Simplify Your View of the Market

Being the analytic I am, it is easy to make things more complex than need be. In fact, I have spent the last two years in a concerted effort to simplify everything I do. The market is made up of so many moving parts it is easy to lose sight of the simple things that make it work. Trend analysis was one of the first things I learned in 1980 when starting what I now call my ‘big dig’ into investing. Yes, that is in reference to the one in Boston that took twice as long to complete and came in four times over budget! Thus, my reference into the ‘big dig’ of learning to invest my money. Because I made it more complex than it needed to be, it took longer than it should have, and the price of learning was much higher than I would have liked. The good news it all worked out… Simple is better, but it ain’t easy.

My latest attempt at simple has been looking at the simple process of taking one index and breaking it into parts that make sense to me visually, intellectually and emotionally. In other words, it encapsulates all the data I need to feel comfortable to invest my money. For the sake of this example let’s take the S&P 500 index. Standard and Poors has been nice enough to break the index into 10 categories or sectors. Each is visual from the perspective that if we took the healthcare sector, as an example, any of us could visually see what companies that involves. Intellectually I can study any of those companies group of companies they represent… for example, healthcare providers. Emotionally I can see (visual), understand (intellectual) and believe (emotional) in the service or product they provide. That allows me to then proceed with a strategy to put my money to work in the sector, industry group or individual stock. A simple process for understanding what I am looking for to put MY money to work.

The chart below is the S&P 500 index with all ten sectors bench-marked against the index. The starting point is the last pivot point or low for the index. This allows me to see the leadership of the index visually on a chart. The leaders off this low are basic materials, consumer discretionary and technology. Simple enough to see, interpret and act on if I have a strategy for doing so.

500 Scatter Rot

If I want to take the consumer discretionary sector (XLY) and look at a chart for the same period I can simply look at it as below. I have added a vertical line to show the starting point from the chart above.

Chart

If we use a simple pattern recognition strategy from technical analysis, it is easy to see the break from the triangle pattern of consolidation from December 30th – February 2nd. That entry point has led to a nice move off the low or pivot point. Trading strategies don’t have to be complex, they simply need to capture three key ingredients… first, how to I get into the position, or the entry process for buying. Second, what if it doesn’t work. In other words, if what I think to be true isn’t where is the exit for the position. This is a stop order to remove the emotional decision making of taking a loss on a position that didn’t work. Third, where am I going? What is the objective, goal, target, or profit objective for the investment? And then, what will I do with the position if and when I achieve the objective? Simple in that it defines how you will enter the position, how you will manage the risk of the position, and how you will manage the profit of the position. In doing these three steps we take control of the process and the emotions of the process of owning the position.

If I want to take this one step further I could scan the stocks that make up the sector or industry group using the same criteria and define the leading or potentially leading stocks within the group and buy them. By using the same strategy, process and discipline it keeps the process manageable and simple. After all that is the goal isn’t it?

Try this process with any index. Break it down into a manageable group of sectors or industry groups and look for the leadership or opportunities based on a defined strategy. Then scan, search, process and define the parts that meet or fit your strategy and then apply the three tools of entry, exit and target. Finding simple ways to break down the market is key. KEEP IT SIMPLE S…… But know this, as you attempt to simplify your process for investing, it won’t be easy.