My System Signals a "Sell" and a "Buy" in Emerging Markets

It's time to "sell" a portfolio holding that has outperformed the market and add a security that looks ready to take off, according to my market-beating, "ROC" system.

I believe that systems take the emotion out of trading, and that is why I follow them. System rules are developed in advance based on logic and back tested so we can be sure the logic is sound. Instead of letting headlines determine when I trade, by following rules, I've seen double-digit returns in bull and bear markets.

The logic I start with is that you should buy stocks and ETFs that are going up and sell them when they are going down. I know that sounds glib, but there are ways to define "going up" and "going down" with some simple math.

There are a number of finance professors who use what they call momentum to do that. They've shown that buying the stocks with the strongest momentum and selling when momentum slows outperforms the market over time.

As traders, we define momentum in terms of relative strength (RS). The stocks or ETFs with the most momentum will have the highest RS. There are a number of different ways to define RS, including proprietary systems used by Investor's Business Daily and Value Line. But I think the simplest way is to use a 26-week rate of change (ROC) calculation. With this system, we buy the ETFs that have the highest ROC and sell when ROC falls.

All buys come after sells, and this week, we are selling one of the positions we have held since we started monitoring this portfolio. iShares MSCI Philippines (NYSE: EPHE) is being sold after performing exactly like a high RS holding should. EPHE has delivered a market-beating gain of 10.81% since being added to the portfolio on May 25. That was better than the S&P 500, which gained 6.85% over that time, and the iShares MSCI Emerging Markets ETF (NYSE: EEM), which gained 8.64%.

EPHE is still trading near its 52-week high, but the RS has collapsed in the past two weeks, a signal that there are better trading opportunities available.

In the chart below, I've converted RS into a MACD-style indicator called the Momentum of Comparative Strength (MoCS). The indicator fell below its moving average only two weeks ago, and has fallen more than 40% in that time. Breakdowns in MoCS often come right before big price declines.



After selling EPHE, the system is signaling a buy in iShares MSCI Turkey (NYSE: TUR).

This chart shows a strong MoCS that is moving higher and is above the moving average. Price is testing support and MoCS indicates that support should hold. TUR is a volatile ETF and can move very quickly.

The Organization for Economic Co-operation and Development (OECD) expects Turkey to enjoy economic growth of 3.3% this year and 4.6% next year with moderate inflation and unemployment. While growing faster than many other economies, Turkey's stock market is trading at a low price-to-earnings (P/E) ratio of 8. The P/E ratio on the S&P 500 is about 13, and EEM has a P/E ratio of 10. TUR is a bargain with high RS.



Recommended Trade Setup:

-- Sell EPHE at market price
-- Buy TUR at market price
-- No stops or targets are used with this system