ETF Complete Strategy Insights: Momentum in the ETF Models (Part 1)

James Kimball | July 21, 2019

The ETF Complete model closed the week up +1.4% compared to the SPY which closed up +1.6%.

After some initially mixed earnings results, strong results to close out the week had markets closing on their highest levels. The Federal Reserve is meeting next week to determine its next move, largely expected to be anywhere from 0 to 2 rate cuts.

Stay tuned for the daily updates and log into the website to see holdings and additional performance data.

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This Week's Strategy Lesson: Momentum in the ETF Models (Part 1)

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When asked one time if making money in the markets was difficult, Jessie Livermore (the semi-biographical protagonist in “Reminiscences of a Stock Operator”) famously responded:

“Not at all! I have found an easy way and I stick to it. …I will tell you my secret… I never buy at the bottom and I always sell too soon.”

Everyone has heard the old maxim that you must “buy low and sell high” to make money in the market. And while technically, at the very least you do have to sell higher than you bought to make a profit, the usual connotation of “buying low” (usually meaning a depressed prices) is not the only way to approach the market.

The truth is we never know ahead of time if that new high in a stock will stand for a while or if it’s just the first of many new highs over the coming weeks and months. And likewise, unless a stock is at zero, you cannot be sure it has bottomed out. Stocks are never too high to buy or too low to sell if you have good reasons.

Buying stocks on a recent high or after a large move can be a harrowing experience. Talk to anyone who has been trading long enough and its almost guaranteed they will have a story about the time they sold the all-time low in coffee or bought the all-time high in a now defunct dot-com stock.

The ETF models can put some of our fears to the test. At its core, the models are about being in the strongest TSI (Trend Strength Indicator) ETFs. This generally means the ones we get into are coming off a period of strong outperformance. They might not always be at new highs, but they will typically already have made a nice move before we get into them.

Let’s look at a few trades that fit this description.

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Earlier this year, we entered a trade in TAN (Solar Power) in both the Sector and Global Macro models. When we entered in February, TAN was already up around 30% just in January. Despite entering on what might have been seen as “too late” at the time, TAN would go on to power considerably higher and recently reached a profit target in both models. We are still in this position.

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It is not uncommon to enter ETF trades after they have already made a sizable move or have been trending for awhile. We had a similar looking trade in FXI a couple years back. In September of 2017, we entered FXI after it had already been up nearly 30% for the year. This trade went on to reach a profit target and exited shortly after.

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However, it goes without saying that not all trades work. Even some of the strongest, best-looking trends eventually peter out or end, sometimes very quickly. An example might be the Coffee (JO) trade from 2016. JO that had been in a multi-month upward trend that was just breaking out to new recent highs. Unfortunately, this trend reversed almost as quickly as we entered and we ended up rotating out this trade for about a 12% loss.

While markets have as recently as this past week, put in new all-time highs, we are only trading a few percent higher than the peak we saw in January 2018, more than 18 months ago. During this time we have had multiple -5% to -10% corrections and even one correction that briefly reached -20%, so it has been a tough time for trading equities.

The ETF models track a wide variety of instruments, though the one thing we are consistently doing is entering these instruments after they have shown some absolute or relative trend strength and are making moves. This can often lead to fast trades where we quickly discover if we are right or wrong on a trade. This higher volatility is one of the hard-to-avoid aspects of a momentum-based strategy.

We have seen here a few great examples where buying strength, even buying new highs has worked. But why does it work? What forces are working in our favor to help give us our edge? In the next couple of articles, we are going to explore the underlying reasons that causes stocks and ETFs to trend up or down and how our TSI helps us pick up on which ETF might be the next to sprint away from the pack.