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With the Olympic Games just behind us, interest and memories are fresh of London, where world-class athletes went head-to-head in a lifetime quest to win gold medals. Now a couple of months later, back home investors continue to chase life-long dreams in hopes of someday striking gold with their investments. So in honor of the 2012 London Games, here are five “rings” of advice (one for each Olympic Ring) to help you build a portfolio worthy of Olympic Gold.
Blue Ring: Analyze the Market
The first question you must ask and answer before you invest in the stock market is “Who’s got the ball?”
It never ceases to amaze me that most investors and money managers never ask or answer this question. They are always fully invested in the market regardless of the market’s direction. The problem is that there are times the market is supporting higher prices and times when it’s not.
Think for a minute about your favorite soccer team. When the market is supporting higher prices — you have possession of the ball. You must run offensive plays. When you have the ball your job is to take as much money from the market as possible. This is the time you must try and score.
During times when the market is not supporting higher prices, you’ve essentially lost the ball and should run defensive plays. During such times, the goal of the market is to score against you by extracting as much money away from your portfolio as it can.
How well would your favorite team do if they ran only the offensive plays every game? They might do well when they have possession of the ball, but when the opposing team has the ball your team would be scored on at will. The net result of your season would be mediocre at best.
This is the problem most investors and their advisors have. They simply don’t know whether to run offensive or defensive plays, much less in what stadium the game is being played. The NYSE Bullish Percent Index clearly signals when the environment is ripe for your offense or your defense.
In 1955, the late A.W. Cohen, the first editor of Chartcraft, Inc., developed the NYSE Bullish Percent Index. Mr. Cohen was trying to create a market indicator that was bullish at the bottom of the market and bearish at the top. The NYSE Bullish Percent Index simply measures the percentage of stocks currently on buy signals.
There is a time for your offense and a time for your defense. You must coach well and decide which plays to run, which players to put on the field and when.
Yellow Ring: Select a Sector(s)
Sector Analysis is one of the least examined parts of the market but one of the most important. When you think of sector rotation, picture the produce section of the supermarket. Just like produce in a supermarket, sectors in the stock market rotate in and out of season. You don’t go into the produce section to buy summer squash in the winter and winter squash in the summer. Instead, you would want to buy summer squash in the summer and winter squash in the winter. Your shopping cart in the fall may include a pumpkin, berries and even a gourd or two. But during the summer tomatoes, cucumbers and sweet corn find their way into your cart.
And why does this happen? Because vegetables taste much better in the springtime when they’re at their peak. The stock market goes through similar cycles, and you must know what sectors are in season.
Let’s turn to Cohen’s Bullish Percent Indexes (which have subsequently been refined by Mike Burke), but this time we’ll use it for the 42 sectors we currently follow. The Sector Bullish Percent Indexes provide a soulless barometer to put us in sectors at bargain prices and take us out at inflated prices.
Black Ring: What to Buy?
Fundamental analysis helps you in answering the question of “What to Buy?” The idea is to pinpoint specific stocks in fundamentally sound companies in the sectors discovered in the Yellow Ring section above. The simplest way to find the best fundamentally sound stocks is to ask your advisor for his firm’s recommended list. Qualified analysts are paid millions for their research. If you use a discount firm you can use S&P 5-Stars, Value Line 1’s & 2’s or Zach’s Research. Whatever you deem to be fundamentally sound comprises this list.
Green Ring: When to Buy?
It is now time to evaluate those fundamentally sound stocks on a technical basis to select the investments that, in effect, have possession of the ball. Not only do you want to invest in stocks of fundamentally sound companies you want to be sure there is a high probability that your stocks will outperform the overall market.
The two factors you should be most concerned with are relative strength and trend analysis. Recall, relative strength is a measure of price trend that indicates how a stock is performing relative to other stocks in its industry or the overall market. Trend Analysis is defining the general direction in which a security or market is headed.
There are a total of five technical attributes any given stock can achieve, which I have outlined below:
Positive Technical Attributes
- Relative strength vs. the market is on a buy signal
- Relative strength vs. the market is positive
- Relative Strength vs. its industry group is on a buy signal
- Relative Strength vs. its industry group is positive
- Trading in an uptrend
If a stock has all five of these qualities, it is a market leader that is trending higher in price. If a stock does not have any of these five qualities, it could be a stock with a specula-tive future and more risk than other stock choices. That doesn’t mean it can’t rise, but your odds of outperformance are much less with low attribute names vs. high attribute names. It is also impractical to require every stock you buy to have all five traits listed above positive, so having three or more will be sufficient and increases your odds of success.
Red Ring: Review and Monitor
Once you take a position in a stock you must continually evaluate and monitor your portfolio to become aware of something that may require action. You need to know what you will do if all your plans go your way and you score. Or what you will do if your plans don’t go your way and you lose possession of the ball. This is a rather simple but important step most investors and their advisors fail to consider.
Will your portfolio rise to the surface, surpass all others, and cross the finish line to be considered the Gold Medal Champion? It all depends. If you grab hold of these five “rings” you may soon be standing on the podium with a gold medal portfolio.
