Existing the Emerging Markets – 062909

Learning is a continual process. Some people learn by watching, others learn by listening, but most learn by doing.

Learning is a continual process. Some people learn by watching, others learn by listening, but most learn by doing. By experimenting with different ways of investing, investors learn their trade while becoming comfortable with a set style.

This approach seems logical, but it often leads in many different directions. Go to any book store and you will find an endless number of investing books. Buy a few and pore over the pages and you will receive a litany of rules to follow. One of the more common describes how to handle winning and losing trades. The standard logic is we should be quick to exit losing positions while allowing our winners to keep moving in our direction. Such an approach has a proven track record, but I also find it incomplete. Preventing large losses from impaling a portfolio while allowing large gains to grow larger may be noble goals, but how do we decide which trades will blossom and when to exit these winning positions? 

Knowing that no stock will go up forever, we must have a process in place that allows us to recognize when the gains have reached our targets and it is time to head to the sidelines. In my weekly newsletter EPIC Insights, when making fundamental trades, I use an estimate of fair value to trigger sales. With technical trades I rely upon a combination of price targets and trendlines to allow me to exit trades that have run their course.
The goal of knowing when to exit brings us to this week’s recommendation. One of our more successful trades has been to buy the ETFs that track commodity-producing countries.

Specifically, we own positions in the iShares Australia Index Fund (EWA), the iShares Canada Index Fund (EWC), and the iShares Brazil Index Fund (EWZ). With the markets in Australia, Canada, and Brazil higher this year by 5%, 15%, and 37%, respectively, our positions have performed nicely. Our ETFs have returned an average of 45% with EWZ’s 57% gain leading the way.
Having let these trades move in our favor, we have clearly allowed our winners to run. However, the time has come for us to exit. Examining charts of each country’s stock market, I see similar patterns that point to lower prices. 

The Brazilian market remains well below resistance (blue line), recently fell below a long-standing uptrend (black line), and has carved out the first two points of a potential head-and-shoulders top (red arrows). While the market stands a chance of rallying toward 53,000, I believe this would be a peak that traces out a head-and-shoulders pattern, so the possibility of a slight increase is not worth the risk of a significant decline. 

Turning to Australia we see a similar story. Prices remain well below resistance (blue line), have recently violated an uptrend (black line), are flirting with the declining 200-day moving average (MA), and have a potential head-and-shoulders reversal forming (red arrows). While a rally toward 4,000 is possible, the risk/reward tradeoff does not favor chasing the market.

Finally, Canada completes a familiar story. Prices are below resistance (blue line) and the uptrend has been violated (black line). Canada’s chart is the strongest of the three with the index well above its 200-day MA and the absence of a potential head-and-shoulders reversal. However, until we see prices settle above 10,800, I am inclined to view the trend as bearish and steer clear.

Based on these studies, there is only one path of action. Our exposure to EWA, EWC, and EWZ combined has reached 11% of the entire portfolio. With my belief that prices are heading lower, I must protect these gains and exit the positions.