Portfolio Pruning 101

07/26/2012 3:05 pm EST


Thomas Aspray

, Professional Trader & Analyst

MoneyShow's Tom Aspray takes an in-depth look at his successful Charts in Play Portfolio, as he looks to take profits on some positions and close out others in order to reduce the equity exposure as the stock market enters an uncertain period.

The deterioration in the daily technical outlook for the stock market over the past week suggests we could see more choppy trading in the weeks ahead.

This does not change my longer-term positive view, and I still think we will see a much stronger rally into the end of the year. But the market internals currently reflect a level of risk that warrants a less fully invested position in the stock market. When the NYSE Advance/Decline line signals that a major new intermediate-term uptrend is underway, that will be the time to be more aggressive in the stock market.

Currently, the "Charts in Play Portfolio" is about 68% invested in stocks and ETFs, so now is a good time to examine the portfolio with the goal of lowering the equity exposure. Instead of just adding my recommendations to the table below, I thought it might be instructive to show you some of the specific technical reasons why I am reducing or closing out certain positions.

Learning to critically examine one's portfolio can be an important process in achieving long term success. So I hope you will find this discussion on "portfolio pruning" beneficial.

Editor's Note: This Trading Lesson was written before the surprising announcement Thursday by European Central Bank President Mario Draghi that they would do whatever necessary to preserve the Euro. This has boosted all of the world equity markets...but one day's action is not enough to reverse the recent deterioration in the market internals that I discussed Tuesday. Even though this action could resurrect the market's uptrend, I prefer to act on hard data, not expectations.

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The chart above shows the current holdings of the Charts in Play Portfolio, and I have added a column for current yield, as the yield will play a role in what type of action I may recommend for any particular holding.

Next: Technology



Of course, with the release of its earnings this week, Apple (AAPL) and the technology sector are getting lots of attention, so I will start with this sector.

Apple (AAPL) traded as low as $570.51 on Wednesday after its earnings were released, but was as low as $565 in after-hours trading Tuesday.

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The weekly chart shows that the $565 to $567 level (20-week EMA) is an important level of short-term support. The major 38.2% support is at $516.31, with further chart support in the $490 to $500 area.

The weekly relative performance is now just below its WMA, but well above its long term support (line a). The weekly on-balance volume (OBV) is also below its WMA, but volume was strong early in the year, so the OBV is well above its longer-term uptrend (line b).

Given the long-term prospects for AAPL, I am willing to give this position some room. As a rule, I do not like to have a profit turn into a loss, but am making an exception for AAPL. On longs from $567.80, use a stop at $564.80. If we are stopped out, a drop back to the major 38.2% support is not out of the question.

We also have a long position in the Select Spyder SPDR Technology (XLK) from $28.22. XLK has a 19% weighting in AAPL, 8% in MSFT, 7% in T and 4% in INTC- all stocks that are part of the current Charts in Play Portfolio. The key support for XLK is in the $27.63 area (line d), which corresponds to the late June low.

The daily relative performance is in a downward trading range, but has formed higher highs over the longer term (line e). The OBV bottomed in June, and is still holding above its support (line g). A break of this support could trigger a decline to the $25.50 to $26 area.

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Also in the tech sector is Automatic Data Processing (ADP), where we are long from $53.98. It closed Wednesday at $55.41. ADP traded as high as $56.97 last week, and tested trend line resistance (line a). The heavy-volume trading on last Friday's weak close set the stage for Monday's down-gap opening.

The relative performance is still in its uptrend and positive. The daily OBV has dropped well below its WMA which is now flattening out. This may be a sign of further weakness.

While the semiconductor stocks do appear to be bottoming, a very heavy exposure in any one sector is only justifiable when the overall stock market is trending strongly. Given the recent action, the market may not start to trend higher until later in the summer.

New longs were recently added in the Market Vectors Semiconductor ETF (SMH) at an average price of $30.74. This ETF has a 19% holding in Intel (INTC), but I like the technical action of SMH better.

The weekly chart of Intel (INTC) shows the major breakout above resistance in early 2012 (line d). INTC rallied to a high of $29.72 in May and tested long-term resistance from 2005 (line c).

The RS analysis turned positive ahead of prices last fall, but has broken its uptrend (line e) in the past two months. The weekly OBV has been below its WMA since mid-May, and has continued to move lower. It is still above longer-term support (line f).

In addition, we are also holding long positions in three other semiconductor stocks: Spansion (CODE), Microchip Tech (MCHP), and NVIDIA (NVDA).

Technology Sector Recommendations: I recommend closing out the entire long positions in Automatic Data Processing (ADP) and Spansion (CODE). I would close out half of the position in Intel (INTC) and use a tight stop on the remaining position.

Next: Health Care


Health Care

As I noted last Friday, the weekly technical view of the Select Sector SPDR Health Care (XLV) ETF still looks strong.

There are currently six health-care stocks in the portfolio, and the two largest positions are iShares Nasdaq Biotechnology (IBB) and Bristol-Myers Squibb (BMY), which are up 12% and 13% respectively.

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The weekly chart of Bristol-Myers Squibb (BMY) shows that it came very close to its weekly Starc+ band just two weeks ago, hitting a high of $36.34. Our recommended long positions were established at $31.98, and it yields 3.9%.

There is next support at $33.80, with the 38.2% Fibonacci retracement support from the August 2011 lows at $32.29. The weekly Starc- band is currently at $32.56.

The relative performance did not confirm the recent highs, as it formed lower highs (line a). The RS line is still holding above its long-term uptrend (line b). The weekly OBV is also acting weaker than prices, as it has formed lower highs (line c). A break of support (line d) would be more negative.

Abbott Laboratories (ABT) is acting better that BMY, but is also overextended, as it came very close to its weekly Starc+ band last week (see arrow). Our recommended long positions were established at $60.81, and it yields 3.2%.

The rising 20-week EMA has acted as good support, and is currently at $61.62. The long-term chart shows that ABT staged a major breakout early in the year when it surpassed the resistance (line e) in the $59 area.

The relative performance overcame long-term resistance (line f) and has confirmed the recent highs. The volume has been strong over the past two weeks, and the OBV has continued to act stronger than prices after it broke through long-term resistance (line g).

Other health-care stocks in the portfolio include in Amgen (AMGN), Pfizer (PFE) and Eli Lilly (LLY).

Health Sector Recommendations: Sell half of the positions in both Bristol-Myers Squibb (BMY) and Abbott Laboratories (ABT). Stops have also been adjusted in the other health care positions.

Next: REITs



Two of my REIT holdings look vulnerable on a short-term basis, and are nearing a seasonally weak period.

The weekly chart of SL Green Realty (SLG) shows that it has formed lower highs (line a), suggesting the recent rally was part of a continuation pattern. Our recommended long positions were established at $72.11, and it yields 1.3%.

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There is next support in the $73 to $73.30 area, with major support in the $70 area (line b). The weekly RS line has dropped back below its WMA, and could test longer-term support (line d).

The weekly OBV has formed lower highs (line e) and has dropped back below its WMA. The daily OBV is below its WMA, suggesting that a further pullback is possible.

The Taubman Centers (TCO) also has turned lower after challenging the recent highs in the $79.70 to $80.69 area (line f). Our recommended long positions were established at $71.34, and it yields 2.4%.

The recent trading range (lines f and g) is likely to eventually be resolved to the upside, but a test of the $70 to $72 area is possible first. The relative performance is still in a strong uptrend (line h), and is acting stronger than prices.

The weekly OBV has formed slightly lower highs (line i), though it is trying to move back above its WMA. The daily OBV is still below its declining WMA.

We are also long in Camden Property Trust (CPT) from $63.33, and it currently has over a 12% gain. It also has a much more attractive yield at 3.2%

REIT Recommendations: I recommend closing out half of the positions in SL Green Realty (SLG) and Taubman Centers (TCO). As per the Charts In Play Portfolio page, I have raised the stops on the remaining position to lock in a profit.

Next: Consumer Staples & Retail


Consumer Staples & Retail

As I discussed in last week's column, the chart of the Select Sector SPDR Consumer Staples (XLP) did show some signs that it was losing upside momentum.

This ETF has over 10% in Coca-Cola (KO), Procter & Gamble (PG), and Philip Morris (PM). It also has over 4% in Kraft Foods (KFT), which was stopped out of the portfolio this week. I would hold onto the ETF, since it gives the portfolio some further diversification.

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The daily chart of HJ Heinz (HNZ) shows a broad trading range (lines a and b) so far in 2012. Our recommended long positions were established at $52.63, and it yields 3.7%.

The relative performance has formed lower highs (line c), and it is well below the highs seen last year. The daily OBV has also formed lower highs (line d), and has just dropped below its WMA. The weekly OBV (not shown) does look more positive.

The retail sector typically bottoms out in the late summer or early fall, but on July 11, I saw signs of bottoming and recommended SPDR S&P Retail ETF (XRT), Macy's (M), and Dillard's (DDS).

Macy's (M) is already up almost 10%, while SPDR S&P Retail ETF (XRT) is flat. Our longs in Dillard's (DDS) were recommended at $63.34, and it closed at $62.93 on July 25.

The daily chart shows that DDS has formed a series of lower highs (line f), with important support in the $61 area (line g). A break of this support could drop DDS back to more important support in the $55 to $57 area. The company reports earnings on August 6.

The daily RS has also formed lower highs, and is also not far above its support (line h). A drop below this level could precede a break in prices. The daily OBV is trading in a narrow range, but holding above support (line i).

Consumer Staples & Retail Recommendations: Since our longs were established in HJ Heinz (HNZ) near the lower end of its range, and because of its high yield, I would recommend selling just half of the position. Dillard's (DDS) is another story, and I would sell the entire position.

These changes in the portfolio will reduce the equity exposure in the Charts in Play Portfolio by about 14%, to what I feel the appropriate exposure for the current market. If the market drops further, the equity exposure will decline even further.

There are, of course, quite a few positions that I have not discussed, and the majority of these look quite positive technically. Gold prices have bounced recently, suggesting that the seasonal low may be in place. Still, we need higher prices and stronger volume to confirm an important low for gold. Stay tuned

I will be continuing to adjust the positions in the portfolio, and suggest that you follow my feed on Twitter @TradersExpo and @TomAspray for additional changes in our position. For the portfolio record, I will be using the opening prices on Friday, July 27 for any new recommendations in the Trading Lesson.

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