Adding foreign spice to investment

Looking at tourist brochures of holiday spots in faraway lands is always enticing, but once you get there the country can seem, well, so foreign. A similar problem confronts the investor who yearns after foreign financial markets. The prospect of a  steady 150% trend return over 12 months in 2003 from a Singapore listed stock like Neptune Orient Lines is enticing. A fast return of a three day 54% from Singapore listed China Aviation Oil adds some sizzling spice to any portfolio. The chart pictures are attractive, but assembling all the relevant information necessary to make the trip can be daunting. Fortunately there is a short cut that delivers the full picture in a single move.

These are the Exchange Traded Funds (ETF) and they are designed to track a selected index. They take some of the hard work out of investing by removing the need to make individual stock selections. When the broad market rises, the value of the ETF also rises.

Call this a lazy approach if you wish, but the ETF gives us the opportunity to participate in the rewards delivered by a group of winners. The company that issues the ETF takes care of the selection and ensure the ETF closely tracks the index. All we have to do is decide when to buy or sell a single stock – the ETF. This is not quite a “hands-off” approach, but it is significantly different from the full “hands-on” approach required of active trading of individual stocks.

The ASX World Link service offers access to a number of these products, including the United States listed QQQ and SPDR series. These notes look at an ETF a little closer to home, the Singapore listed STI. With a twelve month return of 41% this is an attractive market.

Broadly speaking, there are three possible approaches to making money from the market. They are:

The buy-and-hold approach. This works very well in rising markets. However it can lead to very severe losses when markets fall and investors continue to hold.

The trader’s approach. This is at the other extreme. The trader actively manages risk by capturing shorter-term trends. This is more difficult in international markets where we do not always have the same access to breaking news.

The defensive approach. It is essentially a trend trading approach and is designed to capture trends lasting weeks, months or even years. It does not assume that market will always go up. It recognises that losses have a significant impact on profit growth and capital preservation. It also recognises that most people are not suited to the demands of frequent trading.

The Straits Times Index chart for the past year shows the result for the buy-and-hold strategy. This has delivered a 40.77% return. Note, this is not 46.15%. This is only possible if you had sold at the peak of the STI rise. The buy and hold strategy means exactly that – hold. When the market declines, your return is reduced. The figures at the bottom of the chart show the return from $100,000.

A defensive strategy relies on using a technique or tool that helps to identify the significant decision points where we no longer are able to identify the direction of the trend with confidence. On the chart, these are shown in the areas circled in red. At the time at which these index retreats developed it was difficult to decide what was likely to happen. Over the past year traders used the 10- and 30-day exponential moving averages as a robust tool for tracking the trend behaviour of the Singapore Straits Times Index. This trend activity can also be tracked with a straightedge trend line, with a Guppy Multiple Moving Average, or any one of a number of other trend following indicators.

A good indicator tells the trader when the old trend is no longer clear – time to take defensive action – and when the new trend has become established – time to buy back into the stock. In this example, it is the crossover of the two moving averages that provide the signal conditions for this decision.

On this chart extract, as shown by the table, there are three trades. Each trade uses only the original trading capital of $100,00. Profits are swept aside into a separate account. The total return is 42.7%. This is better than the buy-and-hold returns, but not outstandingly so. With hindsight it is very easy to say that the two market retreats in the circled areas were not a serious threat to the trend and that therefore the buy-and-hold strategy is a successful technique. However, in real-time, these decisions rest on a less sound analytical framework, so the defensive strategy offers better protection against trend failure.

Simple trend trading tools are easily applied to analysing market trends in international markets. Using an Exchange Traded Fund and ASX World Link allows investors to sample the entire market without having to make difficult decisions about stock selection. Trend trading tools make it easy and profitable to add SPDRs, QQQs and other spice to your investment performance.

Daryl Guppy is a full time trader and author of Trend Trading, Trading Tactics and Better Trading. He runs trading workshops  in Australia, Asia, China and the US. He can be contacted via www.guppytraders.com.

© Guppytraders.com Pty Ltd ACN 089 941 560. All rights reserved 2004. This article has been prepared by Guppytraders.com Pty Ltd and licensed to ASX. The views are those of the author and not necessarily of ASX. This material is educational and it is not intended to constitute financial advice.

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