Saturday, August 25, 2012

Discretionaries Outperform Staples: Is the Risky Trade Returning?

Staples and other conservative, higher-yielding stocks have outperformed the broader market since May.  The chart below shows the S&P500 as the horizontal black line, with Staples (orange) and discretionaries (purple) either outperforming or underperforming the S&P500 (depending on whether the orange or purple line is above or below the black S&P500 line).


Discretionaries peaked in April and have underperformed vs. Staples until recently. Staples peaked in mid-July. In mid-August, we have seen discretionaries bounce above their moving average as staples did the opposite, possibly hearkening a revisit to the risk-on trade.  Our take is that the run-up in conservative risk-averse stocks has gone a bit too far.  Better values can be found in more cyclical stocks, while dividend-paying stocks have become rather frothy. Not only is this an indication of reallocation into the riskier sector, but it represents potentially more fuel for the continuation of the uptrend.

Indicators such as discretionary and staples relative performance are used weekly in our Baseline Analytics TrendFlex indicator.  Click here to learn how you can stay on the right side of the market trend.
 


Saturday, August 18, 2012

Market Breadth Supports the Uptrend

The NYSE Advance/Decline ratio is a useful trend-confirming technical indicator.  Since breaking out in January (see top portion of chart below), NYAD has pushed to a new high.  When such broadening participation in the uptrend develops, it is tough to ignore being long.  Investors are encouraged to stick with the trend when NYAD continues to push higher.


The setback in May was a short-term scare for bulls, as NYAD fell below its 34-day moving average. Likewise, Up/Down volume (the middle chart) also sank below its 34-day moving average.  Tactical asset allocators could have lightened up on long positions upon this warning sign. The 34-day exponential moving average used on these two charts worked reasonably well in timing market decisions, however, this indicator should not be used alone.

Another (among many other) indicator we use to assess the market trend is NYSE New Highs vs. New Lows (the bottom chart). This indicator has meandered higher since bottoming in late May and also supports the current uptrend.

At Baseline Analytics TrendFlex, a blend of technical, fundamental and macro-economic indicators is utilized to define a trend assessment score, helping investors stay on the right side of the market.




Monday, August 6, 2012

Setting Stops Using Average True Range

Setting stops on portfolio positions is often a mixed blessing.  Often, a stop is activated and money is left on the table as the stock continues to rise. One approach is to incorporate volatility and the longer-term trend in determining the stop level or trailing stop threshold. 
The following stop-setting strategy can help an investor stay with the stock’s main trend for as long as possible.  This is an objective-based approach, rather than an approach prone to subjective opinion, enabling the investor to remain honest with himself and his capital.
We are utilizing ATR as a basis of setting stops.  ATR is “Average True Range,” and is calculated based on a stock’s volatility, incorporating recent highs vs. recent lows in a stock’s price.  In the chart below of Apple, the ATR varies approximately from a high of $38 to a low of $10. A simple, objective rule to follow is to use 2x the ATR. There is nothing scientific or “secret sauce” for using 2X other than avoiding daily volatility whipsaws. 
Assuming a buy point of $250 in September 2010 (first blue vertical line), the ATR at that point was $16.  $16 x 2 = $32 stop range, or a stop of $218.  As APPL continues its uptrend, the stop is adjusted at a point where the stock bases, near $325 a share.  At this point, the stop is set just under $300 per share.  This is a simple, mathematical approach that will help the investor avoid arguing with himself about where to set stops.

Similarly, this objective approach can be set with a trailing stop.  Use the same 2X ATR to set the trailing stop and simply let it ride.
We find that using weekly charts and their resulting ATR values are most useful is holding positions as long as possible to maximize gains during an uptrend.  Using ATR as a stop-setting mechanism is a sure way to avoid the trap of guessing when to get out of a position.
As for taking profits (and losses) a prudent strategy is to set such ATR-based stops, but also take random profits (or losses) now and then. An investor can, for example, use the ATR stop strategy on 70% of his portfolio, but apply a concerted profit or loss-taking strategy on the balance of the portfolio.  Markets trend, yet they can also be volatile and easily take away the capital gains that an investor has achieved.
Visit Baseline Analytics TrendFlex, our subscription-based service helping to keep investors on the right side of the market at all times.