Investor's Corner

How Psychology Affects Trading In Some Sectors

Before you buy a stock, understand the psychology of the major investors who play in that stock's sector.

Why? The general behavior of the market's big guns can vary.

Some are giant pension funds aiming at stable, long-term returns. Others are aggressive hedge funds that like to dart in and out of fast-moving stocks. No wonder, then, that stocks in some sectors seem to move like gymnasts on a trampoline. Others act more calmly.

In other words, the behavior of institutional investors can affect how a good stock acts during a breakout and its run-up.

If you've bought numerous stocks at the proper buy point and traded through a few market cycles, you can get a feel for the way stocks in a certain sector or industry group act. To further increase your cognizance of the stocks you buy today, reflect on your own past trades and listen to the experiences of others.

Once you properly time the market, discover the true No. 1 company in a leading industry, identify a well-formed chart pattern and buy shares at the correct entry point, you don't need to think too much about the psychology of the stock or its group. Stick with core IBD sell rules. Don't fear cutting losses short if it's not working right. Sell in most cases when the stock is up 20% or 25% from the price at which you bought.

Some stocks naturally move more wildly than others.

Semiconductor stocks make huge price swings. Why? Chipmakers often see a tremendously high level of cyclicality in their earnings and sales.

Among 69 stocks in IBD's Oil & Gas-U.S. Exploration group that trade at least 12 a share, the average beta ratio was 1.1 — much higher than 0.74 for 31 names in the Utility-Electric Power group.

Is it possible that oil exploration stocks move in a more jagged way vs. the market? Crude oil futures do swing fast. Since the spring of 2011, the price of crude fell 15% or more over a short time frame more than a dozen times. This volatility may impact the minds of traders in oil stocks.

When Continental Resources (CLR) broke out of a deep cup base in late 2011, the action was hesitant at first (1). Oil prices were volatile at the time. But the ultra-quiet trade in a few down weeks in December (2) was a subtle sign that sellers were far in the minority. The rally heated up in January 2012, and Continental roared 34% past a 72.39 buy point.