Why trade etfs?
I run my own retirement funds. I do not want to sit in front of a screen all day watching prices go up and down. I also do not want a single corporate event or a bad news day to cause one of my positions to move significantly against me. Etfs or exchange traded funds give a smaller investor (and believe it or not I would include myself in that group) an ability to diversify away a lot of the risk from individual stocks.
How I go about selecting the funds I will use in the portfolio
I frequently get asked what sector etfs I trade. The list changes a bit from time to time, but essentially here’s what I like to do. First, I decide on how many sectors that I want to trade. This is a function of how much money I want in each position, how many dollars that I am trading in the strategy and how much time I want to spend updating stops each day. I decided that 20 etfs in diversified sectors would suit me and my situation just fine. I could do more. I could do less. But this seems to be my own personal sweet spot.
Next up, I need to decide which sector funds I want to include in my list of 20 potential candidates. Some factors to consider:
How liquid is the fund? I’d rather not be in a lightly traded startup fund.
Is there any other sector fund that I’ve already included in the list that is similar to what I have already selected? If so, then move on.
What are the fee costs associated with the selection? The lower cost, the better.
An Example using SPDR etfs
I took a screen shot of the SPDR sector etfs list. This may be a little small for old eyes like mine, so if you want to go to the actual SPDR webpage…
I start at the top of the list and work my way down the page. The first is a higher cost and looks a bit managed, so I move on. The NYSE Technology fund looks like larger tech companies, so if I want to stay away from smaller, new tech companies and invest in larger more potentially stable tech companies, I might add this one.
Looking ahead down the list, there’s The Technology Select Sector etf, The S&P Internet etf, The Software & Services etf and the S&P Semiconductor etf. There may some overlaps with the NYSE Technology etf, so I’m going to compare them and see if they move in lockstep with one another and only select one that make sense for me. I personally think that Semiconductor and Technology Select are going after different things, so I’m okay with having both in my portfolio possibilities and maybe skip over the NYSE Technology fund.
The process continues looking for as much diversification as possible. I’m not expecting the S&P Homebuilders to move exactly like the Metals and Mining or Healthcare Equipment sectors. As you get to 20, ask yourself if any of the remaining etfs on the list would be better candidates than something you already selected and replace that etf with the better candidate.
Now add a Buy/Sell Engine
Now you have your portfolio candidates. I just trend follow them long on buy signals and move to cash investments on sell signals. I view the stock market as slightly upwardly biased over time due to inflation and a weakening currency, so I use 21-day indicators for the buy side and 50-day indicators for the sell side. This makes it easier to get into the long position and harder to get out. Most broker platforms will allow for enough indicators to accommodate this concept.
My exposure can go from 0% to 100% invested. It currently is running 25% long/75% cash. It takes about 6-7 minute a day to update the 40 orders for the two accounts I have running this strategy and I’m done. I will always catch some of every strong up market and I will miss some of the downside of an outsized bear in each sector.
Not surprisingly, right now I’m in Aerospace, Energy, Utilities and Metals and Mining due to the rest or the sectors suffering in the recent stock market weakness. Three of the five positions are profitable to their stops and I’m enjoying the ride!
Hi Tom,
If starting this today would you buy the ETFs that are in up trends or above the Mid point of their channels? Wait until they retouch the 21 day? Thanks for your input
Does it ever happen in your strategy that a buy signal is reached but the volatility is so high that adjusting for a proper position size to accomodate for the normal market noise make that position size so small that it doesn't reach a minimum threshold for the trade to be worthwhile?
Eg, on the post above it seems you've currently got 25% portfolio exposure with 5 positions (~ a 5% position each), but if one is trading instruments much more volatile than ETFs and the volatility is so high that the proper position size would just be a small % position (eg 1%, 2% position of the total portfolio), would you say it's worth even taking those trades (or better to totally sit out and preserve capital until conditions allow for larger positions to be taken)?