Sticking to the Plan When It Comes to ETFs

By Tom Lydon | July 21, 2008 | 10:32 AM | 1 Comment

Last week's downward fall in oil illustrates something that's key for investors to remember: sticking to the strategy.

Our strategy when it comes to exchange traded funds (ETFs) is to get in only when a fund is trading above its 200-day moving average. When it falls below that point or 8% off its recent high, we sell. As often has been said, buying is easy. It's the letting go where it gets tricky.

How do you do it after a run like the one oil has when it suddenly falls more than 11% in a week? The questions start coming fast a furious: is oil a bubble? Will this week be better? Will it fall further?

Easier said than done, but as an investor, drowning out the noise is imperative if you want to protect your profits - which might be considerable depending on when you got in. Many, many investors fell prey to this rationalization back in the dot-com crash, hanging on, hoping against hope that their Pets.com or Webvan stock would pick it up again and start delivering the returns.

It's not the end of the world if you have to sell, however. Sure, you might miss out on gains if your holding turns around. But you've protected your profits, and you have money you can use to get back in. It might be at a higher price, but what's worse? Losing everything, or paying a little more to re-enter the market?

Money Coach Alvin Hall once pointed out that many investors don't have the strength to take their thoughts and feelings out of when they enter and exit the markets. But we say that with practice, you can do it. You only need to see that exiting after an 11% loss is far better than exiting at a 40%, 50% or even a 90% loss. It's all relative, right?

Your stop loss point is a matter of your own tolerance. We like the 8% because it enables us to ride out any of those wacky whipsaws that would cause us to sell frequently if our point were lower, for example, at 5%. On the other hand, it also gets us out at a point where we protect what we've made and guard against greater losses that would happen if our sell point were 20% or 30% off the recent high.

Check out Tom's new book iMoney here. 

Tom: You make it sound so Tom: You make it sound so easy but by your analysis you would have entered USO (the oil ETF) back in June, 2007 as it closed above and below its 200 day moving average; we will give you the notion that you stayed with your position despite the whipsaw. Then you would have exited your position about 2 months later in August, 2007 when USO pulled back greater than 10%. In effect, you would have taken yourself out of a winning position because crude oil/ USO went on to double over the next 8 months. So you may have sold on an 8% pullback, but when did you get in once you sold your position? If you only get in at the 200 day moving average, then you would still be sitting on the sidelines. I wish it was so easy or are we benefiting from the technician's favorite tool -let's look to the left for the past 6 months and assume that it always works that way? Submitted by Guy M Lerner (not verified) on Mon, 2008/07/21 - 11:21pm » reply |