When leading stocks fall, you need to read the situation impartially.
However, if you have a position in a top stock from a top group, emotions can cloud judgment.
You might sell in fear, or you might hold firm in stubbornness.
A drill is the best way to avoid subjective decisions. The drill doesn't change because you own the stock. The questions are what they are, and the answers are what they are.
Let's look at a recent example.
The biotech group began rising briskly in 2012 with a 40% gain for the year. Biotech stepped up the pace to 75% in 2013. The biotech group was up 36% for the year in late February, but by mid-April the gain was virtually gone.
As the pullback began, the time for a drill arrived. Here are some checkpoints:• Length of run: IBD research shows that in general a leading stock's bullish run lasts about 18 to 24 months. The Medical-Biomedical/Biotech group was up for more than two years, so age was working against it. However, the group had two significant pullbacks along the way: an 18% drop in the fall of 2012 and a 16% decline in the fall of 2013.
• Group chart action: If you have access to MarketSmith, plug in the ticker for the biomedical group. (The ticker is G8063.) The action was tight and smooth through most of the run. However, after a 17% weekly gain in January, action became less confident. And the group chart showed railroad-tracks action in the week-ending March 7.
While railroad tracks on a group chart might not carry the same meaning as it would on a specific stock chart, it does reveal retracing action, which is not ideal.
• The RS line: A leader has to lead. It's a bad sign when the leaders in a group start to show fading RS lines. Celgene's (CELG) RS line began to flatten in October (1) and began to slide in late February (2). Celgene was the first top-rated biotech to show weakness.
• Growth rate: Is growth quickening or slowing? On Oct. 24 (3), Celgene reported Q3 earnings-per-share growth of 21% — its slowest growth in almost three years. In Q4, growth slowed further to 14%.
• Drop from screen: Celgene dropped from the IBD 50 on Feb. 3, returned Feb. 18 and was gone Feb. 24 (4). Other biomeds held on longer. Alexion Pharmaceuticals (ALXN) fell off the IBD 50 on April 7. Biogen Idec (BIIB) fell off April 14.
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