The ETF Discipline is my name for an investing method
similar to what traders call a “system.” The goal is to hold
the best-performing lowest-volatility exchange-traded
funds (ETF’s) in bull markets and to protect the portfolio
from large losses in bear markets. Disciplined investing
consists of four elements: time frame, trading vehicles, a set
of rules, and emotionless execution.
What We Buy
In today's choppy markets, we look for trends that typically
last weeks to months, making our decisions on 6-month or 1-
year daily charts. We choose funds as opposed to stocks,
because, not being affected by individual company news,
they offer most of the performance and less volatility. After
2006, we abandoned mutual funds for ETF’s because of
high fees and costs, and the inability to buy or sell them
during the trading day, a major disadvantage in today's fast
markets.
When We Buy and Sell
The ETF-Letter scans for top-performing, not-too-
volatile ETF’s and monitors about 80 that cover most
market sectors. We buy when we find qualified uptrends
and hold while the trend lasts or breaks sideways. When the
trend points downward, we sell. We may also choose to hold
certain funds in downtrends and preserve their value by
buying put options.
We precisely define uptrends and downtrends using support
and resistance levels to identify when transitions take place
and determine where to set buy and sell stops. The details
are explained in my book, The X-Discipline: Financial
Independence for the Web-Savvy Investor. (“X-Discipline”
has morphed into ETF Discipline).
The Secret Sauce: Sentiment and Execution
Just kidding. There is no secret sauce; however, investors
often mistake the mechanics of charts and trends as the
only keys to success. Successful traders and investors have
learned that investing is personal, and understanding
market sentiment gives you an edge, because it
determines how markets react to news events. We assess
sentiment each week in the ETF Letter.
This disciplined process works to reduce the emotions that
come from putting your life savings at risk. Emotions
drive you off your plan, leading you to buy and sell at
the worst times. Disciplined investing controls
emotions by establishing known entry and exit prices and
limiting the risk of every position. You learn to invest in
ways that let you sleep at night.
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Click Charts to Enlarge
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Each successive rally brings out new leaders. The ETF-Letter
uses relative strength charts to identify the best-performing
funds, moving our portfolio to where money is going.
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We use trends, support, and resistance to identify when to
sell. The fund above gave ample signals well before it crashed.
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Funds can equal the performance of an individual stock, but
are much less volatile, as shown in this relative strength chart
of an airline industry mutual fund and a single airline.
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