On February 7, 2017, we sold our shares of the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) at $38.83/share for an overall profit of 53% over 11 months.
While this is a very good profit, how did we know it was time to sell rather than hold for a longer duration?
Applying Our Methodology
The first thing we looked at were the calculations from our strategy. Based on our purchase price, our Sell Threshold was $29.86 and our Absolute Sell Threshold was $49.76. XOP was just about halfway between these thresholds when we set a 5% trailing stop order that resulted in the sale detailed above.
But why did we decide to set the trailing stop order?
XOP had been on a tear since the Organization of Petroleum Exporting Countries (OPEC) announced a reduced production deal back on November 30, 2016. The deal proved to be more than just a political maneuver on paper, as OPEC crude oil production dropped in January 2017.
Lately, the effect of this deal has been eclipsed by increased US crude oil and refined product inventories, a rise in monthly US crude oil production, and a rise in US crude oil rigs. Additionally, XOP has a correlation of approximately 65.6% with US crude oil, meaning that any earnings produced by the individual stocks within the ETF will likely be outweighed by movement in the price of crude oil.
This increased US crude oil and natural gas production continued to weigh on overall crude oil prices. The Trump administration’s energy policy, with its focus on infrastructure and domestic jobs, could lead to further increases in US drilling and a resultant increase in crude oil production.
With a considerable amount of bearish news surrounding the sector, we decided that it would be a prudent move to set a 5% trailing stop order on XOP in case US production continued to weigh on the sector. This trailing stop eventually resulted in the sale of XOP noted above as the sector continued to fall.
Alternative Buying & Selling Analysis Tools
A large premise behind our strategy is to take emotion out of investing. However, I must note, there is still a lot of opportunity for emotion to creep into the equation with such a large band between the Sell and Absolute Sell Thresholds, or when purchasing below the Buy Threshold. I spent a significant amount of time analyzing news and fundamentals to help refine the “right time” to sell XOP… in my opinion, too much time.
Is there an easier way, using math to come up with more calculated buy and sell solution sets?
Let’s look at a few popular technical analysis tools that could be used to analyze ETF trends to better target buying and selling opportunities.
1. Simple Moving Averages
A Simple Moving Average (SMA) is exactly that – on a given date, it presents the average value of the security over the past “x” number of days. For instance, the 100 day SMA shows the average price over the last 100 days.
An SMA by itself is useful for seeing overall trends through a smoothed line, but its more popular use is through two separate SMAs, looking for crossover points.
For instance, a common example uses the 200 day and 50 day SMAs to determine when to buy or sell based on the crossover points. When the 50 day SMA crosses up through the 200 day SMA, it is considered a “buy point,” and crossing down through the 200 day SMA is a “sell point.”
The XOP graph below shows an example of this method.
This strategy lags market performance too much for my liking.
In this example, the ETF grew by almost $10/share prior to the buy crossover in late May, which is well after I would have preferred to buy. The same lag applies when selling.
Instead, let’s consider using the 50 day and 10 day SMAs. As you can see below, this method results in buying and selling points that occur sooner than then 200/50 day SMA crossovers. Unfortunately, these SMAs also generate more crossover points, which could inadvertently trigger a premature buy or sell.
Let’s stay with this set of SMAs for now and see how we can refine our buying and selling points through additional technical indicators.
2. Moving Average Convergence Divergence
The Moving Average Convergence Divergence, or MACD, is made of two exponential moving averages (EMAs) covering two different time periods to indicate the trend and momentum of a security. This tool plots the two EMAs on a single graph – all you have to do is look for the crossovers as an indication of when to buy or sell.
The graph below also shows the MACD as a series of bar plots, which makes it easier to visualize. A transition from a positive value to a negative value indicates a selling opportunity, and vice versa for a buying opportunity. For instance, if we’re already considering a purchase (such as in May 2016), the positive MACD value reinforces that it may be a good time to buy.
3. Relative Strength Index
The Relative Strength Index (RSI) helps to indicate when a security is “overbought” (due for a drop) or “oversold” (due for a bounce). This helps to show whether a particular increase or decrease in price is supported by a significant amount of buying or selling pressure, respectfully.
The RSI is plotted on a scale of 0 to 100, with the overbought value equal to 70 and the oversold value equal to 30. As the RSI trends in a negative slope and approaches, or perhaps crosses down through 70, it’s time to consider selling. Consider buying as the RSI has a positive slope, with the best case as it approaches or crosses up through 30.
Here is an example of what the RSI looks like. Below you can see the correlation between price increases/decreases with corresponding increases/decreases in RSI.
4. Stochastic Oscillator
The stochastic oscillator is another 0 to 100 scale plot that indicates momentum of a security. It indicates overbought conditions above 80, and oversold conditions below 20. The same buy/sell rules discussed for the RSI apply for the stochastic oscillator, this time looking for trends either up through 20 or down through 80.
5. On-Balance Volume
On-balance volume (OBV) measures a cumulative total volume flow, or number of buys and sells for a security, depending on the price movement. The theory is that an increase or decrease in volume precedes a significant price movement, perhaps providing a leading indicator.
An increase in OBV means that volume is increasing as the price increases (buying indicator); a decrease indicates increasing volume as price decreases (selling indicator). Movements in this indicator may not be as obvious, or drastic, as the other four indicators.
See an example below:
If one thing is clear, it’s that a single indicator is not sufficient to determine a definite buy or sell point for a security.
Instead, let’s see how we can focus in on a few opportunities to make better use of our time spent researching. In the graph below, I’ve plotted the SPDR S&P Oil & Gas Exploration & Production ETF over the last year, along with our Sell Threshold and the 50/10 SMAs, MACD, RSI, Stochastic Oscillator, and OBV indicators.
Additionally, I’ve identified the points on the graph where all five indicators indicate a selling opportunity (red arrow), and again where four of the five indicators indicate a selling point (orange arrow).
You can see that we’ve been able to narrow our analysis down to four points over a year where we would consider selling XOP. Two of the four points were supported by all five technical indicators, while two points in early-May and mid-September 2016 were supported by four indicators.
- In early-May, a potential sell point was identified through a MACD crossover from positive to negative, a decreasing RSI and Stochastic Oscillator, and a drop in OBV. There was no SMA crossover point at this time.
- In mid-September, a potential sell point was identified through a MACD positive-to-negative crossover, a decrease in values for RSI and Stochastic Oscillator, and a drop in OBV. There was no SMA crossover point at this time.
At each of these points, we would then conduct a detailed analysis of the industry state and ultimately make a decision to sell or not. That’s a pretty good reduction in required analysis, cutting our “deep dives” down to only four instances!
All indicators show trends but don’t predict the future. We only discussed a few of the many technical indicators that have been established to demonstrate a good way to narrow decision points when considering the purchase or sale of a security.
By combining our buying and selling zones defined in our strategy with a few technical indicators, we can now further narrow the instances when we need to “dive into the details” to determine whether it’s the right time to buy or sell a specific sector ETF. This will hopefully help you make smart decisions while saving time – a true win-win!
What indicators do you personally use to help decide when to buy or sell? How might a different combination or strategy further help you make sound investment decisions? Please let me know your thoughts below!