There's no reason to take profits in an emerging leader when it's under accumulation and breaking out from an early-stage base.
But after big runs and a series of breakouts, leaders in an industry group invariably start to show signs of wear and tear, mostly due to persistent signs of institutional selling.
At some point, savvy fund managers and big investors cash out and rotate into other areas of the market. Recognizing when this happens is key to locking in profits in a big winner.
A lot of money was made in the home-building group when a multiyear bull market kicked into gear in March 2003. Homebuilders started breaking out from early-stage bases in May — two months after the Nasdaq confirmed a new uptrend on March 17, rising 4% in strong volume.
After a two-year-plus price run, a wave of institutional selling hit the homebuilder group in the summer and fall of 2005, marking the start of a lengthy downtrend for the group.
Several top performers in the group were breaking out from late-stage bases at the time. PulteGroup (PHM) cleared a fourth-stage base in June 2005 (monthly chart is shown) but institutional selling started to hit the stock a few months later (1). The stock tried to form a new base but failed. By January 2008, Pulte fell 83% from its 48.22 peak.
Ryland Group (RYL) tried to clear a fifth-stage base in June but it suffered the same plight. See how the stocks began falling well ahead of signs that the housing market was headed toward a nationwide crisis
Fast forward to today and homebuilders have a bona fide leadership role in the market again.
If you were fortunate enough to buy Ryland when it cleared a first-stage base in late April 2012 and held on for the ride, congratulations. You're sitting on a big gain, even if you decided to take profits on the way up.
After big price runs, some homebuilders just recently broke out from late-stage bases. Lennar (LEN) has been hitting new highs in light volume as it tries to clear a third-stage base. Ryland and PulteGroup also recently cleared third-stage structures.
The homebuilders aren't flashing sell signals yet, but they've run up a lot already. Keep an eye on the leaders. At some point, history will repeat itself.