Market Volatility & Exchange Traded Funds

Exchange Traded Funds
The video that follows is about Exchange Traded Funds (ETF’s) and the growth seen in that type of investment product.  I have chosen this particular video for a couple of reasons.  The first reason has to do with managing expenses within our portfolios and the second is to talk about the way in which I use ETF's.  iShares used to be a separate company that offered ETF’s.  It is now owned by Blackrock and is a subsidiary of that company.  The good news about ETF’s is they are cheaper to buy and own than mutual funds.  The bad news is ETF’s are not actively managed like most mutual funds. Since ETF’s normally mirror a particular index, they don't need to be managed the same way as a mutual fund.

Expenses
Personally, I like ETF’s because they offer better diversification than individual stocks, while at the same time, controlling expenses better than mutual funds (or buying the stocks individually).  I'm not a big fan of mutual funds.  The biggest reason is their larger fees which are not justifiable given most mutual funds under-perform the markets over longer periods of time.  I have owned many, many different mutual funds in the past.  Given the growth in the popularity of ETF’s in recent years, I have long since replaced all of my mutual funds with ETF’s.

Volatility
Periodically I will also trade individual stocks, but with the volatility in the current markets, I find that ETF’s provide me with much more diversification and less volatility than simply owning a few stocks.  Since I'm not a buy-and-hold type of investor, my goal is to own whatever sector is outperforming at any point in time.

Constructing Portfolios
The discussion in the video talks about creating portfolios using ETF’s.  Personally, I think that most portfolios are way, way, way over diversified and that's largely because of the need on the part of the financial services industry to sell more products.  More product, in my experience has never improved returns.  Some would argue it's not about returns, it's about the safety of our portfolio.  By spending only a few minutes a day on my investments, I get both.  I see no reason if we're actively managing our portfolios why we need any more than the top 60 companies in the TSX.  I understand most people don't actively manage their portfolios, but I have to believe they don’t understand the magnitude of the increase in returns they can achieve in only a few minutes a day.

Less Is More
Regardless, there are a couple of portfolios listed in this video.  Some people may want to model their own portfolio on one of those shown, and that's fine for people who are not actively managing their portfolios.  Myself, I tend to largely use ETF's, rather than stocks or mutual funds, but, I hold a very small number of ETF’s at any particular time because I'm only interested in the funds that are performing.  That is why I incorporate Technical Analysis into my methodology.  The non-performers are dropped from my portfolio once they stop outperforming.  Either way, whether  you want to build a portfolio of ETF's, or you simply want to use ETF's to dampen  the volatility in the current markets, the use of ETF's will reduce expenses and, to me, provide a better alternative than mutual funds

Would you care to share your preference(s)?

Click Here To See The Video

September 2012 Returns

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September was not all that bad, this year, considering its history for being the worst month of the year.  It is a good illustration of how seasonality is based on probability, not certainty.  Having said that, I am still concerned about this market, particularly since we seem to be deviating from what I would consider to be normal seasonal patterns.  In itself, that wouldn't bother me so much, if it were not for the fact the major technical pattern called a head and shoulders, which I wrote about earlier this year, is still intact.  

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The momentum indicators I follow would indicate the market is heading lower.  If that turns out to be the case, the fact we did not make it above the previous high from last February is more bad news.  I would not be surprised to see the TSX drop below the 200-day moving average which is only some 150 points, or so, lower than the close of today's market.  We could get there in a single bad day!  

The returns shown above use the XIU ETF as a buy and sell signal.  The idea is to buy when XIU is above it's 200-day moving average, and sell when it is below.  Bad things can happen in the markets when they are below the 200-day moving average.  The real danger is, however, if we get down below the 11,000 mark.  A pattern such as this would indicate going back to the lows in the last Great Recession.  It will be interesting to watch - the markets normally finish the year stronger, but that was not the case is 2008, either.  If we do see these things begin to happen I will be looking for opportunities to short the market (using inverse ETF's) rather than looking for buying opportunities.

21 month return for TSX @ September 30, 2012 = -7.86 percent
Return for Basic Timing Model Using XIU =          11.97 percent
Return for Advanced Timing Model =                    -4.36 percent
Money for charity =                                            $0.00 

Are you expecting a year-end rally?

Buy Agriculture Now?

Yes, COW
I am not a financial professional, and cannot recommend equities for you to buy.  Having said that, I want to share my analysis with you.  I do this as a means of teaching others a (relatively) simple approach to arriving at price targets.  Why agriculture?  This is a seasonally strong period of the year for agriculture stocks.  Second, my calculations  indicate there is as much as a 24 percent upside to the Exchange Traded Fund (ETF) with the ticker symbol COW on the TSX as at Saturday, Sept. 22.  I will provide additional details of my calculations over the next few posts, but first, a little more about COW.

Diversification
iShares lists the top holdings in COW by weighting.  By adding the weightings, we can see the top 13 companies make up 81 percent of the fund.  These companies are headquartered in Canada, the U.S., Chile, Brazil, Japan, and Switzerland.  As in this case, ETF's give me the most diversification at the cheapest price.  I could go out and buy each of the 13 companies (or only the one's I like), but the cost of the commissions to do so quickly adds up.

Price
Prices of ETF's such as this one follow an index.  As such, there is no fund manager deciding which company to buy, and when.  iShares manages the fund so it reflects the holdings in the index it is tracking.  The price follows that of the index because institutional providers package up the stocks of companies in the index to sell to iShares when it is cheaper to do so, and buy them back again when they become cheaper than the stocks. As a result, the constant buying and selling of ETF units causes the price of the ETF to mirror the index of stocks.  Price is a function of earnings.  At any given point, we can show the price of a share of stock as being the amount of company earnings divided by the number of shares multiplied by some number.  In other words, Price = Earnings/Share Times X.  Calculate the future price based on future earnings for most of the companies in an ETF, and we can compute the target price of the ETF.

Technical Analysis
Technical Analysis only goes so far when it comes to individual stocks.  That is doubly true of stocks which have a limited trading volume.  A volatile market such as the one we find ourselves in currently compounds the problem even more.  A price of a widely held ETF of widely held stocks is much more predictable than a single company.  The fundamental analysis I am in the process of sharing with you shows me what to buy.  I then use technical analysis to determine when to buy what I have calculated as having a cheap valuation relative to the current price.

Questions?  Comments?


   

Trading Stocks

Trader, Not Traitor
I remember one analyst on BNN in particular as he looked down his nose at the commentator and said, "I am not a trader (emphasis on the NOT), I invest for the long term!"  In other words, he was better than any trader.  Trading, to him, was for the amateurs.  At the risk of repeating myself, surely you and I are playing a different game than any fund manager, let alone the talking heads that appear on television.  The major difference being, what they make from their stocks is mostly a side-show for them.  Most of them are compensated six ways to Sunday and get paid regardless of how well their stock picks are performing.  I have also seen analysts on TV who don't even have any of their own money in stocks!   (Conflict of interest LOL!)

Do No Harm
This blog is about my sharing what I have learned over many years of playing the markets.  I decided at the beginning of the year to publish my trades as teaching moments.  I hesitated to do so for a couple of reasons.  One, was because one trading style does not suit all.  Another was because my time horizon has become increasingly shorter.  I trade during the day.  I don't want to put people behind the curve, trying to imitate me while they can't get in and out as easily as I can.  I cut any losses extremely quickly in the current environment.

Bad To Worse
At that rate, I don't see the benefit of me sharing my trades with the average person trying to buy low and sell high as a means of making a reasonable return in these markets.  The regulators forgot the meaning of their role a long time ago.  High frequency traders manipulate prices in the name of so-called market liquidity.  Highly leveraged Exchange Traded Funds (ETF's) change how markets function.  Dark pools exist for the wealthy fund managers to hide transactions from the average investor.  Derivatives cause nuclear level shock-waves in the markets.  The rules put in place after the Great Depression to prevent it from ever happening again have either been revoked, or totally ignored.

Looking Ahead
Does that mean I think the personal investor should just give up, take what's left of their money and go home?  Not at all.  It just means keeping an eye on what's going on.  With the rate of change in technology and in society, obsolescence is guaranteed.  Buy and Hold has as much chance succeeding these days as the horse and buggy did outlasting the automobile at the turn of the last century.  Nortel, and Research In Motion are recent infamous Canadian illustrations of what has become the half-life of modern day success.

The Goldilocks Solution
If Buy and Hold can't work, and day trading is overkill, then what is today's personal investor to do?  In looking for an answer, I thought about the investing club I started.  If anything, it perfectly illustrates the need for a Goldilocks solution - neither too hot, nor too cold.  Investing clubs do not lend themselves to day-trading, and most fail to make money or serve to educate if the time horizon is too long.  My solution there is the same as here - use technical analysis to decipher medium-term trends and trade (yes, trade!) accordingly.  As a result, the trades I share on this blog are the trades we are making in my investing club.

Next Time
I want to remind people that I am not a professional, and as such cannot advise others what to buy or sell.  However, I have no difficulty sharing with others what I am doing, in the hope of serving as an example.  Next time, we will take a closer look at how we trade in my investing club.

What is your strategy in this changing and evolving environment?

Old Scars

Too Little; Too Late
Most people I talk to about their investment portfolios seem to have at least one thing in common.  They have an investment they purchased some time ago which is just sitting there, not contributing to their returns.  Usually, it isn't hurting them any longer, either.  That is because it sank in value, big time, a long time ago.  Now, there it sits - a reminder of that big loss, and too small and unimportant to do anything about - not even sell it.  Why bother to sell it?  Perhaps, one day, it might actually appreciate in value.

Hoarding
We can hope all we want, but it makes for a poor investment strategy.  Sure, the damage has, largely, been done, but why not put that money into something useful?  The reason is simple.  We raise money by selling the investments that are in the black, and we hold onto the ones which are in the red.  Perhaps it provides a little insight into hoarders who can't bring themselves to throw anything out after suffering a catastrophic loss in their lives.

Back To Even
We all have the same tendencies.  When we aggregate these tendencies into market-wide behaviours, trends begin to emerge.  Technical Analysts refer to certain points on the chart as "resistance", and "support".  These points exist on the charts for the very reasons I have just described.  If a large number of people bought the same investment at a level where it started to lose value, that point will later become a point of resistance, since human nature is to sell as soon as we get our money back.  Normally, we don't care how much higher it could go - we were wrong once, so better to take the money and not get greedy, thank you very much.

Depends On Your Viewpoint
When an investment drops to a level where a large number of people previously watched it reverse, they might even be inclined to buy more, this time around.  It is like the investment is now on sale.  These become areas on the chart where support for the price is established.  Once violated, support levels can turn into resistance, and resistance levels into support.

When To Buy
Technical Analysis is not just a bunch of lines on a chart.  There are good reasons to explain why things happen the way they do.  These are only two very basic examples.  Personally, I don't rely on Technical Analysis to determine what to buy - I use historical data and earnings forecasts to do that.  I use Technical Analysis to tell me when to buy once I have determined it to be on sale.  This doesn't work so well when buying commodities, but there are other ratios we can use to see, historically, if they are cheaper than normal.

Moving On
Long story short - I  ask myself, "If I didn't already own this loser, and knowing what I know today, would I still buy it?"  If the answer is no, then it is fairly obvious it has outstayed its welcome.  Time to move on and look for a better use of whatever is left.  Otherwise, it brings to mind the definition of insanity which refers to doing the same thing over and over, again, each time expecting a different result.

Any such losers in your portfolio?  Nortel, anyone?

Portfolio Diversification

Click Here To Play The Video

A Small World After All
I am not a professional, and cannot tell you how to balance your portfolio, but I do want to share a couple of things.  In the video, Dale Jackson refers to geographical diversification.  I seldom buy shares of companies outside of Canada because I want to avoid exchange fees and currency fluctuations.  For companies outside of Canada and the U.S., I would rather hold a basket of companies, rather than individual stocks, so I use Exchange Traded Funds (ETF's).

Cyclical Sector Solutions
The TSX is comprised mostly of Energy, Materials, and Financial companies.  These sectors are largely cyclical in nature (fluctuate according to economic growth).  Still, we find some of the very best companies in the whole world trading on our very own TSX.  For times when economics are not in favour of cyclical companies, I buy inverse ETF's (which make money when markets decline) and/or bond ETF's.

Seasonality
The sector allocations shown in this video are based on the make-up of the S&P500, and not the TSX.  The underlying assumption is that we are always fully invested all of the time, so we need to weight our portfolio similar to the market in order to get market-like performance.  Studies done by people like Brooke Thackray, or the Stock Traders Almanac would suggest there is a certain seasonality to the various sectors.  Different sectors tend to outperform during different times of the year.  I seldom have all of my money invested in the markets at the same time, and I use Technical Analysis to detect which sectors are outperforming (usually based on seasonality).  There is a certain rotation I normally follow, rather than just blindly throwing money at everything in the market.

Trade-Offs
Because I am an active investor,  being overly diversified tends to make more money for my advisor in fees and commissions, while lowering my own overall return.  In my experience, one size does not necessarily fit all.

How do you allocate your portfolio?

Using The 200-Day Moving Average

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The 200-Day Moving Average
Plotting the 200-day moving average involves computing the average price for the previous 200 days,  then for another 200 days starting one day later, and so forth for the specified duration.  The reason for using moving averages is to smooth out some of the day to day volatility.  The longer the current price is above the 200-day moving average, the higher the average, resulting in the line on the chart curving higher.  Of course, the inverse is true when the price remains below the average.



Technical Analysis
Any student of technical analysis soon learns of the 200-day moving average.  When the price is above the 200-day moving average, that is taken as a positive sign.  When the shorter 50-day moving average crosses the 200-day moving average from below, that is also seen as positive.   Since there are 5 market days in a week, the 200-day moving average is also the 40-week moving average.  Today, not many people would probably assign much importance to a period of 40, but in the Bible, it was always seen as a significant period of time, whether days, weeks, months, or years.

Transition Point
The Basic Timing Model I propose on this blog uses the XIU Exchange Traded Fund (ETF of the largest 60 stocks on the TSX) and the 200-day/40-week moving average as the transition point from a good market to a poor one, or from a poor market to a good one.  It can also serve as a level of resistance when the price is below, and a level of support when the price is above.  The direction the price is headed will often reverse right at the 200-day moving average.  Whether this is self-fulfilling, or not, is irrelevant.

XIU
Such is the case with the price of the XIU ETF on the TSX.  The price has been steadily rising since before the end of last year, crossed yesterday, only to go lower today.  For people without the benefit of any knowledge of technical analysis, yesterday's price crossing the 200-day moving average would be taken as a buy for equities traded on the TSX.  Myself, I prefer to play the probabilities afforded me through technical analysis.  The above chart shows us the trend is growing rather tired.  Longer term, and perhaps even in the shorter term, the price would appear headed above the 200-day moving average, but the probability is the price will go lower than it is currently before continuing the uptrend.  I always look for the possibility of buying lower and selling higher.

Net Return
It may make little difference in the long run, but careful analysis could prevent us from bouncing in and out of the stock market as the price struggles in an effort to cross the 200-day moving average.  Regardless, buying  as the price crossed yesterday (after selling when it crossed going lower last summer), would result, according to my calculations, in an almost 6 percent gain relative to those who rode the market all the way down, and back, again, since the moving average has dropped that much during that time.  If/when the price rises above the 200-day moving average, it may signal a more favourable market, but given the headwinds the stock markets are facing, I am still quick to take profits when I can.

Questions?  Comments?

Market Timing Myths

Not For Everyone
Another of the myths about market timing is, if market timing actually worked, then everybody would be doing it.  If you are familiar with my blog, then you know the main reason this is not true.  Personal investors do little to influence market direction.  It is the mega-sized orders of the large fund managers that determines the direction of the markets.  It is the very size of their positions that prevent them from jumping in and out of the markets.  It takes a period of days and weeks to either establish, or eliminate their market positions.  For them, market timing is not a viable option.

One Size Fits All?
So, if it doesn't work for the professionals, then it can't work for the little guys, right?  That is like saying the route I choose in a dinghy has to be the same as that of the captain of an aircraft carrier.  As for me, I would not attempt to cross the ocean in a dinghy, just as I would not try to pilot an aircraft carrier down the local river.  While the purpose of the boat determines its size and dimensions, the size and dimensions of the boat also limit how it can be used.  That is not to say professionals do not use charts to help them make portfolio decisions.  Fund managers use every tool in the shed, including technical analysis.   

How Popular?
If it works best for personal investors, then why don't more of them use it?  One reason is financial institutions want people to think they are unable to manage their own portfolios. If people believe they are unable to do it for themselves, then they have little choice but to hire a professional.  Yet, I am willing to bet practically every nurse on the planet can read a chart, so, why not a stock chart?   

References
Another reason people won't time the market is because is doesn't work for them.  While that may seem like a perfectly good reason, we have to wonder why it doesn't work.  It actually is not because timing the market does not work, it is because most people are, well, people.  Given to emotion, most people buy high, and sell low - just the opposite of what they should be doing.  As a result they label timing the market as being too hard, even impossible.  Their inability makes it clear to them that market timing, simply, does not work.

Denial
Yet another reason everyone does not try to time the market is because of something called denial.  Not a lot of people want to believe that group behaviour is, in some way, predictable.  We see ourselves as acting independently of those around us.  After all, we have a mind of our own.  How dare anyone suggest our decisions are similar to that of many others despite the fact their situation may be similar to our own.  Denial is far more than just a river in Egypt.

Either/Or
I have never understood why, but there is another whole segment of investors who believe technical analysis precludes any sort of fundamental analysis.  One taints the other.  I say, why work with only one hand, when we are perfectly capable of using two?  The result of using one technique should complement the use of the other, not contradict it.

Bottom Line
We can see there are all sorts of reasons why everyone will not embrace technical analysis and market timing.  The belief that everyone needs to is yet another example of the misinformation surrounding the real issues.

Convinced?  Should market timing be expected to work for everyone?  

Position Size

80/20 Rule

Decisions, Decisions.
Size matters, or so I am told.  From "too big to fail", to sports like boxing, size is a factor.  The question is, how does size affect one's investment portfolio decisions?   For those who don't have a sell strategy (i.e.: Buy and Hold) diversification is the only hope, and what follows will be of little use.  Having a sell strategy provides me with a few more options.

Call Me Arrogant
First, I have heard it said that buying a whole position all at once is the dominion of the arrogant.  That may be true if we are not using technical analysis to time our entry points.  My method of determining when to buy has proven to me that what I call a buy signal is just that - the point in time when the odds are most in my favour.  Averaging into the market almost always reduces my returns, it does not improve them.  If I buy all at once, and I am only partially right, then I can begin to reduce the size of my position.  If I am completely wrong (read: losing money) then I sell everything I just bought.  I would rather be out the commission than lose capital.

Diversification
Next, we should talk about the size of a position.   I have seen academic studies that demonstrate even twenty stocks is not enough for any one portfolio.  (That study was probably commissioned, pardon the pun, by the financial services industry - cha ching!)  Note that a single broadly based Exchange Traded Fund (ETF) can contain well over the twenty stocks required to provide me with enough diversification.

Market Correlation
What I am saying is holding broadly based ETF's provides me with all of the diversification I need, thank you, even if I put my whole portfolio into one ETF!  "Wait!" the experts will say, "You need diversification between various regions of the world!"  Do you hear the cha ching in the background, again?  Since I have a sell strategy, if my investments in the TSX are under performing, when I do sell, nothing says I have to buy the TSX, next time around.  Understand that markets around the world are highly correlated, these days.  By that I mean when one market tanks, the others are likely to do so, also.  Maybe not at exactly the same time, but close enough.  

80/20 Rule
Having said all that, I believe in the 80/20 Rule.  Applied to investing, the rule tells us that 80 percent of our returns will come from 20 percent of our holdings.  Rather than watering down my returns by casting my money into everything in every market, I use seasonality, technical analysis, and fundamental analysis, to focus on the areas of the market that are working, and simply forget about everything else until the conditions change, again.

Returns
The major lesson the market has taught me is I don't have to have all of my money in the market all of the time.  I used to think I was wasting opportunities by not being all in!  Nothing could be further from the truth.  If I divide my portfolio into five, how much of a return do I need to make 20 percent, over all?  You get it, I still have to make 20 percent each time.  Each fifth of my portfolio that makes 20 percent contributes 4 percent to my overall results.  Do that five times, and at the end of the year I end up with 20 percent.  Or, I can make 10 percent on any one position (each time contributes 2 percent), and do that 10 times, and still end up with 20 percent per year.

Better Than Average
Do you get what I am saying?  I only need to have 20 or 40 percent of my portfolio in the market at any one time, and as long as it returns 10 percent in a month, or two, I can take two months of the year off, and still make a twenty percent return.  Not bad, when the average annual rate of return for the markets is around 8 or 9 percent! (Which, by the way, most active fund managers fail to do over the longer term, after expenses). 

Sleep Tight
I am not saying this is what you should do with your own portfolio.  I am not qualified to give that kind of advice.  I am saying, with practice, and experience, it is possible.  Consider the possibilities that not having everything in the stock market all of the time creates.  If nothing else, it helps me sleep better, especially in these crazy markets!

How do you decide how much to put into any one investment?

The "Social Media" Investing Model

Good Advice
I was doodling on my note pad at the Social Media seminar I attended earlier in the week.  It occurred to me the advice we were receiving would be useful for those wanting to learn more about investing.

Learn/Listen
The fastest way to learn anything (other than from adversity) is from other people's experience.  Since there are as many investing strategies as there are people, look for the classics like "The Intelligent Investor", by Benjamin Graham, "Stocks For The Long Run", by Jeremy Siegel, "The Wall Street Journal Guide To Understanding Money and Investing", by Kenneth M. Morris.  I like "How To Make Money In Stocks", by William O'Neil.

Technical Analysis has increased in popularity of late.  I recommend achieving an intermediate (as opposed to beginner) level of understanding.  Search Amazon, and look for something of interest.  I started with Stan Weinstein's "Secrets For Profiting in Bull and Bear Markets".  The investing world is divided between fundamental and technical investors.  Why rely on a monaural approach when we can enjoy the advantages of a fully enhanced stereo experience?  I suggest using fundamental analysis to determine what to buy, and technical analysis to identify when to buy. 

Set Goals
Do you want to become independently wealthy?  Do you want to supplement your income?  Do you want a fully paid vacation?  Remember, goals should be SMART (Specific, Measurable, Achievable, Realistic, Time-sensitive).  Consider setting short-term goals based on longer term ones.

Practice
Paper trade.  There are sites and contests on the internet which allow us to buy and sell stocks using practice accounts instead of losing real money.  It is rather like learning to ride a bike.  We are bound to fall and get a few scrapes before we can hold our own at the Tour de France.  Understand, however, paper trading only goes so far.  There is nothing like the feeling of losing significant amounts of money in a bad trade, or the excitement of riding a huge gain.  Learn to set limits based on the level of personal experience.

Participate
Keep accurate records.  Use those records to identify what works for your situation and what doesn't.  Do more of what works and less of what does not.  What works in some situations will not work in others.  Nothing in investing works all of the time.  Anyone who says otherwise is lying.  Be prepared to shorten time horizons, or lengthen them.  Trade more; trade less.  Never fall in love with an investment, or a trade.  They all have their day, then, can turn on us in a heartbeat.  Investing is like public speaking; getting too comfortable or too lazy is usually a mistake.  Anticipate various scenarios and plan appropriate responses.  Plan ahead, do not react.  Instinctive reactions are necessary for survival; they usually go contrary to good investing practices.

Measure
Measure progress toward goals.  Make improvements without relying only on the advice of others.  Investing is like playing poker.  People come to the table with their own agendas and strategies.  If their real agenda is consistent with what you are attempting, then fine.  Understand that nobody in the Financial Services industry wants to make you money if it interferes with how they make their money.  Also, understand that they almost never get paid based on the amount of money they make for you.  If that were the case, there would be a lot of starving workers in the industry.  Ever wonder how companies can afford to pay those huge bonuses?

The advice for determining the percentage of equities in a portfolio based on age is only a guideline.  Revise your goals based on your results and your desired results based on your goals.  I know that sounds like double talk, but just like fundamental and technical analysis, we are not limited to one instead of the other. 

Repeat
I started out in the safest of mutual funds, then sector funds, then Exchange Traded Funds (ETF's), then leveraged funds, then individual stocks.  I will be trying my hand at options when I open my first Tax Free Savings Account (TFSA).  Each time I found myself repeating the process.   Sometimes it is necessary to repeat the process because of a change in goals, or because of differing results.  It took me a long time to determine what works and what doesn't, and that wasn't for a lack of asking questions - I rarely received straight answers.  According to the industry, we are not supposed to do it ourselves ("Doctors don't operate on themselves!"), and we sure as heck are not supposed to time the markets ("It is time in the markets, not timing the markets!")  I invite you to take advantage of what I have learned.  Use me as your resource.  I love doing this stuff, it is what I do, and I am more than happy to share what I do with others.

Have you followed a similar approach?  How do you test your ideas?
    

Technical Analysis - Research In Motion



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Troubling Chart

Despite the fact that, fundamentally, Research In Motion appears to have value at current prices, the chart points out a significant problem.  The weekly chart shows the stock has been in a multi-year downward trend.  The region between the green lines I drew on the chart is known as a trend channel.  The closer we get to either boundary, the greater the chance of a reversal.

While the chart does not indicate RIM is a good longer term investment, buying at a reversal near the bottom of the channel could result in a healthy shorter term profit.  What does not appeal to me about this option is where the channel leads in relation to the blue line which appears close to the top of the channel.  That line represents the 200-day moving average.  It is the result of the average of the preceding 200 days, and the average of the preceding 200 days one day prior to that, and the average of the preceding 200 days one day prior to that, and so on.  I always hesitate to own stocks which are trading below their 200-day moving average because they have a greater probability of downside surprises.

Technical Indicators

For most people, it would be too lengthy to go into an explanation of all of the technical indicators I use.  The ones I rely on include Volume, Moving Averages, the Relative Strength Index, Keltner Channels, Percentage Price Oscillator, and Stochastics.  For more information on these, I recommend http://www.stockcharts.com/.

For more of an introduction to Technical Analysis, my favourite is an older classic called Secrets For Profiting In Bull And Bear Markets by Stan Weinstein.  It is a well written book that covers the basics.  I had thought it was out of print, but recently found it to be available on Amazon.  Investigating the Stockcharts website listed above can help in understanding various technical indicators and overlays not covered in that book.



I have also recently read Trend Trading for a Living by Dr. Thomas Carr.  I like the way in which he steps his readers through his process, step by step by step.  This is for more advanced traders, as he also describes his methods for options trading later in the book.  Even without the parts on options, the information is quite helpful.

Not This Time

For now, the technicals are telling me I should not be buying Research In Motion for my portfolio.  That's okay.  While there are not that many tech companies in Canada the likes of RIM, there are many, many good, growth companies I can make money with.  I like great companies I can invest in, but I love great companies whose shares are at the extremes of what they should be selling for when the charts are signalling the start of a new trend.  That is the advantage gained by combining Fundamental Analysis with Technical Analysis.  

Research In Motion

Who Is Right?
It seems Research In Motion (RIM - TSX) is in all of the Canadian media these days.  With the release of its new Playbook tablet, there is no end of debate as to the future of this company.  It seems there are strong arguments to be made both for and against owning stocks in this company.  In fact, there seem to be as many opinions as there are analysts who follow this company, and there are over 50 who do.  Despite all of those opinions, sentiment seems to be split pretty much down the middle, for and against.  Does that mean investors should just let the dust settle before deciding whether or not to own shares in RIM?

Fundamental, or Technical Analysis?
I am not a professional, so, as I keep saying, I cannot advise people as to which companies they should own, or not.  However, I think this would be an excellent opportunity for me to reveal the process I follow when evaluating a stock for my own portfolio.  Some people prefer to rely on fundamental analysis, where the company financials are dissected and numbers crunched.  Others prefer a technical approach, instead, analyzing charts of price patterns. 

Why Not Both?
Personally, I have never understood why it has to be one, or the other.  Why would anyone try to do their best work by, first, tying one hand behind their back?  I understand why some people prefer one method over the other, but something I learned a long time ago was to solve a problem using one approach, then check the result using a different approach.  This can create a situation which reinforces the old proverb that a person with a watch knows what time it is, while a person with many watches can never be sure.  In other words, what to do if the fundamentals and the technicals do not agree?  My advice is the same as any situation when there is too much uncertainty - don't buy!

What To Buy and When To Buy
In fact, I use both approaches because I am actually trying to determine the answer to two different questions.  The first question is what should I buy, and the second question is when should I buy?  I do not simply buy stocks in fundamentally good companies and wait for something to happen.  I use the price charts to determine whether the stock is in an up trend, or not.  I don't believe in purchasing a stock where the share price is losing money, because my first priority is preserving capital.  Neither do I like to have money sitting in stocks that are not performing.  There is an opportunity cost to tying up money that could otherwise be earning a return.

When To Sell
Buying a stock with a price that is in an up trend is fine, but how do we know how long to hold it?  We can simply hold the stock until the trend breaks, but there is a chance of leaving money on the table.  Stocks rarely rise in a perfectly uniform trend line.  The purpose of having a price target is to increase my probability of selling at the best time.

Next Time
Next time I will describe the process I use to determine my price target.  Whether the analysis is fundamental, or technical, the principle is to buy stocks when the price is low and to sell them when the price is higher.

Do you have a preferred process in determining what stocks to add to your portfolio?  Do you have a sell strategy?

Fundamental AND Technical Analysis

Tools of The Trade
Orienteering is a sport that requires competitors to find flags hidden outdoors by using a map and a compass to navigate a course. The map shows the contours of the terrain, and uses different colours to illustrate the type of ground cover - trees, clearings, water.  The compass is used to orient the map and to guide the competitor in a particular direction. Close to the flag, the use of the map is crucial in pinpointing its whereabouts. The course could be navigated with only the map or the compass, but it would usually take longer because it is much easier to make navigational errors when not using both.

Fundamentals or Technicals?
When I hear advisors who say they rely on the fundamentals and others who say they rely on the technicals, I often think of orienteering. Why would they want to rely on only one, or the other, when both are available to them? I suppose we have all heard the expression, "Jack of all trades; master of none," but we don't need university degrees in either area to use them effectively. We don't need to know every last detail. I think we can all agree that knowing how many pennies the CEO has in her purse, is detailed, but useless information. Likewise, knowing the number of years in a row a stock has made an uptrend in the month of September is, for the most part, of little value.

Done properly, fundamental analysis tells us what we can reasonably expect to pay for a share in any company. Likewise, technical analysis can tell us whether we are close to the beginning, or the end, of any trend in the price. Armed with that information, alone, we can make intelligent decisions about what to buy and when to buy it.

Why Not Both?
I continue to hear the talking heads proclaim they are a fundamental, or a technical sort of person - and proud of it. I understand the two types of analysis represent a different approach and mindset. They are two different ways of looking at companies. That is the strength of using both types of analysis. If they both confirm a buy decision, then great. If not, then why risk it? Would you recommend a dentist who only uses half of their tools? Imagine your dentist saying, "I don't do x-rays because I don't find them very helpful!"

The problem is the two approaches are seen as either/or instead of both/and. The fundamentalists cast dispersions on the techies claiming how much more thorough their analysis is. The technical analysts claim the fundies are not even necessary. Yet, it is not the type of analysis, which is important, but the information that each yields about any potential investment. Unless, of course, we assume there is no use trying to buy at a low price because we are almost never going to sell, anyway.

The Bottom Line
So there is the rub. Why give credence to any tool that flies in the face of the sacrosanct buy-and-hold marketing strategy? Funny thing is, I'm willing to bet that most fund managers actually pay attention to moving averages and other technical signals. It would likely have a negative affect on returns if they didn't. Doesn't it go to follow, then, that the very existence of technical analysis would dispute the notion that it is impossible to time the markets? Unless, of course, technical analysis is just a lot of creative imagination.

What do you think? Which is for real, technical analysis, or buy-and-hold? 

Investing Seasonality

Nasdaq Composite

I am not one to make my investment decisions purely on the basis of seasonality.  I do watch for seasonal trends.  One of the best ways of monitoring what's in season, and what isn't is to check http://www.equityclock.com/.  From the main page click on the Seasonality tab at the top.
We can see from the list of Primary Sectors that the Information Technology sector is normally strong from October 9 to January 17.  If we look at the chart for the Nasdaq Composite we can see the momentum has carried right into the end of February.  Missed it, right?

No, since I believe the markets are due for a correction anyway, what better way to play the decline than to choose the sector which has just recently peaked?  More bang for the buck, so to speak.  The easiest way to do so is with the Horizons' Nasdaq 100 Bear ETF.  The ticker symbol on the TSX is HQD.  Although I like to use these ETF's, I have to warn others who might want to that they use leverage.  In this case, for every single percent the Nasdaq 100 falls, this particular ETF will gain around 2 percent.  I say around 2 percent, because this type of ETF does not always track the underlying index perfectly.

In a very exaggerated example, think what would happen if the market rose by 25 percent in one day.  This would mean the ETF should drop 50 percent (2 times).  The next day, if the market dropped by 25 percent, the market would be around 94 percent of where it started.  The ETF, on the other hand, would lose 50 percent, then gain 25 percent (50 percent of 50 percent) and only be at the 75 percent level of where it started.

This is one trade where timing is everything.  Success will depend entirely on getting in and getting out at the right time.  With the help of seasonality, and technical analysis, it can be a very lucrative trade.  Still, if it goes wrong, the key is to recognize that fact, and just unwind the trade.  Any time a trade is costing me capital, I have to be doing it wrong!

Paying attention to market seasonality is one way we can identify setups for profitable trades.