ETF Sector Plus Strategy Insights
On Friday, we issued the following trade alert:
Sell DRN (3x Real Estate) at the market on the open Monday 8/11/14
Buy TECL (3x Technology) at the market on the open Monday 8/11/14
Our new three positions starting Monday will be SOXL, ERX, and TECL. This means the model will sellout of the DRN position and reallocate all the available funds to purchase as many shares of TECL as is possible.
In the Stops & Targets model we are out of SOXL and only have 2/3rds positions in ERX. DRN has been a great trade, reaching a target in the Stops and Targets model and likely closing out around 18% above our entry.
TECL also presents us with a unique opportunity. While it has sold off with the rest of the market, it has been gaining in relative ranking compared to its peers by selling off less. It is now sitting right under its 50 DMA and should the market bounce back from the recent selloff, it could really shine going forward.
The SPY closed the week up +0.38%. The ETF Sector Plus model was up +0.26%. The ETF Sector Plus Strategy is up +34.45% year-to-date compared to its benchmark, the SPY, which is now up +4.59% year-to-date.
This Week’s Strategy Lesson: Guidelines for Constructing a Portfolio
(Part 3)
We continue our short series on some guidelines for constructing and managing your own portfolio. We have covered the importance of committing to a long-term strategy for growing your portfolio and last week we went through some considerations on determining the right mix of investments for your financial situation and temperament as a trader.
This week we are going to cover the next step:
3) Develop A Mix of Investment Strategies
Depending on the size of your portfolio and the amount of time you are able to spend managing it, the ideal portfolio for you might contain a few simple strategies or a diverse mix of trend following, contrarian, value, passive and active, and short and long term strategies. I briefly define and summarize some benefits of each strategy, though there can be a lot of overlap amongst them.
Trend Following Strategies
These types of strategies, as their name implies, try to find and trade trends. Trends are simply the tendency for financial instruments or markets to move in the same direction over different periods of time.
Longer term trends that could last years are called “secular” trends. These can be caused by the liquidity cycle, research and development, or changing demographic and consumer trends. They can offer some of the greatest price appreciation potential, but they take time to play out and in the meantime, you will have to sit through the normal oscillations of the market. The Sector and Country ETF strategies were principally designed with some of these longer term trends in mind.
Shorter term trends can be anywhere from a day trade that could be over in minutes to a swing trade that could take several weeks to play out. Successfully trading these short term patterns can lead to quick profits and often profits in up and down markets, as you aren’t limited to traditional long only positions. The Opening Range Success Formula is primarily focused on catching these types of moves.
Contrarian Strategies
This is a loosely defined diffuse group of strategies that create trades or trade instruments that are counter to the prevailing sentiment or trends. The popular “dogs of dow” strategy is a good example of this where you buy the most “beat up” companies in Dow Jones expecting them to bounce back.
Using the “oversold” or “overbought” indicators, anticipating market pullbacks after a big move in either direction is another example. These are all instances of “mean reversion.” Many processes in markets and in the world follow a mean reversion paradigm. There are many self-correcting forces that come into play, like food shortages when an animal population in nature grows too large, or unemployment benefits and other safety nets that smooth out the troughs in economic cycles.
Treasuries are an example of instruments that tend to move in contrary motion to the market. Commodities can also trade to their own rhythm and can offer investment returns that are uncorrelated with the broader market. Including these investments in a portfolio can smooth out your returns and lower your overall risk.
Value Investing Strategies
Value investing attempts to buy companies when they are cheap relative to their peers. These buying opportunities can come up when negative news stories or temporary slowdowns in a company’s performance cause fair weather investors to head for the doors. But investors with the time to do the research and a willingness to sit with investments over a longer time horizon can take advantage of these temporary “mispricing” as the news blows off or the companies longer term growth strategies play out.
This type of investing, made famous by Warren Buffet, requires a lot of detailed research that often requires you to have good understanding of corporate accounting and the ability to read financial statements. Though, if you can find a trusted information source (like Valueline), this can cut down on the work required to follow such a strategy.
Passive and Active Management
This primarily refers to the level of involvement and frequency with which you reassess and revaluate a trade or holding. A popular example of passive investment is buying index ETFs. If you were content getting the “market” rate of return, or you wanted a portion of your portfolio to track the market, buying shares of SPY offer a low fee way to achieve this goal. If you plan to buy and hold this position over a long period of time, it can be called a passive investment. Buying mutual funds or bonds can also fall within this definition.
Active investing involves market timing, trend trading, using stops and targets, and other techniques that allow you to pick the right tool for each market environment, but require you to actively monitor and reallocate your holdings.
A balanced portfolio will typically have a portion in passive management (to reduce your workload and smooth out returns) and a portion in active management (to make the most of current market conditions and earn a higher rate of return).
Which Strategy Is The Best?
The best strategy for you is the one that fits your trading or investing personality. You don’t need to limit yourself to one specific approach, but you will be more successful if you understand and adhere to the discipline behind strategy you are trading.
It’s very important that you understand why you are entering and exiting your trades so that you can make the correct decisions in when to take losses if the market moves against you, and how to take profits to maximize your returns. For example, do not enter a trade based on a momentum strategy, and then change your strategy to that of a value investor if the trade goes against you.
Every good system has its reasons and rules to enter an exit. Make sure you know them before you get into your trades. For example, even though our “Basic” models in our ETF Sector Plus and ETF Country Plus strategies don’t have traditional stops or targets, the still have very definitive rules for exiting at a profit or a loss.
The Current Condition of the Model
For the Sector model, we initiated a position change from DRN into TECL. Please see the opening paragraphs for analysis of this event and stay tuned to the daily updates should there be any other changes.
Here is a summary of the weekly performance of all the ETFs that the strategy monitors:
Best wishes for your trading,
James Kimball
Trader & Analyst
MarketGauge