My apologies, I was been pretty quiet last week. I was on vacation and I failed to put enough articles in draft! I guess this is what happens when you take back-to-back vacations right after the Holidays!
So today, I’ll continue my series on trading ETFs using a moving average. Back in January, we explained what the moving average is with an example. Today, we will see how to use this technical analysis tool.
What is the purpose of trading ETFs using a moving average?
As you know, an ETF is a group of stocks or commodities created in order to replicate a specific index. It can be bonds, a stock market, a sector or simply a commodity (such as oil or gold). Since they are not guaranteed, ETFs are subject to fluctuations. As an investor, you want to capture the gains and avoid important losses. While this seems like a perfect trading fit, it is almost impossible to achieve since we don’t have a crystal ball. However, it is possible to use the 200 days moving average to predict important ETF movements.
Therefore, it becomes easier to capture ETF gains and avoid most of the losses.
A practical example of trading an ETF using a moving average
I’ll continue with my ETF example from the previous post and will work with a graph of the past 5 years of the SPY, an ETF following the US stock market.
SPY ETF Graph:
Trading according to the moving average is pretty easy. In fact, you have to follow 2 simple rules:
#1 Buy the ETF each time the ticker price crosses the 200 moving average in an up trend.
#2 Sell the ETF each time the ticker price crosses the 200 moving average in a down trend.
Trading ETFs has never been so easy, right?
So following the same graph, here is where you should have triggered a buy (green circle) and a sell (red circle):
As you can see, this technique allows you to capture most of the gains while avoiding most of the losses. But how come you can simply trade ETFs according to such a simple rule? While the technique is not perfect, here’s the reasoning behind it:
Understanding how to trade ETFs according to the moving average
The stock market can be compared to a huge stomach: it gets all kind of information and it tries to separate the good from the bad while digesting. Based on the moving average definition, it shows the average ETF price for the past 200 days. In other words; it shows the strong trends of the ETF. Therefore, if the ticker price at closing crosses the 200 moving average in a up trend, it confirms that the price is pushing strongly in a up trend. Hence, chances are that we are in a bull period.
Since there is a huge psychological factor in trading, trends are very important. When an ETF starts going up, it gathers more and more attention. Then, more investors buy it and the price keeps rising. It is the same thing when investors hit the panic button and start selling.
Going back to the graph, you will notice that this method would have helped you make good returns while avoiding most of the downfall. In the upcoming post, I’ll push the example a little bit further by providing a full ETF asset allocation model trading with the moving average.