Trend following trading with exchange traded funds (ETFs) is fast, easy (and in some cases free)! But there are also some expensive errors you need to avoid. So…
In this article, you’ll learn everything you need to know about how to follow trends in the stock market using ETFs. Sound good?
I think the easiest way to broach this topic is probably with a quick and easy pros and cons list. That way you can learn about the good and the bad for yourself. So let’s dive into it, shall we?
Pros of Trend Following with ETFs:
– Trend following with ETFs let’s you access different markets and sectors. This is probably the biggest benefit of trend following with ETFs for do-it-yourself stock market investors. Whether you want to invest in a particular market sector, a given commodity, or even a currency, ETFs make it all possible. This can be a huge advantage for individual investors because it allows you to tackle all kinds of different trends right from your brokerage account. This avoids the complexity of managing your exposure across multiple different account types. For that reason, ETFs present a great opportunity for individual investors who want to jump on an uptrend or downtrend.
– Many online stock brokers offer free ETF buying. And as you probably know, in the game of investing, keeping your fees low is more than half the battle. So if you can cut your commissions in half by buying ETFs for free, then you’re well on your way to trend following success. Just be sure you don’t buy and hold ETFs with high management expenses. Make sense?
But you should also know, trend following with ETFs isn’t without risks. So to balance our view, let’s take a quick look at the downside of trend following with ETFs. It’s important you thoroughly evaluate the risks of your investing.
The Cons of Trend Following with ETFs:
–Liquidity for certain markets can be limited. If you’re buying an obscure ETF you may want to keep an eye on trading volume and bid/ask spreads. Any advantage you get from commission free buying can be lost in slippage, if you aren’t careful. For thinly traded ETFs you probably want to use a limit order.
–ETFs don’t allow for fundamental analysis. Of course for traditional trend following this isn’t a problem. But for my intelligent trend following approach, I like to focus on only the best fundamental stocks that are trading at a discount to a conservative estimate of intrinsic value. This helps put the odds in my favour. But when trading ETFs that represent a large basket of stocks or a given commodity, it’s almost impossible to do basic fundamental analysis. This is a big reason ETFs only make up a small portion of my trend following portfolio.
–Never buy and hold levered ETFs. This is a very common and very expensive mistake that a lot of novice traders and investors make. The reason you should never hold a levered ETF for more than a few days is because these ETFs use futures contracts to try and replicate the DAILY performance of an underlying asset class. They aren’t long term instruments. They are designed for very short term hedging or speculating. So if you hold these levered ETFs for more than a week you are almost sure to see your buying power decay. Got it?
So as you can see, trend following trading with ETFs has upsides and downsides. But hopefully, now that you’re familiar, you can better incorporate ETFs into your trend following trading.
And of course, if you want even more help getting a leg-up on the market, I encourage you to read more about my intelligent trend following newsletter and alert service. It’s a great way to see smart trend following in action. Could it be right for you?