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Correlated Versus Uncorrelated Stocks

How to make your watchlist better rounded

Hey Traders,

One topic that I get a lot of questions about is, “how can we trade stocks that are not necessarily correlated to a broader index or ETF, and, why is it a good idea?” 

Well, short answer: it‘s a good idea. 

If we’re always looking at heavily weighted stocks within the sectors that are also heavily weighted within the indices, we’re always tethered to the broader markets. For the most part, I prefer to have that kind of clarity. 

Think of it this way…

Let the S&P, Dow, Nasdaq, and Russell show you the big picture of what’s moving which way. This is the first read of how we look for relative outperforming sectors then relative outperforming stocks. If the broader markets’ heavily weighted sector starts to get choppy, it makes sense to navigate around that narrative (or to manage around that structure). 

We want clarity

Clarity in the broader markets makes for the easiest kind of trading. However, we need to have a plan B in case that structure breaks down. 

Sometimes, we need to look to the broader indices to direct us where we gain exposure to non-correlated/uncorrelated markets. These are places where we can find clarity and possible opportunities. 

Again, most of my lists will be tethered to the broader indices or sector ETF. I have another list that I like to keep an eye on that I refer to as, “double greens” which indicates the potential setup for a “long is favorable” — uptrend environment. In this case, I’d go back and look at what type of ETFs would be best suited in this scenario. 

Countdown Fun Fact: The world of ETFs is massive and probably most stocks will have exposure to some kind of ETF. 

However, because the stock has exposure to an ETF, we need to ask ourselves if that ETF is influential. We need to define what’s known as a high concentration ETF, meaning how much weight does a specific stock have within an ETF. 

What’s the influence on the stock that’s heavily weighted within the ETF? 

Let’s look at an ETF like the XRT:

The XRT is a retail ETF that contains BLNK. BLNK is heavily weighted within the ETF, XRT. You could have an ETF which trades (plenty of volume) over 7 million on the one-month average and over four and a half million on the three month. But then the next question becomes, well in this particular ETF, “where does the weighing sit?”

BLNK makes up about 1.7% of the ETF. So, XRT isn’t going to have as big of an influence over it. The 1.7% doesn’t mean that BLNK won’t go up with XRT, that just means XRT won’t have as big an influence. 

They’ll typically move together but that influence, in the way that high concentration weighting can create, is not going to be there. That’s why I say it’s not completely separate but more separate than the relationship of a high concentration weighted ETF and the top one, two, or three stocks within it. 

Here’s the bottom line… 

BLNK doesn’t have to rely on the broader indices. BLNK can move without the S&P, NASDAQ, or the DOW when they move higher or lower. 

Heck, it doesn’t even have to rely on a particular sector. It can go its own way. 

In fact, it’s a little bit less correlated. It’s important to have stocks like this in your trading watchlist. This is one of the recent trades that we took, because it gives us a little bit of a play away from the broader markets, especially with the kind of volatility that we’ve seen. 

Keep that in mind, you don’t always have to play boats within a larger tide. Sometimes you can play a boat that’s all off on its own. It’s smart to have stocks like that on your watch list.

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