I am trading the EUR/USD and it gives a good example of trading a longer time frame by plotting an entrance in a shorter time frame. Though I’m using the minute and 15 minute chart of the FX, it applies just the same to the daily and weekly chart of an equity chart.

Looking at the 15 minute chart, the bigger structure shows an uptrending channel with the price having just bounced off the diagonal support line.  Though I used the one minute chart to time the entry, I can now look at the slightly bigger picture for the forecast that it could climb above 1.38 before even nearing the topside resistance line of that channel.  Buying around 1.368 with a sell order below 1.364 support area gives me a risk in the trade of about .004.  Using an initial target of the potential resistance at the last high around 1.378, this gives a profit potential of .0100.  So the reward to risk ration is about 2.5/1.

Using a target of somewhere toward the top of the channel, say 1.3880, the risk reward would be about 5/1.  If you make 5 when you win and lose 1 when you lose, you can be wrong 8 times out of ten and still make money.  Now, it may be not reasonable to expect a 5 to 1 risk/reward ration for every stock trade you want to put on, but it is a good example of the power of putting the odds in your favor.

This is based on the simple principle that markets move in trends.  Trading with the trend, buying low in the channel and selling high in the channel is one of the best strategies for entering a trade with a higher probability of success.

Look at how long this “base” has been formed and now finally broke out above the resistance line.  The days of the breakout action are on big volume.  Now it is testing that level as new support.

Here’s an ETF of Water Resources. Broke above resistance of a double bottom reversal but without major breakout volume.  Could be a “fakeout” but we’ll see if the line holds as new support.

Here are some general principles to digest.

It’s all about putting odds in your favor.  This is why the stock market is not like a casino, or gambling.  We’re the guppies in the big ocean, so we want to swim with the big fish.  Jump into the moving tide and let it take us for a bit until we jump off.  Each time, we grow our money a little bit by keeping losses small and letting winners be bigger winners.  The amount of money then gets steadily increased by just a bit with each new trade.  Eventually, after finding some consistency in following a plan for money/risk management and recognizable structures for entering and exiting trades, the wonder of exponential growth makes us steadily more and more profitable by just repeating the same process.  It should eventually be almost boring, like commonplace.

The one major necessity is to always be looking forward.  We cannot predict the future, but we can recognize what IS happening and PLAN accordingly.

• MIND YOUR MONEY! – Money Management is the MOST IMPORTANT part of the puzzle.  By concentrating on losing as little as possible, making money will eventually take care of itself.  The primary focus must be to keep losses small.  When times are tough, the most important reality is that we have to live to trade another day.  With each large loss, the next win has to be that much larger just to get back to break-even.  Read this bit on “Position sizing – A Free lunch.”
• Identify your goals.  What do you want from the market, how active you want to be, and what is your tolerance for risk.  The simplest measure of this for most people is, if you can’t sleep at night about the money you have at risk, it is too much.

• PRICE IS KING!  – The current price is the most up to date information about the stock.  It reflects all publicly known information and the according sentiment of the market(the rest of the world of investors, analysts, and traders).  Technical indicators like moving averages and stochastics and hundreds of others can all be helpful but are all “lagging” indicators in that they are a representation of PAST price performance.  They can be used to confirm what we are seeing in the price action.  Most indicators are just as good as any other.  It’s just a matter of knowing what they tell you and how to read them for your purpose.  They are all derived in one way or another from the price action.  They are just a tool that can be used, but are not a necessity.  Focus first on studying price movement and identifying highs and lows in any trends present.  Moving averages are the simplest way to confirm what you’re seeing in a trend of the price action for a given time period.
• TRADE WITH THE TREND – “The Trend is your Friend.”  This is one of the most commonly spoken maxims of technical analysis.   Along with trend comes the equally important SUPPORT AND RESISTANCE.  As you know, levels of support tend to become resistance when broken and vice-versa.  Support and resistance come on horizontal and diagonal planes and often border the extremes of a trend up, down or sideways.  This is called a CHANNEL.

• Candlesticks – Candlesticks were developed and have been used for hundreds of years in the far east, originating with the rice traders.  This way of looking at charts allows for quick identification of what has happened in a day, week or hour, depending on the setting of the chart.  We can identify the characteristics of each candlestick formation and in combining them into successive patterns up to two and three days in a row, we can take further confirmation of price action continuing or reversing in the context of the bigger structure and/or trend.  Here is an example of probably the most often mentioned and most likely candlestick to find at the bottom of a downswing, the HAMMER.  It comes in a down trend of successive candles and signals a potential bullish reversal.  It needs confirmation in closing higher in the next candle stick.  Here is one of many places on the internet to find a gallery of the many candlestick patterns.  It is not all that important to learn their names or even worry about the extensive lot of them.  It is important simply to understand the psychology of what they tell us about the buyers and sellers throughout the pattern and each individual candle.  They are either confirmed by finishing the pattern, or negated by not.  Candle sticks are another form of technical indicator, but unlike the lagging indicators, they show us the closest thing to current signals we can take beyond the current price itself.

A stock market going in the shitter?

According to a 4 year old it’s what the monthly chart of the SPX looks like, though the M is not finished yet.

Read this and give some thought to your time horizon and how active you want to be with your account.

MC

Let’s take a look at the relative performance of the 9 major sectors represented by the Select Sector Spider ETFs compared with the S&P 500. (Link in the right column to the Sector Spiders website)

First, however, let’s talk about conventional wisdom for the person not interested in the markets or actively investing. The general consensus seems to be that over the long, LONG term, investing broadly in the market (some mix of broad market funds including big and small caps, growth and value, etc.) will bring you an average annual return of 10%. I found a somewhat amusing and mildly assuring column from USA Today on the subject as the first result in a Google search. I say, “Mildly,” because it makes sense, statistically, but that sure isn’t very convincing or reassuring in the face of some major problems nationally and globally that don’t look like they’ll be going away anytime soon. Economic slowdown(recession?), Energy issues, war, etc.

“Statistics show that large-cap stocks (measured by the Standard & Poor’s 500) have produced 10.4% yearly returns on average over the past 79 years through 2004, according to data from IFA.com,” writes Matt Krantz. “What about inflation? Certainly, the declining purchasing power of the dollar over time does erode returns. To be exact, the 10.4% annual return of the S&P 500 is actually 7.2% if you adjust for inflation, according to data from Standard & Poor’s.

“But keep in mind that just investing in the S&P 500 is not adequate. You need to add other asset classes to your portfolio, including small-cap stocks, which have returned 9.1% returns on average a year even after inflation. Foreign stocks and emerging markets stocks, which have a place in many investors’ portfolios, have done even better.”

But doesn’t being invested in more than just a broad fund that matches the market involve some active choices of what funds, what foreign funds, when and if to sell and change funds, etc.? For the sake of the discussion, let’s assume that the average uninterested and investment-wise uneducated person will do the “buy and hold” approach to a fund or group of funds that are comparable to the S&P500.

While ten years is arguably not quite the “Long term,” in terms of a lifetime, and perhaps not the time frame they mean when siting this average annual return of 10%, how long is long enough to judge what works NOW, from this moment forward?  I woudl think ten years is sufficient.  The most recent ten years seems plenty more relevant than any ten year period before it, to say the least.

Here’s the most recent ten years in the S&P 500.  To be fair, this may not be an entirely accurate representation since I don’t think the index itself would include the payment of dividends, but it’s at least a ballpark for discussion.

The index is up approximately 35%.  With compounding interest, an annual 10% gain over ten years should result in a profit of 159.37%.  Even adding dividends, I suspect the gain over ten years in the SPX would not be anywhere near this figure.  (For the record, I am FAR from an accountant or CPA.)

So let’s look at the prospects for potentially investing in selected funds that show relative strength.  I think it’s reasonable to say that most people could look at 9 sector funds every few months and try to stay balanced in 4 that are more toward the best performing ones, or at least stay out of the worst performing ones.  Here is a comparison using the Select Sector Spiders, described on their website as such:  “Select Sector SPDRs are unique ETF’s that divide the S&P 500 into 9 sectors. To strengthen your portfolio, simply choose the sectors that fit your investment needs.” (Judging from the chart, they weren’t introduced until December of ‘98.)

(Click image to see it bigger)

I think most of us, even those who only peripherally pay attention to the news could know that the Energy sector has been very strong for a number of years and that from early 2000 to late 2003 the tech. sector got cushed, losing 80% of its value.  Is it not reasonable to think that even with less than precise timing, a self guided investor could have gotten out of tech somewhere along that plunge and could have later gotten into Energy sometime along its ascent?  Keep in mind that I say this with the idea of someone looking at only these 9 ETFs consistently every few weeks or month or so.   Here’s a comparison of the last five years.

By adding all of the Select Sector Spiders using the “comparison chart” function under Chart Settings, you can see a percentage comparison of all of the 9 sector ETFs versus the SPX or whatever stock or index you’re interested in for any time frame. SPX makes the most sense, of course, and should fall somewhere in the middle of the pack at any given time.

Here is a look at the last year. The top performing sectors were Industrials, Consumer Staples and Utilities, in that order.

Now the last 3 months, particularly relevant considering the downdraft solidifying the bear market and the increasing likelihood of a recession.

Healthcare is leading the way, followed by consumer staples.   Coming in third, just barely above the middle of the pack, is Utilitites.  These first two are sectors thought of as “defensive,” because regardless of a potentially poor economy, health and basic needs will always be a primary destination for money.  Utilities are also somewhat defensive because most utilities are not focused on growth and therefore rather than reinvesting their earnings toward growth, they tend to pay dividends.

In the healthcare ETF, the XLV, the top holding is Johnson and Johnson, making up 13% of the fund. Nice move above resistance and then test of new support at 68 before shooting higher.

Proctor and Gamble makes up 16% of the XLP consumer staples ETF followed by Walmart at 11%.  PG hasn’t had such a beautiful year to date, but just this week it seems to be breaking the downtrend.

Walmart, on the other hand, looks to have had a great year so far.  Not only did it alreaday have a nice run, but after some months of consolidation, it appears to be moving higher out of that range this week.

I think you catch my drift.  And I think this post has gone on WAY too long.

The SPX is down roughly 12% from this time last year and roughly 11% year to date.  How do we feel about holding those broad market funds for the last year?  Is it reassuring that, statistically speaking, at some point it’ll all work out so that this year was really as good as a 10% gain?

Here is a look at three of the major index ETFs as well as the Financials ETF. I tend to look at the Dow Jones or DIA a lot less because it is only 30 stocks and therefore not quite as good a representation of “the market” as it used to be back in the day. Notice that while people still quote it and talk about “the Dow,” when it comes to actually measuring performance, they refer to the SPX.

This picture shows the ETFs tracking the SPX(SPY), Nasdaq 100 (QQQQ), Russell 2000 (IWM), and the Financials sector (XLF).

Just to make sure you know, “The NASDAQ-100 Index includes 100 of the largest domestic and international non-financial securities listed on The NASDAQ Stock Market based on market capitalization. The Index reflects companies across major industry groups including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology. It does not contain securities of financial companies including investment companies.”

“The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.

The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.”

There’s nothing fancy in these charts other than daily candlesticks for roughly 9 months and some support/resistance lines. Notice that the tech stocks(QQQQ) and small caps (IWM) show relative strength to the other two in putting in a higher low over the intermediate term. Also, in the last month or so, they show tighter consolidation just under resistance. In contrast, SPY and XLF show a weaker chart on the longer time frame and a looser consolidation in the last month. Interesting thing is how similar the SPY and XLF look in the last month. People have been fixated on the financials for the last month at least and I suspect that the market moving higher or not in the short term will depend on whether or not the big boys take the financials higher. If so, I suspect that the Tech stocks and then the small caps will outperform if we do get a good rally here with a confirmed new high on the short term in all the indexes. This is not any kind of voodoo prophecy. Just a prediction based on relative strength. As always, there is no certainty, but probability.

(Click image to see it larger)

Notice that I included a link in the right column to a page with info on ETFs and a comprehensive list as good as I’ve seen anywhere. Also, in the box titled “Access,” there is a link for RSS feds for posts and comments. I don’t know which is the best way to use these, but there are numerous ways in which you can set these kinds of feeds to let you know when there is a new post or comment on the blog or anything other sites or widgets that you subscribe to the RSS feed. For example, if you use Google or whoever for a personalized homepage, you can include a module for the RSS feeds you subscribe to. Also, Google reader is a pretty good resource for keeping an eye on blogs that you’re interested in via these feeds.

There were two life long friends.  Both, artists.  Unconventional lives call for unconventional methods.  Together they will learn and progress toward making healthy returns in the stock market.