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3 Good Principles for Buying ETFs
By Mike Wang | August 26, 2007
Author: Mike Wang
- 1st Principle: Buy in the period of September to October
By studying the historical trends of how S&P 500 perform during the years, you will realise that during the months of November to April, it performs better than the period of May to October mainly due to the end of year rally till the first quarter of the next year, also known as the Santa Claus Rally.
So a good period of time to buy ETFs would be around the period of September to October as these are historically the worst performing months for the S&P 500. This argument can be said of the STI index as the Singapore market performance is closely affected by the performance of the US market. So normally the prices tend to be the lowest in the year during the period of September to October. Although this is not always observed every year, it occurs around 68% of the time.
- 2nd Principle: Avoid buying when it is overpriced
A simplied way of looking at whether the market is overpriced is by looking at the PE ratio (Price to Earnings ratio) of the S&P 500 and the Dow Jones Index. We can know the PE ratio of these indexes by going to this website and key in their symbols to find out about their PE ratios (SPX for S&P 500 and DJIND for Dow Jones Industrial Average)
The median PE ratio for S&P 500 is around 15 for the past 50 years. So the ETF is considered underpriced when the PE ratio is 10 and below and overpriced when it is 20 and above.
- 3rd Principle: Avoid Buying when the market is in a downtrend
By looking at the trend of how the ETFs index move, we can see whether is it in a upward trend, downward trend or consolidation trend. The general rule of the thumb is not to buy when it is in a downtrend as we do not know how long it will take for the market to turn around. The best time to buy is when the market just start to turn around from a downtrend into an uptrend or from a consolidation trend (moving sideways) to an upward trend.
image obtained from www.moneycentral.com
Topics: Finance |