are then broken down into smaller sub-sectors
(technology, healthcare, energy, telecommunications, and auto-manufacturing are
examples), and as a trader, it is your mission to then cull through those sectors to find
the right stock to trade. But, to do that, you must work from a macro view first by
starting with an analysis of the four sectors above in a global economic context.

5
 Top-Down Trading

I. Understand The Money Flow

Top-down trading is about understanding that market money flows from one area of
an economy to another, and that flow is not random; it moves from sector to sector
with a purpose to capture the best ROI, and the entities behind the purpose are
government and corporate pension funds, mutual funds, REITs, money managers,
insurance companies, investment banks, commercial trusts, endowment funds,
hedge funds, and sovereign wealth funds. Collectively, these are the institutional
investors that drive the money flow, and the amount of money they move is huge,
upwards of $35 trillion annually.
Understand, the money movement is not concerted, but institutional investors all
follow similar strategies, and those strategies are based on fundamental economic
principles. True, some of the $35 trillion is highly speculative bets, particularly in the
energy sector, but, for the most part, the money moves on time-tested economic
theory, or, simply, common sense.
As a top-down trader, it is your job to first understand why, where, and when the
money will flow, and then to break down the sectors to determine market movement
within specific sub-sectors, and then to drill down to find a stock to trade (For the
purposes of this e-book, the US economy and US stock market are the focus
throughout.).
In todays world, markets are woven together, interdependent, and movement of one
affects movement of another. Markets are interconnected and to understand one, you
need to analyze many. Intermarket analysis is complex, and it is best done with
software such as VantagePoint Intermarket Analysis software (VantagePoint). But, no
matter how you do it, understanding sector movement in the US economy and US
market is key to success.
Analyzing strength in the various US market sectors based upon your understanding
of economic activity is step one. Step two is understanding how the global economic
web affects movement in the various sectors and subsectors, and step three is to zero
in on stocks that will move relative to the global economic/market movement, stocks
that will go with the flow of money.
VantagePoint is a tool that will help on both the sector level and the stock level.
From a broad perspective, you also need to understand when, why, and how the
money flows to maximize its effectiveness. Along with tracking the global economic
fundamentals, you can track US ETFs to see how a given sector might perform based
on what you know are catalysts.

6
 Top-Down Trading

ETFs track US-based markets and global markets, and in both (US and global ETFs),
one can see where the money is moving, and then from that understanding one can
extrapolate the sectors in which to look for stock picks. VantagePoint uses predictive
technology to help you track the sectors and then it can help you find sector stocks
that have a high probability of a trending move in the near term.
For example, lets take the Consumer Discretionary sector just before the November,
2016 elections in the US. Had you understood the US real estate market was still hot
because people were trying to get the best rates before the Fed likely raised rates in
December, you might have decided to check out a Consumer Discretionary ETF using
VantagePoint and found this:

VantagePoint pointed to an uptrend in this ETF. Given this, you might have gone to a
particular focus of consumer discretionary spendingreal estate. Drilling down, the
iShares Real Estate Mortgage Capped REM appears and one can see this ETF is
pointing to an uptrend as well.

7
 Top-Down Trading

Drilling down to an individual stock is the next step and VantagePoints proprietary
Intelliscan feature finds stocks based on your selected criteria. Had you been
searching for a solid stock in the real estate market because you understood the
market was still hot because of the Fed, you might have found this stock in
VantagePoint EQR pointing to an uptrend.

8
 Top-Down Trading

And had you made a play based on VantagePoints patented moving average
crossover technology (show above when the blue line - the Predicted Moving
Average (PMA) crossed above the black line the Simple Moving Average (SMA), you
would have profited from a defined up move in the stock through November 7th, and
had you sold it based on the unpredictable nature of the upcoming election, you
would have made a profit.

Two things to keep in mind here. The first is that the above is a simple example of
how the strategy works, and it can be that simple, i.e., deducing a real estate play by
understanding market and economic fundamentals, but it can also be more complex
in that the possibilities for making trades are enormous, and many variables can affect
the simplicity of it, so I recommend learning as much as you can about the
market/economic fundamentals, the sectors, and how market investors utilize them
to move their money around.
The second is when I refer to movement, I am referencing forward, or an uptrend.
However, if your trading strategy calls for trading bear markets, or shorting stock, the
fundamentals laid out in this e-book will work just the same, only in the opposite
direction, of course. Keep in mind as well that not all stocks in any given sector
perform equally. You still need to do the work of finding the right stock play.

9
 Top-Down Trading

II. Understand Sector Analysis

The Sector Analysis Strategy is common among institutional investors, which is why it
is good to follow the money. The basic premise is that institutional investors utilize
Sector Analysis to move money based on the potential performance of a given group
of companies in a specific sector of the economy.
As stated earlier, there are four large sectors (Agricultural Drilling, & Mining;
Manufacturing & Construction; Consumer Services; and Information Services) and within
those are more than a few sub-sectors that contain tradeable stocks. The most
common are the list below.
Industrials/Basic Materials
Consumer Durables/Staples
Consumer Cyclicals
Energy
Financials
Healthcare
Services
Technology
Transportation
Utilities
The sub-sectors above are broader classifications than industries, but, in fact, more
than a few are industries (Financial, Healthcare as examples), and more than a few
companies can make a case for being in more than one industry or sector.
Generally speaking, though, whatever sector a company finds itself in, it is likely it will
correlate (move in tandem) with other companies within that sector, relative to
revenue and earnings growth, stock-price performance, and earnings forecasts. This
is truer in the near term than in the long term.
The above sub-sectors break down even further to more specific industries within the
economic framework.

10
 Top-Down Trading

Industrials/Basic Materials
Chemicals Agricultural
Chemicals Commodity
Chemicals Diversified
Construction Materials
Containers & Packaging
Forest & Wood Products
Mining & Metals
Paper Packaging
Precious Metals & Minerals
Steel Production

Consumer Non-Discretionary
Beverages
Food & Staples Retailing
Food Products
Household Products
Personal Products
Tobacco

Consumer Discretionary
Apparel & Accessories
Auto & Truck Manufacturing
Broadcasting
Entertainment
Entertainment Production
Footwear
Home Furnishing
Leisure & Recreation
Real Estate
Restaurants
Retail Catalog & Internet Order
Retail & Discount Stores

11
 Top-Down Trading

Energy
Coal Mining
Integrated Oil & Gas
Oil & Gas Drilling
Oil & Gas Exploration & Production
Oil & Gas Refining & Marketing
Oil Related Services & Equipment
Alternative Energy Production

Financials
Banks
Consumer Financial Services
Financial Services Diversified
Insurance - Life & Health
Insurance Multiline
Insurance - Property & Casualty
Investment Services
Investment Trusts
Real Estate Operations
REIT - Residential & Commercial

Healthcare
Advanced Medical Equipment
Biotechnology
Healthcare Facilities
Managed Health Care
Medical Equipment, Supplies & Distribution
Pharmaceuticals - Diversified
Pharmaceuticals - Generic & Specialty

12
 Top-Down Trading

Services
Consulting Services
Education Services
Financial Planning

Technology
Communications Equipment
Computer Hardware
IT Services & Consulting
Office Equipment
Semiconductor Equipment & Testing
Semiconductors
Software

Transportation
Air Freight Couriers
Commercial Airlines
Marine Shipping
Railroads
Trucking

Utilities
Utilities - Electric
Utilities - Multiline
Utilities - Natural Gas
Utilities - Water & Others

If the market is moving, look at different sectors to find which ones will provide the
greatest potential for good trades. Certain sectors perform better than others, so if
the market is heading higher, buy stocks within sectors that are performing the best,
sectors that are outperforming the overall market, or, better yet, will outperform the
market.

13
 Top-Down Trading

For example, in a relatively healthy economy, you can bet the Consumer Discretionary
sector will see major activity as the summer ends. For example, Retail Apparel and
Footwear, will see an uptick, while Real Estate, Recreation, Restaurants will see
downturns (unless outside forces, such as the Fed, intervene). Now, the question
becomes finding the right stocks in the sector to play.
You can do this by studying the fundamentals of companies and then putting them
in a contextual time frame (such as the example above), reading about what is hot, or
you can use VantagePoint, which analyzes stocks in specific sectors relative to
intermarket analysis, a context for overall and specific market movement (See
below.).

The point is this: Sector movement happens for a variety of reasons cyclical,
fundamental, technical, emotional, and through rotation. Large-scale investors drive
the rotation, and the next chapter will look at that specifically, but the takeaway in this
chapter is this learn how to analyze sectors relative to global/US economic
movement, understand the catalysts that create that movement, and then drill down
to find solid stocks that will perform well or outperform the other stocks in that sector.

14
 Top-Down Trading

III. Understand Sector Rotation

Sector rotation happens when the institutional investors move money from one sector
to another based on a belief that money will garner higher returns in the new sector,
for whatever reason. It is the flow of money. Understand that this movement is not
generally swift and it does not end suddenly; rather, the money is moved slowly and
left for a specified holding period. Big investment money is looking 6-9 months
down the road. The moves are strategic and carefully thought out, but they do
happen.
Rotation happens, but why and when depends on multiple variables. Market cycles,
economic cycles, business cycles, and the calendar are the primary catalysts, but one
cannot rule out speculation based on something such as a US presidential election.
Like the seasons, big money expects the cycle to turn, and they plan on it, but, unlike
the seasons, the timing is never the same. The solstices and equinoxes are
predictable to the day, but because the catalysts are all interdependent and variable,
predicting exactly is, well, difficult. But as a trader, you dont need precision timing;
you only need approximate timing, so studying the cyclical nature of economies,
markets, and business, and learning how they all tie together, is essential to
understanding sector rotation.
Given that, though, having an approximate idea of money movement via sector
rotation (again, ETFs are a good near-term indicator for this), will work just fine, as
once a rotation begins, it will take some time to complete, and the money will remain
there for some time. This, of course, presumes all things being equal, meaning, no
external force is acting upon the market, something such as war, terrorism, or political
elections.
Your job is to identify when and where the money will flow, and then to find trades
within that time frame. One way to track sector rotation is to track economic activity
on a global scale. Specifically, though, since the US economy and the US market are
the largest on the planet and they provide the bulk of market and economic
movement, it is best to focus on those two behemoths to figure out where the money
is going and when.
Again, the real work is finding the right companies to buy. Consider, as well, that you
might just trade ETFs. It is a larger pool, but it can offer some risk mitigation. As with
most things, different approaches offer different ways to the same end, so here are
three, specific strategies institutional investors utilize to rotate money from sector to
sector.

15
 Top-Down Trading

Three Approaches to Sector Rotation

Economic-Cycle Approach
Some economic theories assume economies follow a well-defined cycle (expansion,
peak, contraction and trough). This generally true, but not always. Nevertheless, it is
a theory. The idea is that different industry sectors perform better at various stages
of the economic cycle. The idea is that just before each economic stage begins or
ends, traders and investors have an opportunity to get in low, and when the cycle
shifts, get out with a profit. When a sector reaches the peak of its move as defined by
the economic cycle, the trading cycle is complete.
As stated just a paragraph ago, the major problem with this strategy is that the
economy does not always follow the economic cycle as exactly defined. Even
economists cannot always agree on the trend of the economy.

Calendar Approach
I described the calendar strategy earlier with my example of the end of summer and
the back-to-school season. Vacations end, buying school clothes and other school
needs begins, people stop eating out as much, and so on. So, there is a shift in the
economic money flow and retailers have an opportunity to make some money based
on the reality that the spending for back to school has become a ritual in American
culture. Now, almost immediately after this opportunity comes another, non-
discretionary spending opportunity the holiday season. And as fall turns to winter,
the energy sector offers opportunity with heating oil, gas furnaces, and electric
heating. Big money tracks this pattern, and so might you.
You see how simple this is. Yet finding the right stock to trade is not necessarily as
simple.

Geographic Approach
The third approach relates to tracking global economies. The premise is that certain
economies in certain parts of the world move independently from one another for
variable reasons. For example, as we have seen from 2008 until now, different
economic regions and their central banks have implemented economic stimulus
independent of one another. The European Central Bank and the US Federal Reserve
have not been on the same page as each other, much less Japan and China. Now,
when each of those economic powers does implement stimulus, money flows in that
direction.

16
 Top-Down Trading

What we have seen, though, is that the central banks lead the stimulus with obvious
clues. While never actually assigning dates to activity, the central banks manage to
let markets know when action will occur.
As we have seen since late 2009, Saudi Arabia, through its proxy OPEC, can influence
money movement into or away from the energy sector, specifically the oil and gas
sub-sector. It can also influence money movement into the alternative energy sector
as we saw in 2016 with its announced plans to invest billions into solar power
production. China with its ever-growing use of oil can move the same money if its
economy is showing signs of stable and continued growth. And US oil producers can
do the same when it announces numbers relative to oil rig counts, exploration and
drilling, and refinement capacity.
Countries and economic regions can attract money, so it is smart to track the global
economy for top-down trading. The point is to either predict where the money will
flow or to get there early enough in the cycle to take advantage of the money flowing
in or out of a particular sector.
To stay ahead of sector rotation requires work, but much of that is up front, the time
it takes to learn the repeated market/economic/business cycles, to learn the
repeated patterns of institutional investors, and to figure out which predictable events
(presidential elections, for example) will catalyze the flow of money from one sector
to another.

17
 Top-Down Trading

IV. Get in, Watch, Get Out

As stated earlier, simply picking ETFs to play is one strategy. It is a safer one these
days than it was ten years ago when trading ETFs was much like the going to Las
Vegas. For example, given, the good economic data relative to wage increases that
came out in October of 2016, it is easy to see why a retail ETF might rise in price. But,
as you can see below, RTH did not. Keep in mind, there were election jitters, and as
the election neared, the market tanked.

Yet, as the election neared and the drama faded, institutional money began flowing
into the ETF, suggesting future power in the retail sector. Had you been tracking this
ETF with VantagePoint, it would have been clear the time to buy was just about four
days before the election.

18
 Top-Down Trading

So, on average, with an ETF, even if all stocks in that basket dont go up, you still
make an ROI. Now, it could be considerably more if you pick the right stock, but that
requires more work and acumen, as well as good tools. Utilizing VantagePoint can
help. For example, thinking that consumers have more money to spend for the
holidays, a toymaker might be a possibility for a bump up.

Hasbro tracked right along with RTH above in the two weeks before the election, and,
as seen in the above chart, the time to buy was just about four days before the
election. Money was moving.
One could drill down for stocks looking for the ones that have been on a roll, along
with the sector. For example, you might look for strong stocks with solid appreciation
over a relative time frame. Hasbro fits the bill. In the past month, despite the election
jitters, investors saw this as a stock to get into and stay with.

19
 Top-Down Trading

Understand, the general rules for solid stock picking and trading still apply when
top-down trading.

Stocks must have good liquidity, meaning a high volume of trading. Usually,
good volume will exceed one-hundred thousand shares per day, at least.

Stay away from the penny stocks with this strategy. Even though they are
cheap ($5 and under), they are subject to serious fluctuation from forces other
than fundamental market forces.

Choose stocks with good fundamentals. Generally, stocks that are found in the
relative ETF re stocks with good fundamentals.

Get in and get out, meaning set your target profit reasonably, set your loss
reasonably, and use limit orders on the top and bottom sides.
Dont get greedy. You can use a rolling limit on the upside once you lock in your profit,
but always keep your stop on the bottom side.

20
 Top-Down Trading

Conclusion
Top-down trading is good way to earn your ROI. The key word is earn. Do the work
to make it happen, and then continue to work to make it happen on a continuous
basis. Here are few more rules.
Become fluent in the language of global economics.
Watch and read the news to stay current with what is happening in the world.
Watch and track the markets generally and specifically the ones you want to
trade.
Learn how big money moves, the why, when, and where of the process.
Want to do trade right.

If you do all of the above, and you use good tools to find the right ETF or stock, you
might well find success in the top-down trading world.

21