Monday, September 19, 2011

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  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.

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.


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