If you follow financial news and commentary, which you presumably do if you are reading this, you will no doubt have heard many times that long-term investors should not attempt to time the market. Many take that warning to mean that trading of any kind should be avoided in investment accounts, but that is not the case.
When it comes to position entry, the techniques of traders can be adapted and used to great advantage when the set-up is right, as is the case now with the iShares MSCI Eurozone ETF (EZU).
One of the biggest differences between trading and investing is that when trading, a technical setup alone can justify a trade. Traders look for a short term pop or drop in a stock that will pan out over minutes, hours, or occasionally a few days. The likelihood of that can be assessed by looking at past price action and current momentum. There are many ways of analyzing those things and every trader has their favorites, but essentially it all comes down to those two things.
Long-term fundamental factors may be considered later as a reason to run or cut a position, but from an entry perspective, they are not that important. It is not unusual for a trader to sell something in anticipation of a retracement, for example, even though their long-term view of what they are selling is bullish.
For investors on the other hand, it is the opposite. What to buy and when is ultimately dictated by the long-term fundamental prospects of a security, but when a bullish outlook combines with a technical setup, it makes sense to use that to your advantage. That doesn’t just mean that technical factors should influence your timing; it also means that in many cases your investment should be structured as a trade.
So, what does all that mean for EZU? Let’s start with the fundamental case. Eurozone stocks have been depressed recently based on a combination of things. First, the European Central Bank (ECB) has expressed a desire to tighten monetary policy begin winding down its version of QE. That would mean less cash in the system and therefore less money chasing stocks, and European markets responded accordingly in the early part of this year.
Combined with the threat of Trump’s trade wars, it is not surprising that EZU lost close to fifteen percent from its January highs.
However, a strong case can be made that in both cases the market has overreacted. Yes, the ECB has said that it wants to start on a path to tighter monetary policy, but there is not yet any clear timetable for that, and the nature of the institution makes it likely that it will be a very gradual process. Any decision the ECB makes must be a compromise between the competing interests, agendas, and economic imperatives of the nineteen Eurozone countries. Decisive action and rapid decisions in that situation are impossible, so any change will be extremely gradual.
Regular readers will know that I regard the threat from trade wars as real, but so far, the market disagrees. Even if I am right though, the effects will be felt over a long period of time and will, once again, likely be gradual in nature. It is also worth bearing in mind that the EU economy as a whole is now larger than that of the U.S., and when combined with other targets of Trump’s tariffs, such as China and Canada, dwarfs it entirely. The trade imbalance makes it possible that the EU will be hurt, but probably not to the extent that the market seems to be assuming.
With EZU looking oversold on a fundamental basis then, let’s look at the technical setup.
On the bottom of the above chart is a MACD histogram, a study that shows, or rather confirms, changes in momentum. When the bars cross the line and change color it signals that the short term moving average has crossed over the long term, and momentum has reversed. In this case, there is now clear upward momentum and many traders will see that as a buy signal. The fact that EZU is bouncing off a 52-week low adds another dimension to the technical case: it sets up a logical stop-loss level just below that point.
Investors with long time horizons often eschew stop-losses. They believe that short-term fluctuations should be ignored, but that makes no sense to me. When you take a position, you are making assumptions about the price in the future and if those assumptions turn out to be wrong, you whole rationale for buying disappears. In that case, it makes sense to at the very least cut and re-evaluate.
When you combine the technical and fundamental situations for EZU then, it is clear that buying EZU could be a good investment, but one that should be protected by using a basic trading technique. If you buy here and place a stop-loss order that would be triggered on a move down below $40 your maximum loss on the investment would be around five percent, and with a lot of potential upside, that looks like a risk well worth taking.