Use the Best Stocks in the Market to Identify Tops
Table of Contents
Laying the Foundation
Let’s analyze one of the most commonly heard phrases in the market: focus on the leaders.
In plain terms, we should be focusing on the best stocks in the market that have outperformed on a multi-week basis and have led higher over that span. More often than not, these are the companies with the largest growth numbers that institutions need to hold and accumulate if they want to outperform their benchmarks.
The interesting thing about leaders is they can lead to the upside and to the downside. The chart above intends to paint the visual of what the second part of that sentence means in real-time.
We have plotted the date of the highest high over the past 52 weeks of 27 symbols on to the price chart of $QQQ., This list is subjective, but the idea is to show that a top in the market is often led by the strongest stocks breaking before the general market does.
The topping process on the $QQQs started underneath the hood some 3 months prior to the actual top!
Younger, more inexperienced traders may think that there is just one crash that ends it all especially if you have only been in the market since March of 2020. In actuality, most, if not all tops and corrections begin with leadership breaking down in the week/months prior.
Best Stocks in the Market (2021) & Their Topping Dates
What Does This Tell Us?
The $QQQ would stage a downside reversal on 11/22/2021, marking an intermediate top in the markets. Interestingly enough, only 6 of the 27 names topped on or after this date. That means 21/26 names topped before the market did.
This is exactly what we mean when we say leadership leads upwards and downwards!
This data can be interpreted in many different ways, but the most clear and actionable way that we want to analyze today is by knowing that l eadership leads both ways , we can begin to look for warning signs while everyone else is exuberantly celebrating their gains. Or, better said, we can hone in on our risk management skills a little better than the crowd would.
We have to be able to spot cracks in the best stocks in the market well before the crowd does, as these cracks are telling us that distribution is taking place by institutions on the way up.
Some clear forms of distribution in an up-trending stock/index
Yes, there are more, but let’s use these clues in our analysis of one of the names on the list, $APP.
Chart Example: APP
As we can see in the chart above, $APP gave us multiple signals that it was going through distribution by major institutional holders.
First, we can see a strong gap up on volume that at the time was the highest since IPO week, or HVIPO. We can also see that in the sessions following this gap, demand was the dominant force as price closed near highs for multiple sessions.
It wasn’t until 10/20/2021 that we got our first red flag, which was an outside day to the downside on volume, highlighted in the chart. This type of action is different than what we had been experiencing prior, and doesn’t require us to sell our position out completely but should raise your eyebrows that the trend might be changing in the name.
Then we start to see more supply coming to market with weak closes right near the $100 psychological level. If demand was the strongest force in the market, we would have seen a major push through this area – and we didn’t! Red flag #2.
To give investors one more scare, price would gap down and close at the lows (right on the 20ema) the day prior to earnings. We can consider this again to be red flag #3 if the stock did go to gap up +20% the next session. Overall this is hard to interpret and would definitely have challenged your ability to hold size through earnings!
Finally, red flags #4 and #5 come in quickly as price is unable to hold the gap up day’s low, and then ultimately breaks down 2 sessions later on an unfilled gap down. Both of these are signs of supply coming to market in a big way and should be telling us that the rest of our shares need to be sold!
To bring this analysis back into the bigger picture, $APP was giving us multiple reasons to sell before the general market broke down. If you go through this process with the other 26 names listed above, you will see very similar characteristics.
If you did this exercise with the $QQQ’s price action alone you would see the same thing!
The Best Stocks Require Work
While we should always be on the lookout for price action that challenges our bias, whether this be to the long side or to the short side, it shouldn’t mean that at the first sign of character change we abandon the position completely.
Often times you will get multiple red flags on a position before it finally breaks down from its trend. And, of course, every stock is different. Stronger stocks may be able to endure multiple distribution type bars before breaking down whereas a younger, thinner name may only need 1-2 sessions before completely breaking down.
This is where your work ethic, discipline, and understanding of you and your system come into play. Some people may feel comfortable selling on the first sign of weakness while others want to be kicked out on multiple sessions of weakness. You have to know what suits you best – then go out and execute.
Putting it Together
The indexes can paint a different picture than the stocks we buy that will actually make us money from session to session. The key here is to understand that no matter what the headlines say, no matter how far or not far the indexes are from highs, the most important thing to focus on is the action of the best stocks in the market!
We encourage you all to go through the same processes in your own portfolio. It will be rewarding and calming to know that you are prepared for whatever situation the market may throw at you, which can’t be said for everyone when the top gets printed.
Charts of stocks we mentioned in the list above
What Makes a Stock Strong?
To be able to identify and trade the best stocks in the market, and eventually be able to conduct this study on your own, you must have a good understanding of what makes a strong stock.
At TraderLion, we believe that the best stocks in the market typically fit under the CANSLIM framework.
Here are some common chart patterns that the best stocks in the market make over and over again.
Extra: Best Stocks to Buy for 2022
So far this year (up until the end of June 2022), the strongest stocks in the market have been in the Energy, Oil & Gas, and Commodity space.
Here are some names that are leading our Year To Date % Change Scan:
You’ll find that many (if not all) of these names displayed the Winning Characteristics that we quickly ran through in the section above! This isn’t a coincidence.
If you take the time to really study the market, you’ll realize that the same patterns are repeated over and over again.
Learn more: What is a stock gap?