Submitted by Covestor Ltd. as part of our contributors program.
Author: Michael Arold
August turned out to be one of the best months of the year for the Technical Swing trading model, which gained 4.6 percent during the month.
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As always, it paid to ignore the headlines of mainstream media and analyze price action instead. During the summer months, equity indices printed a price pattern that has become familiar in recent years: volatility “shocks” followed by a period of volatility decay and finally by strong low-volatility rallies.
This type of market structure initially appeared in 2006 and could be identified regularly since 2010. This volatility shock/decay pattern presented itself again in the last few months, which is why I had been trading predominantly from the long side and why I think stocks could go higher from here.
The second bullish sign I’m seeing is the strong behavior of market-leading stocks, which held up fairly well during corrective phases. Since it is one of my strategies to buy minor declines of market leading stocks, it doesn’t surprise me that the Technical Swing Model outperformed the S&P 500 Index in August.
I found market leaders in the U.S. Retail and Homebuilding sector. After months of outperformance of dividend stocks, it seems like investors are in risk-on mode again and are buying beta: in August, SPHB, the ETF which tracks high-beta equities, developed better than DVY, a dividend-focused ETF.
The stock usually goes through relatively long consolidation periods, interrupted by short but strong rallies, often in anticipation of new products or positive earnings announcements. Apple is expected to present a new version of the iPhone in September. The stock is a good teacher of the classic investment lesson “buy the rumor, sell the fact”.
Another topic that gained traction again in August is gold, which broke out of an intermediate-term consolidation. I was initially skeptical of the breakout. However, when price consolidates in a tight structure after strong moves, the pattern offers a good entry with clearly defined risk. Gold did just that during the last days of August, but I did not trade the metal itself. Instead, I took a position in Royal Gold (RGLD), a royalty company.
I believe that RGLD’s price could rise faster than the metal itself. Investing in traditional or even junior gold miners is in my opinion not a good strategy these days, since these companies are struggling with rising costs. Essentially, they have to dig deeper nowadays to get the metal out of the ground. A royalty company doesn’t have these costs, because it doesn’t do the digging. Instead, RGLD finances mining companies around the world, who basically pay back the investments with the gold they find. The company financed various mines at very favorable conditions during the financial crisis, when credit was tight. This strategy is paying off now.
Even though I’m obviously bullish on Gold and equities, monitoring major indices is important because they are trading at critical resistance levels: the S&P 500 needs to leave 1,400 behind and the Dow shouldn’t break 13,000 to the downside.
Should these indices not be able to keep momentum, their charts would be in a very difficult technical situation and bears would gain control. There are enough potential catalysts for selloffs – should the situations in Europe or China deteriorate, the Dow could easily drop 500 points within a couple of days, so risk management is still a high priority.
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