ETF Update: Finding a System that Works for You

What is a good trading result?  One that works!  It makes a profit.  We can all agree on that.

There the agreement ends.  Is it better to have a lot of "base hits" or should we go for the long ball?  How much risk is acceptable?  How do we measure risk?  What drawdown is acceptable?

There is no "correct" answer to these questions.  A really great trading system could have higher risks and drawdowns, if the ultimate payoff was high enough.  If the investor is going to quit after the first loss, it is the wrong system -- at least for that investor.

Our approach is based upon extensive computer analysis of past trading results for stock sectors.  We look for (T)rends, because that is the most important indication of strength, but we also identify (C)ycles and use fast filters to help in (A)nticipating new moves.  Since we apply the method to a universe of 277 ETF's, we call it the TCA-ETF system. (For new readers, there is a more complete description of our methods at the end of the article.)

The Trader Mentality

Traders have a clear notion of what is right:  Sell the rips and buy the dips.

Whether you trade from the long side or the short side, you are expected to make money in a volatile market through a contrarian adjustment of your position.  Noted traders Pete and Jon Najarian explain the concept in this article, while also mentioning some limitations.  It is accepted trader lore, especially when the market is in a (perceived) trading range.

A Small Digression

At "A Dash" we have emphasized that Investing is Not Gambling, but we often use gambling examples.  There is a formal analysis of the games of chance, with solid academic literature.

There is also the work of charlatans, as noted in some email we have received quite frequently.  This is a message that purports to be accidental in nature.  It purports to be a response to a friend asking for the system, apparently sent by accident to you.  It has plenty of spelling and grammatical errors [and some colorful language censored by the Old Prof].  The objective seems to be to drive losers to a specific online casino.  Take a look.

yo mate, ok I`ll give you my trick but if you give it someone else I`ll f**** kill you :) you know in roulette you can bet on blacks or reds. If you bet $1 on black and it goes black you win $1 but if it goes red you loose your $1.

So I found a way you can win everytime:

bet $1 on black if it goes black you win $1

now again bet $1 on black, if it goes red bet $3 on black, if it goes red again bet $8 on black, if red again bet $20 on black, red again bet $52 on black (always multiple you previous lost bet around 2.5) if now is black you win $52 so you have $104 and you bet:

$1 + $3 + $8 + $20 + $52 = $84 So you just won $20 :)

now when you won you start with $1 on blacks again etc etc.  its always bound to go black eventually (it`s 50/50) so that way you eventually always win. But there`s a catch. If you start winning too much (like $1000 a day) casino will finally notice something and can ban you. I was banned once on [XXX] casino. So don`t be too greedy and don`t win more then $200 a day and you can do it for years. I think bigger casinos know that trick so I play for real money on smaller ones, right now I play on [yyy] casino: [hyperlink deleted] for more then 3 months, I win $50-$200 a day and my account still works. You`ll find roulette there when you log in go to "specialty games" - "american roulette". And don`t you dare talling about it anyone else, if too many people knows about it casinos will finally found a way to block that trick. If you have any questions just drop me a line here or on skype.

c ya

Back to Trading

If you do not see the similarity between the roulette scam and "selling the rips" you need to read it again --- more carefully.

The astute readers of "A Dash" will obviously recognize the Martingale approach in the email.  Let us think more carefully about rip selling.

• First, it usually works.

• When it does not work, you double down on a scale.

• When that does not work, you might triple down (or "average up" if you are selling short) for one more time.  At some point you run out of money or margin.  You are "All in."

What next?  If there is a break out, you are blown out.  Some will say that you should have had "protection" but most do not trade that way since it really cuts into profits.  Some will say you should have had stops.  I have lost count of my trading friends who tripled down, stopped out their positions, and then watched the market turn their way.

There are no easy answers.  You need a system that fits your style -- one that you can follow in a disciplined fashion.

The pundits with the slogan seem so smart because they are usually right.  When they are (finally) wrong, they disappear.  There is a survivor bias in "rip selling."

Featuring REIT's

The model's top picks include commercial REIT's as well as home building and financial stocks.  The banks were hit last week by a report from the Congressional Oversight Board for TARP, reporting that there were still some "toxic assets" that could not be properly evaluated on the books of regional banks.  While this hardly seemed to be fresh news, it pressured the market early in the week.

We featured commercial REIT's in April, and the key issues have not changed.  We urge readers to go back to that article to see some of the complexity and tax issues in this yield-based investing.

Meanwhile, we have added the Vanguard REIT ETF (VNQ) to our earlier portfolio selection from iShares (ICF).  The charts are nearly identical.

Those commenting on REIT's are skeptical.  Gary Gordon's analysis about the start of a pullback is typical.

Weekly TCA-ETF Rankings

With only seven percent of our sectors in the penalty box, we continue our bullish posture from last week.  The broad index scores are not that strong, but there are many attractive sectors.

We had a poor week, mostly because of the swift turn in regional banks, spilling over into other financials.  We lost over 3% on the week dropping more than 2% to our benchmark.

Based upon continued, but moderating, strength in the model signals, we continued our bullish position in the Ticker Sense Blogger Sentiment poll.

Here are the top sectors from our expanded universe of 277 ETF's.  The list also includes the values for the broad market ETF's and their inverses.

We had a brief diversion from the model for the employment situation report.  We did our sells on Thursday and our buys on Friday morning.  We also added a small hedge.

In a future article we will explain more about how we decide which ETF in a given sector to trade.

 

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation.  Before turning to the current rankings, let us undertake a review for readers new to this series.

Our Method.  In this past article, we described our basic methodology and why we believe the rankings are useful for fundamental traders and technical traders alike.  While we urge readers to check out the entire article, the key point is that ETF's pose challenges and opportunities different from investment in individual stocks.  The fundamentals may be more difficult to assess.  Even with a good grasp on fundamental trends, there is a lot of technically-based trading in ETF's.  This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves.  Here is an article on that point.

The system synopsis. We look at Trending sectors, Cyclical Sectors, and build in an element of Anticipation for both entry and exit -- thus the name of the model, TCA-ETF.  While we do not reveal the exact methodology for spotting trends and cycles, the system is not a "black box."  The basic elements are used by many, and widely reported.  We even discuss the need for human analysis as opposed to black box trading.

We report the rankings each week, now on the weekend with a one-day delay, using the Thursday output from the model.  We monitor and trade this daily, and offer a free report (request via the email address on the top left of the site) for those interested in our weekly trading program.