From the July 01, 2010 issue of Futures Magazine • Subscribe!

The ETF Trend Following Playbook

The ETF Trend Following Playbook:
Profiting from Trends in Bull or Bear Markets with Exchange Traded Funds
By Tom Lydon
FT Press
$24.99; 205 pages

Since their introduction in 1993, the number of ETFs has mushroomed to more than 800 with a value approximating $710 billion, but it is still a small percentage of assets compared to mutual funds. Lydon recommends that investors take a pro-active simplistic role in managing their portfolios by investing in ETFs when the market trend is positive. This can be ascertained, he points out, by using the 200-day simple moving average (sma), as the critical indicator for making ETF buy and sell decisions. In essence, he believes that buy-and-hold is dead based upon the recent devastating market losses in the two severe bear markets since 2000. Moreover, the author points out that there have been a number of long-term periods where the market has made no progress in price appreciation such as 1929-1942; 1966-1982; and 1997-2009 (the S&P 500 index dropped about 0.4% a year on average during this period). So, he concludes that buy-and-hold has its shortfalls.

In one early chapter, Lydon focuses on assessing the market’s trend using the 200-dma as the key indicator, where a buy signal occurs when the price crosses over the moving average from below. Likewise, a sell signal occurs when the price crosses the moving average from above. Lydon provides a few charts showing the S&P 500 index for two time periods – 1930 to 1970 and 1970 to 2008 – with the 200-day exponential moving average (which weights the more recent data more heavily than a simple moving average). Unfortunately, the two charts are small and are both printed on the same page so it is not clear where all the price crossovers occur. Using a chart with fewer years or each on separate pages would have made the viewing much easier. Lydon never discusses why he selected the 200-day sma as opposed to another timeframe or exponential average. Surprisingly, there was no mention of using specific stop loss orders or trailing stops to protect profits.

Using a single indicator such as the 200-day sma to make buy and sell decisions certainly is a simple approach and provides better risk-adjusted results than buy-and-hold. The author then provides data for the period 1930-1970, illustrating that a $100,000 initial investment in the S&P 500 index resulted in an average annual return or 3.75% for buy- and-holders compared to 7.51% for the moving average approach. Likewise, for the 1970-2008 period, the returns were 6.19% compared to 7.86%, respectively.

The bulk of the book concentrates on providing basic information on ETFs that is available from many other sources in much more detail. He prefers ETFs to mutual funds for many reasons which he explains. A short description of the 16 largest ETF companies is provided along with their websites. Moreover, he provides a handful of useful websites for ETF analytics, providers and charting.

There are two back-to-back chapters reviewing the U.S. and international major indexes and ETFs. Then he shifts the focus to discussing the best-looking ETF sectors, but only mentions a handful of them such as utility, healthcare and financial. Interestingly, he neither mentions the S&P SPDRS nine index ETFs nor other sector ETFs. He also does not mention any methodology to select the “best” sectors or how to construct a portfolio of ETFs with recommended allocation for different investor risk parameters. Lastly, Lydon reviews ETF choices for commodities, currencies and fixed income, including some pointers on leveraged ETFs.

In summary, this book offers an overview on investing in ETFs using the 200-dma as the buy and sell signal criterion. It is best suited for new ETF investors and for those looking for a simple trend following approach. A glossary of terms and resource and reference material was a useful addition. For those investors looking for more detailed information on ETFs, I recommend the author’s previous book, “iMoney: Profitable Exchange-Traded Fund Strategies for Every Investor.”

Leslie N. Masonson is the author of "Buy DON'T Hold" and “All About Market Timing.” Reach him at lesmasonson@yahoo.com

Comments
comments powered by Disqus
Check out Futures Magazine - Polls on LockerDome on LockerDome