How To Know Whether You Should Buy, Sell, or Hold a Stock.

We talked about this at one of our meetings last year and I've had a request to repeat the details once again and I'm happy to oblige the person who asked for this because it can help others as well!

Any time that you are thinking of taking an action with respect to stocks - whether it involves buying or selling - there are three very important questions that you need to ask and answer correctly.

Here's the first question to ask: Is the stock market expensive at this time?

There was a very intensive study taken of stock market activity from the period of calendar year 1927 up through mid-2002 which revealed some very interesting facts. Firstly, that if you buy stocks when the P/E of the overall market is above 17 (when stocks are considered to be expensive) you would make on average only 0.3% a year on your stock investment.

Secondly, if you bought stocks when the P/E of the overall market is below 17, you would have made on average 12.4% a year in stocks. And just buying and holding over the period would have earned you on average 8.03% per year.

Coming back to the present in order to answer the question of whether the stock market is expensive at this time, and using the S&P 500 P/E Ratio (Next 12 mos.) to answer that question, we see that as of March 1, 2005, the ratio stood at 16.4 which would indicate that as of that point in time, the overall market is not expensive. So the answer to the first question is NO. And this is a positive.

Now the second important question: Is the Federal Reserve in the way? As an investor, you should be aware of the fact that interest rates are the major factor affecting stock prices. And as interest rates rise, people are prone to sell stocks!

The interest-rate movements that have had the most dramatic effects on the market have been those changes in interest rates that are set by the Federal Reserve. Yet we find that 71% of the time the Fed is not in the way. But 29% of the time they are in the way, and this always occurs during any six-month period that follows a hike in the Federal Funds rate.

So you need to remember that the Federal Reserve is out of the way either, 1) after the six-month period has ended; or, 2) if the Federal Reserve cuts rates before the six-month period has ended.

Now to answer our second question: Is the Federal Reserve in the way?... With the recent upward revisions of the Federal Funds rate plus the prospect of more such actions by the Fed in the immediate future, the answer to this question has to be unquestionably, YES. And this is a negative.

Now for the third important question: Is the market going up? Market action is critical. Sixty-seven percent of the time the market is strengthening. Stocks have returned on average 12.6% per year when the market is strong. Thirty-three per cent of the time the market is weakening. And stocks have lost on average 1.6% per year in weak markets.

The Market Momentum indicator is simple. It's the 52-week average of stock prices. If the market is above its 52-week average, stock prices are strong. If the market is below its 52-week average, stock prices are weak.

The answer to the third question of whether the market is going up is definitely a
YES, and this is a positive.

With a negative reading on Fed action, the answers to our three questions tell us that at the present point in time, the market is a HOLD, and any action you might take at this time should be on the side of caution.
So just by knowing the answers to these three questions, you will know whether you should buy, sell, or hold at any given time!

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