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Banks in Cyprus were closed for nearly two weeks before reopening today, and the stock market remains closed. While the crisis in Cyprus has been unfolding for some time, the news about a tax on bank accounts seems to have been an unexpected solution, and the reaction, particularly from those affected, has been negative.
Global stock markets, however, seem unconcerned about Cyprus, and U.S. stock market indexes continue to flirt with all-time highs. The chart below shows that stock markets have actually done a good job of anticipating the crisis. When traders correctly anticipate news, they can avoid the need for a rapid reaction, which sometimes takes the form of a market crash.
We can see that SPDR S&P 500 (NYSE: SPY) (shown as the light orange top line) has outperformed the EURO STOXX 50 index (the green middle line in the chart), while the FTSE/Cyprus Stock Exchange 20 Index (the darker orange bottom line) has fallen nearly 90% in the past five years.
The chart above is a comparison chart, which shows the percentage change in prices over time. This is the same idea that I apply in my 26-week rate of change (ROC) system. ROC is simply the percentage change in the price of a stock or ETF over a time period. I use 26 weeks because there is a large amount of academic research showing that time frame works well.
The next chart is similar to the comparison chart shown above, but it adds iShares MSCI Ireland (NYSE: EIRL) (red line) and covers only the past six months.
Again, Cyprus is the laggard while EIRL has been the clear winner with steady gains over that time. Cyprus has also been the most volatile market with a large gain in October followed by a decline. Some traders may have bought the large gain in October, and have since suffered large losses. To avoid short-term reversals like that, the 26-week ROC system uses more data to minimize the impact of sharp bounces.
If we allowed the news to dictate our trading decisions, we would most likely want to avoid EIRL, which is a member of the EU along with Cyprus. Ireland faced its own crisis several years ago, but its stock market seems to be saying the worst of the crisis is in the past. The current chart, and the 26-week ROC system, tells us EIRL is a buy and demonstrates that not all euro countries will follow the same trend at any given time.
I believe it is best to follow rules defined in a trading system rather than the news when making buy and sell decisions. Systems ensure that you follow an unemotional approach to the markets and never allow fear caused by headlines to push you in or out of any position.
A system like the 26-week ROC strategy will also help you avoid extended declines like investors in Cyprus have experienced. Even before authorities closed that market, the large losses over the past few years should have been a warning that the market should be avoided.
Despite all of the turmoil in the world, the 26-week ROC portfolio remains unchanged this week and continues holding only three positions:
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