Stock Market Bottoms

Dot Com Aftermath

To the left is a chart of the end of the dot com collapse.  Although these are charts of the S&P 500 index, many, many technology companies either met their demise, or were left a fraction of their former selves.  As witnessed by this chart, they took the broader markets and the economy down with them.  The downward trend was broken, and the markets then charged upwards and onwards in 2003.

Financial Crisis

2008 was a bad year for the U.S. economy, and global markets, as seen by this chart of the S&P 500 index. Interwoven with the weekly price candles are three moving averages. The blue line is the 8-week, or 40-day moving average, the red is the 20-week, or 100-day moving average, and the green is the 40-week, or 200-day moving average. The bottom came in March of 2009, and, once more, the markets were headed higher.

Now

Presently, we are teetering on the brink of a double-dip recession, with the fate of the Euro zone in the balance.

I invite you to study the first two charts very closely to see if you can identify something that would uniquely indicate a bottom in the market.  Once you have done that, take a look at the current chart to the left.  Do you see that same indication in the third chart after 2009, also?

The answer would be yes.  It occurs when the 50-day moving average crosses the 200-day moving average from below, and the trend in the price candles is rising.  (I  have to add the last part about the rising price candles as the 50-day did cross the 200-day for a three week period in April of  2002, and that, clearly, was not a bottom).  We also saw it, again, in October of 2010.

Here we have two major bottoms in the past decade, or so.  It has been my contention that once the price candles drop through the 200-day moving average, we should stop out of our long positions until the market has bottomed.  Yet we are told there is no telling when to get back into the market, or that we are likely to get in at the wrong time and out at a worse time.

Whether the bottom is the reversal from bear market to bull market, or if it is the bottom of a correction, the likes of which we experienced in 2010, it is a reliable and tradable indicator.  Now you know what to look for before putting new money at risk in these volatile markets.

Are you convinced?

Analyst Recommendations

Click Here To Play Video

As I have said previously, I never use analyst ratings or recommendations to determine if I should buy or sell a stock.  Neither do the guests in this video.  I have also said their function is a marketing function rather than an investing one - Terry Shaunessy agrees.

I enjoyed Victor Adair's comment regarding analysts having a tendency to stay with an idea past it's "best before date".  There are two additional reasons for this not mentioned by Victor.  First, the analyst's universe of stocks is usually too small, so a good idea seems to stay that way relative to a smaller number of stocks.  Second, they rarely suggest selling a stock.

I would have to agree with Terry that analysts probably don't usually have any skin in the game.  Based on their own recommendations I doubt they would be very successful taking their own advice!

I determine what to buy and sell based on Price/Earnings analysis (which does include the consensus analyst's annual earnings numbers), and I determine when to buy and sell using basic technical analysis.

For more, also see:
http://watch.bnn.ca/#clip538906
http://watch.bnn.ca/#clip538908
http://watch.bnn.ca/#clip538912

Do you use analyst ratings and recommendations?

My Recent Trade



Click To Enlarge

Context
This post attempts to answer the question, can the technical indicators be used to time the market?  The Elliott Wave Theory tells us what the overall fractal patterns followed by the markets look like.  The fact that it is some sort of fractal means we can verify where in the pattern we are, by looking at it in the context of the shorter time frame and the longer time frame.  We can view the indicators in that context. One dip, or one rise in the market does not a trend make.  When we see a series of higher highs and higher lows, we have an uptrend.  When we see a series of lower highs and lower lows, we have a downtrend.  That means we can't know the top until, at least, we see another lower high, and we can't know the bottom until we see another higher low.  Rather than try to explain what I mean, let's look at the trade I made at the end of July.

Going Down
First, the RSI indicator at the top of the chart peaked out at the beginning of July as evidenced by the lower high two weeks later.  So did the price candles, the MACD in the section below that and the stochastics in the section below that.  I should have bought (the inverse fund) when the price crossed the green dotted line which represents the midpoint of the Keltner Channel from above.  Instead, I waited for the price to drop below the blue line which represents the 40-day moving average (circled in orange).  By this time any conceivable uptrend had been clearly broken.  Even without any knowledge of the Elliott waves, it would be clear to most people the market was headed lower.

How Far?
At that point in time I had no target price.  I knew fair value based on the historical average annual earnings was  850.  The Point and Figure chart (also found on StockCharts.com) indicated a bottom at 1140.  The Fibonacci ratios associated with the Elliott Wave would suggest a bottom around 1190.  There is nothing in the indicators, initially,  that suggest how much down-side to expect.  On August 9 we had a big bounce, then another drop  on August 10.  I was happy with my gains at that point and exited my position.

Too Early
Had I played the downturn at the beginning of July, I would have been on the right track, but the lower high near the end of July would likely have been sufficient to cause me to start to lose money, even though the longer trend was still down.  I make it a policy to exit such a position when I start losing money.  If the trend resumes in my favour, there is nothing to say I can't take the position again, perhaps even at a better price!

Momentum
The reason I believe we can rely on these indicators is because this "toing" and "froing" in the market is caused by momentum.  The momentum is caused, not by events that happen, but by people's perception of the events that happen.  These optimistic and pessimistic moods take a while to develop and then, to run their course.  Generally, it is not the value of the indicators themselves which I rely on, but the trend in the indicators.  The indicators have since taken a positive shorter trend, but I don't trust it as long as the moving averages are inverted with the 40-day beneath the 200-day and prices lower still.

Comments?

The TSX Example

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Market Opportunities
Before posting my last trade, I decided I would illustrate the typical opportunities the market creates.  These charts of the Toronto Stock Exchange show a period of one year chosen at random.  The charts are courtesy of StockCharts.com.  In addition to great, flexible charting, there is also a ton of learning resources regarding technical analysis and various indicators and overlays at that website.  I am not going to get into detail about the indicators shown here, I am only looking at the trend illustrated by them.

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The Charts
The green lines illustrate an uptrend; the red downtrends.  Both charts are of the period December 7, 2007 to December 7, 2008 (one year chosen at random).  In the section which shows the price candles, the first line indicates weekly, or daily.  The indicators used are the same on both charts.  The moving averages are adjusted for the time period.  For instance, the 200-day moving average for the daily chart becomes the 40-week moving average (40 weeks being the same as 200 week days).

Same, But Different
Overall, the time period shown represents less than one complete trade per month (one buy, one sell) on average.  The trend lines are, for the most part, the same between the two charts.  There are a couple of divergences, however.  If we look at the end of April, the indicators on the daily chart show a break in the uptrend, while the weekly indicators do not.  Also, in October, it is arguable as to whether, or not, all of the indicators reflected a trend change.

Disclaimer
This is the point where I am required to point out that I am not a certified market analyst, so what I am about to say describes what I do, and should not necessarily be taken as advice as to what you should do in your portfolio.  Any time we try to take an approach which is new to us, I recommend trading on paper without risking real money until we are more comfortable over a longer period of time.  How much of  your portfolio to put into any particular methodology is an important decision with which you should involve the advice of your professional advisor.  Every portfolio should be unique to the owner's situation (including risk tolerance) and experience. 

Taking Profits
When all of the indicators are in agreement, then we have a trend we can trade.  I know a lot of people will point to the fact that anyone can look at the historical charts and see where they could have executed a trade.  I am not suggesting we would have bought into the market right at the bottom, or gone short at the top.  What I am suggesting is when we have a long position, and the indicators look like they are beginning to top out, why not take at least some profits, by selling?  Normally at that point, the market begins to go sideways, and most of the gains have been made.  After we have taken our profits, we watch for all, and I mean all of the indicators to begin to show a new trend as the old trend-lines are broken. 

Price/Earnings Ratio
An additional method for assessing the upper boundaries of a trend is to value the companies we hold, either individually, or those held within Exchange Traded Funds (ETFs).  By using historical values for earnings and price, we can determine when stocks are on sale and when they are selling at a premium.  Next time I will talk about a previous trade of mine.  One of the reasons for believing the market would correct, was the Price Earnings ratio for the market as a whole.  At the peak of the market earlier this year, the S&P 500 market index attained a value in excess of 1,360.   The average inflation adjusted annual earnings for the market as a whole was $53.50.  The resulting Price/Earnings ratio was over 25.  The average all time ratio for that market is 15.9!  While we can't use that ratio to tell us when to buy and when to sell, it is useful in telling us when we are paying too much!  By the way, the S&P 500 would be trading at 850 for it to be at the average P/E ratio of 15.9.  It is currently around 1,200.

Next time I will discuss my previous trade in July/August where I anticipated the correction in the S$P 500.

Questions?

Investing Time Horizon

The Process
The purpose of this post is to express my belief that markets go through a repeating process which results in the achievement of new highs and lows.  While this process does not exactly replicate itself, I do believe it falls within certain parameters.  Allow me to explain why this is important.  For those who think the markets act in some random fashion, what I am about to say will be of little consequence.  Such people are better served averaging into the markets over long periods of time.

The Neatness In Theory
Elisabeth Kubler-Ross popularized the notion that people experience different emotions when confronted with the fact they are about to die.  To her, it seemed there were a number of stages that people would experience, sequentially, one after the other.  While this was a convenient method for studying the process of dying, not everyone agrees those stages are so neatly ordered and labelled.  Few identify the end of one stage with the beginning of another.  Not everyone experiences every stage.  Still, I think most people, today, recognize this as a process, rather than a single event.

Pattern?
For many people to believe the markets follow some sort of pattern, requires that we identify a particular sequence of events that would indicate what was about to happen next.  Few would look to the occurrence of a combination of events, some or all of which would suggest what is to follow.  Surely, for a pattern to exist, at least one event could be identified that we could rely on as a signal of a top in the market, or as a signal of a bottom in the market.  Otherwise, how can we call it a pattern?

Asymmetry
I love to use the example of a toy that was popular when I was a child, called the Spirograph.  Using it, we can produce intricate symmetrical designs by repeating certain simple processes over, and over again.  Instead of following the exact process each time, if we introduced a slight variation of the size or shape of the inside disc, or the outside ring, as we went along, a pattern would emerge, but it would no longer be symmetrical.  In other words, it would not be the same each time.

Fractals
The most interesting thing, to me, is these variations of a theme (in the markets, and in nature), when combined, create a larger version of the smaller design.  These are known as fractals.  Breaking a fractal apart creates a smaller approximation of the larger one, not just a piece of it.  Fractals are abundant in nature: crystals, flowers, lightning and land formations, to name a few.  It is my belief that fractals represent the way things grow.  Markets are a reflection of how society grows economically, technically, and financially.

The Buying & Selling Process
If we believe the markets are an expression of the process of growth in society, and not just some random series of events, then there are a couple of important distinctions we can make.  First, successfully investing in, or trading stocks requires that we follow a process.  Buying at random, without any intention of selling, is an event. Buying with the intention of later selling at a higher price, becomes a process.  Buying at random with the intent of later selling at a higher price is purely speculation.   

Scalability
Second, an investing methodology should be scalable.  Due to the underlying nature of markets, we can use the same processes when day-trading as we can when investing for years at a time.  The difference is in how we aggregate the data.  We can look at charts of minute by minute ticks, or we can choose charts of monthly price data.  We can look at the change in fundamentals on a quarterly basis, or over periods of years.  In either case, the process remains, basically, the same.

Bottom Line
This is our edge.  In order to outperform most other participants in the markets, I am suggesting we need a process, one which is scalable to the time frame that suits our interests, and needs.  If we only want average returns, or worse, then little, or no action is required on our part.  People who don't know these things to be true will tell you it can't be done.  Don't rely on their saying so, just because they don't know how, or are unable to.

Do you know of a scalable process with which above-average stock market returns are possible?

RISK

To laugh is to risk appearing the fool.
To weep is to risk appearing sentimental.
To reach out to others is to risk involvement.
To expose feelings is to risk exposing your true self.
To place your ideas, your dreams before a crowd is to risk their loss.
To love is to risk not being loved in return.
To live is to risk dying.
To hope is to risk despair.
To try is to risk failure.

But risks must be taken,
because the greatest hazard in life is to do nothing.

The person who risks nothing,
does nothing, has nothing, and is nothing.

They may avoid suffering and sorrow,
but they cannot learn, feel, change, grow, love, live.

Chained by their attitudes, they are a slave,
they forfeited their freedom.

Only the person who risks can be free

- Anonymous                         

We cannot avoid risk.  In the stock markets, however, we do need to learn methods which minimize it.

Do you have a low risk strategy for making your money work for you?

Outlook From Ron Meisels

Click Here To Play The Video

Ron sees the possibility of a short-term rally.  He suggests using any such rally to trim portfolios and raise cash as September is, normally, the month of the year where returns are the worst.  He does not believe we have reached a bottom in the larger, longer trend, yet.  He estimates we are almost one half of the way there from the peak we saw earlier this year.  In the last part of this video he demonstrates how basic technical analysis could have saved investors in Sino Forest a significant pile of money.

Myself, I currently have no long positions in any of the equity markets and am happy to wait this out a little longer, given the state of affairs in Europe, and the poor performance of the major equity markets during the month of September.

What approach are you taking?

Portfolio Update



Click On Chart To Enlarge

As I mentioned in my July results, I bought the inverse S&P 500 ETF when the charts signalled the correction. I continued to hold it for the first couple of weeks in August  

I am still watching energy, gold, agriculture and natural gas, with natural gas just now starting to show signs of what might be a shorter-term reversal of the long slide lower.

The return I am showing for XIU (iShares TSX 60 ETF ) remains at the same level as July (when it crossed the 200-day moving average) since it continues to be at a price below its 200-day moving average. 

Eight month return for TSX @ August 31, 2011 = -4.83 percent

Eight month return for Basic Timing Model using XIU = -0.98 percent
Eight month return for Advanced Timing Model (my returns) = 2.84 percent
Money for charity = $411.27

Does anyone think we have seen a bottom, yet?