Sector Trading: A Primer

One of my favorite stock trading setups is to watch an entire group of competing stocks. If there is a market leader, you can watch that stock and trade the laggers to make a quick scalp. This makes money because of the existence of statistical arbitrageurs who keep a sector in line.

Take the agricultural chemicals stocks, for example: POT, MOS, AGU, TRA, CF, MON. Using a statistical technique known as a minimum spanning tree, we can establish POT as the "leader." AGU is the closest lagger behind POT.

So in the beginning of the day, if POT is ripping you can buy a little AGU and have a positive expected value of your return; as long as POT keeps going you can book profit in AGU. The same works on the downside.

Do your own research; look at some good charts to verify what i'm saying. use some stats packages to establish a theoretical price for POT given AGU. the best approach is a combination of the two.