It?s results season and there have been around 200 companies that have declared their second quarter results. And it can be visibly seen that some of the leading companies set a benchmark in earnings and also overall stock price movement in their sector. We have the likes of Infosys and TCS setting the trend for the IT stocks and the likes of HDFC Bank and ICICI Bank setting the pace for banking companies. Now, we have DLF joining the gang as a ?bellwether? for the real estate space. Often enough, savvy investors get strong indications of trends from these bellwether stocks.

Search, find and track

It is not new to see that a certain company?s shares can be sold off based on news or an event concerning a different one. Sameer Kumar, an analyst with a broking firm says, ?Investors must know that almost every stock follows another stock in its industry. Bellwether stocks are those in each industry whose fortunes drive the industry. When these stocks take a hit, or miss their earnings target, the entire industry (or entire sector) can go into rotation, meaning that it sells off.? Hence as investor you must keep a track of such stocks.

An important exercise is to find these stocks. Bellwether stock will be the one on top with a market cap and revenues that are commandingly larger, when compared with the other stocks. For example, in the Sensex we have Reliance, Infosys, and ONGC. When they sell off, the industry tends to go with them. If the bellwether stock for your trade is expecting important news, such as earnings, be aware that a pullback in that stock probably will pull your trade down.

Is it a herd?

Do all stocks follow the bellwether stock? The answer is no, except when a stumble in the bellwether stock causes the industry to sell off or run up. As you might expect in the market, it is always more complicated than that. But unless your trade is the bellwether stock itself, it will track another major stock in the industry. So don?t assume that your stock follows the bellwether stock.

Explains Chetan Bele, an analyst, ?Take for example, Infosys, TCS and Wipro, which are in the same industry, generally, but Wipro does not follow Infosys, while TCS does. However, most small- to medium-cap stocks follow a larger company in the same industry, which is referred to as an alpha stock.?

You can find out whether your stock follows the bellwether stock by simply overlaying price lines for the two companies. That is, lay the price lines for both stocks across the same chart to see how they move together. Another tactic for finding the bellwether stock is to discuss with market watchers and ask if there is a particular stock that your stock follows. Persons familiar with the stock will know. You will obtain detailed knowledge about a stock and how it trades.

Your stock may not usually move with the bellwether stock, except for moves that take the entire industry up or down. If not, select several other major stocks in the industry and compare to each of them to find its alpha stock. The larger stock that your scrip tracks is called its alpha stock. Unless the company you are thinking of trading is an oddball, you will usually be able to find the alpha stock whose movements it tracks.

The difference and the use

A stock is said to track another stock when their respective charts are very similar. There is a certain amount of ?seeing is believing,? of course, but this is not a statistical analysis – it is a common sense analysis. Is the congruence great enough that your stock is likely to track the other? When they are so similar that they are virtually the same line (this isn?t common, but it happens), you?ve got a solid tracker. Says Bele, ?When the congruence is less than 75-80%, or when your stocks make major moves in defiance of the alpha stock, there is no true tracking. The occasional move together is not meaningful. One needs to ask oneself: is the congruence great enough that my stock is likely to track the other??

To find the bellwether or alpha stock, you can follow a simple process. Let?s say you have thoroughly researched a company X and like its potential. No earnings or other major news is expected, or you have concluded that X does not normally react adversely to earnings reports and is comfortable with it even though it will report earnings. But suppose that X very closely follows another stock, which is expecting earnings news. If the news on the alpha stock is adverse, a sell-off may take your stock with it. You have to reconsider whether you follow the right stock.

Obviously, the larger the company, the less its likelihood of being affected by another stock?s fortunes. And many large companies track no alpha stock, because they are the alphas. This is why many experienced investors stick to larger stocks. Experienced traders well understand the bellwether stock dynamics and will refrain from entering a stock if worried about the bellwether stock. Conversely, the expectation of a positive move in a bellwether stock is more reason to consider trading a stock that moves strongly with it.

On the whole, as an investor you need to understand these dynamics before plunging into a stock. Because, just following your own portfolio means not employing out-of-the-box-thinking, which is paramount to the markets. More so, with markets attaining newer peaks, resulting in all-rosy picture, you need to read the movements of bellwether stocks and see if your stocks follow the bellwether ones and act accordingly.