ETF Core Strategies
Aim: To trend-trade general equity ETFs so as to ride rallies and buck busts in the Australian share market.
A special report on online trading in the Australian Financial Review (16.6.10) said market experts estimate that less than 20% of frequent traders break even while only about 5% can make a decent living. The rest lose money.
That’s why we at MarketTiming urge you not to be a daily or swing trader focusing on individual stocks, but become a slow trader concentrating on exchange traded diversified equity funds such as STW or VAS using trend following principles that work for anyone who adheres to certain rules.
As a slow trader (i.e. market timer) you position yourself between the two polar extremes of aggressive trading on the one hand and passively buying and holding shares on the other. Aggressive trading like gambling makes a few professionals very rich, but impoverishes the majority of players. Buy and hold promises a roller coaster ride which few can stomach. Also it assumes that despite turbulence the market always grows which is not true(e.g. a set and forget approach to shares has been very costly for American and European investors in the past 10 years and for Japanese investors for the last 20 years).
By contrast investors using trend following systems have made strong capital gains in all share markets by riding the upswings and sidestepping or shorting the downswings. Because the developed world is drowning in debt which could take decades to fix many experts warn that the future won’t be a replay of the golden age from 1982 to 2000 (which thanks to a commodity boom extended to 2007 in Australia) when a buy and hold approach to shares delivered high capital gains.
Those years saw markets surge in response to falling interest rates and credit fuelled earnings growth. From here on interest rates will either stay low or rise and stricter bank controls and debt deleveraging will put a damper on economic activity. Hence the most likely scenario is one of very volatile share markets as investor sentiment swings between hope (that the worst is over) and despair (at the slow progress in unraveling the debt overhang).
Richard Koo, a Japanese expert on balance sheet recessions, uses the Asian analogy of Yang (bright, hot, expansionary and strong) and Yin (dark, cold, contractionary and weak) to explain what is happening to developed economies.
The Yang phase was marked by a credit fuelled spending binge which is now being followed by a Yin phase requiring a belt-tightening savings drive.
The dotcom share bust of 2000, the housing bust of 2006, the banking bust of 2008 and the sovereign debt crisis of 2010 represented tipping points in asset price bubbles fuelled by excess debt. The great deleveraging that has intensified with each bust has forced most developed economies to shift from Yang to Yin. That requires a new mindset to managing your share portfolio since buy and hold works only in a Yang phase.
By contrast market timing based on trend following works both in Yin or Yang phases. That’s because in good times it keep us in rallies while in bad times it keep us out of busts.
But to succeed at market timing requires objectivity and consistency. This involves:
1. A System – Have a system that gives you a proven edge. Only trend following has the empirical backing to show that it not only beats buy and hold, but does so with less risk (i.e. downside volatility). The reason it works is that markets trend around 70% of the time. Identifying a trend and running with it until it changes course is the essence of market timing. That’s not something you do by following the news, listening to market opinion or subscribing to stock market tip sheets interesting as they may be. Instead it requires monitoring technical trend and momentum indicators that tell you what the market is actually doing not what participants think or want it to do. You don’t have to invest time and money in developing and back-testing a computer model to do this if you subscribe to a service like MarketTiming that does it for you.
2. Discipline – Have the discipline to stick to a strategy that exploits this edge. At MarketTiming we offer you one timing strategy or plan – a Conservative one that captures only large waves. You might think that the Active cycle makes the most sense because it captures all cycles and in the long run has proven the most profitable. That’s true, but its downside is that it also captures a lot of small cycles where the price at which you sell out proves lower than that at which you buy back because the market has whipsawed (i.e. reversed trend before any profits or savings could be made). For instance since the bottom of the crash in March 2009, the Active Strategy has been whipsawed more often than the Conservative Strategy. For this reason you may want to adopt two strategies because when one is lagging the other will be leading. That will make you less anxious than putting all your money on one strategy which might have a poor run before its inbuilt edge ultimately wins through.
3. Fastidiousness – Don’t switch strategies just because one is doing better than the other. Think of market timing strategies as entrants in a race where each paces itself differently before taking a break and then resuming the race. The Conservative Strategy will tackle longer stretches. At different times one strategy will be doing better than the others. For instance the Conservative Strategy will have the least pit stops. If you are backing the latter but then switch to the former because it sprints ahead, don’t be surprised if you lose money as it suddenly stops for a breather. If you can’t stick with one strategy better spread your odds over two as discussed above. Then you should always have a winner in the race and in the long term be ahead in any event since all strategies have one thing in common – they have an edge over buy and hold.
4. Perseverance – Stay committed to market timing through good and bad times. Trend following doesn’t beat buy and hold all the time, but history shows it does so decisively over the long run. The biggest mistake is to abandon market timing when you have had a string of modest trading losses..
5. Loyalty – Staying loyal to trend following means putting your trust in its edge (i.e. odds of winning over time) rather than being swayed by market sentiment which is shaped by news, opinions and herd instinct. It’s human to take notice of what others say, especially if they are so called market experts. But trend following means heeding market realities not personal opinions. It means respecting what the market is actually doing, not what you or others think it might do. When it significantly changes direction our computer generated signals do so too. If you try to outguess the signal you will come asunder since you are taking a position before the market has sufficiently changed course to warrant it. And remember Mr. Market enjoys nothing better than doing the very opposite of what your research or instinct tells you he will do.
6. Dispassion – Become a mechanical slow trader who concentrates on the process of methodically enacting market timing signals rather than worrying about the outcome of each trade. Have the confidence that you are trading with an edge over buy and hold, but only if you obey every signal. Every time you skip a signal you reduce your odds. By all means read and listen to financial news, but use it to explain what’s happened rather than try to guess what you should do next. Whatever your own outlook, always obey the signals since they are telling you what the market is actually doing, not what you or others think might happen. When it comes to risking your savings in the share market don’t let your mind, heart or gut (let alone ego) stop you from acting like a robot that always obeys the signals. Only by keeping your emotions out of it will you prosper.