ETF Update: Gaining Trading Discipline in a Time of Turmoil

by: Jeff Miller

When there is news that seems to be dramatic, it creates a stressful environment for traders and investors alike. Everyone should analyze the fundamentals of the situation, as we did on Friday.

It is also helpful to have a system. Understanding your own method is the key. It requires a level of system development and testing where you have real confidence. Our own method is not geared to turning points in the market, but it reacts pretty quickly to key changes.


In our disciplined system, we study sectors continually, looking at the charts and ratings for hundreds of ETF's. Each week we provide a list of our top-rated sectors for the next three weeks, along with some of our current observations. ETF investors can check out the list and compare our findings with their own conclusions.

In our analysis, we consider Trends, Cycles, and a bit of Anticipation. Since we apply the model to nearly 300 ETF's, we call it the TCA-ETF system. (For new readers, there is a more complete description of our methods at the end of the article. We also have a free report with more detail on the system and results, available on request.)

The model also provides a nice feel for the overall potential of the market. I'll take a look at the macro picture first, and then take a look at our featured sector of the week.

The Macro View

From an overall market viewpoint, our indicators have improved. The key elements are as follows:

  • 80% of our ETF's in positive territory ( up from 55% last week). The median strength rating for the overall list is a plus 18 (up significantly from +1 last week). A score of "0" implies the average long-term ETF expectancy.
  • Only 27% (down from 97%) of our sectors are in the "penalty box." This means that they are currently disqualified from the buy list for technical reasons. You can think of this as a sophisticated "stop loss" rule, often applied in advance. See our article here for a further explanation of this method. We implemented some faster filters this week, accelerating moves both into and out of the Penalty Box.
  • Our index package is positive. For this rating we look at the ETF's (both long and short) for the S&P 500, the Dow, and the Nasdaq. You can see these ratings is the results table for this week.

Spotlight on Dubai

It was a week of turmoil. Occasionally breaking news seems more important than trading fundamentals. This is especially true in a holiday week, where thin, half-day trading exaggerates the impact.

Looking at Fundamentals

There are many different ways of interpreting the news depending upon one's method and time frame. There were plenty of instant experts on Dubai. At Abnormal Returns, the go-to source when you want viewpoints on current issues, you can find the expected arguments. These range from those who foresee a massive sell off to those who view the problem as "contained." (Someone needs to find a synonym for that word in a real hurry!)

Abnormal Returns serves up the best arguments from all sides, and then it is up to you. That is fine for a certain audience, which includes those looking for assurance that their current position is correct. Many readers need more, including some interpretation of the conflicting analysis. David Merkel wrote a thoughtful analysis and also included some good links. His conclusion is mixed.

Jim Bianco, writing at The Big Picture, emphasizes the importance of the timing of this issue. His nice article includes capsule summaries of many mainstream media pieces.

My own Friday piece may be useful for those trying to interpret the news. I attempted to highlight the actual analysis and how to interpret the actual trading by following the dollar. If you are not really an expert on Dubai, why pretend? It is better to evaluate the arguments and issues.

In my own review, I was troubled by several prominent bearish arguments:

  • The market reaction showed the inherent fragility. In fact, the market reaction was little more than normal volatility, especially in thin trading.
  • The dollar would have a flight-to-quality, leading to major stock selling. Actually, the dollar spiked at the opening and sold off rather quickly. The dollar lost ground to the Yen, but DXY is still in the range from the past week.
  • The dollar carry trade is about to unwind, and the market could crash. I am really trying to pin down how the cross-currency carry trade relates to US equities. There is a generalized claim about "printing money", borrowing at zero percent, and buying "risk assets" which are deemed to include stocks. I am still looking for the specific mechanism for borrowing at zero percent and buying stocks. I invite reader enlightenment on the specifics. (I wrote about the correlation, but there are many conflicting reasons for that.)
  • Most of those advancing these arguments have been looking for such signals for many months. There is a natural "reach" for any evidence.

On the other side, there seem to be many reasons to view this problem as a matter for lenders and backers, in an amount that is small compared to their assets. A solid analysis of other areas that are real-estate dependent would be most welcome.

Looking to Your System

An important check on one's fundamental analysis comes from actual trading. Our TCA-ETF system helps us in this way.

By looking at actual trading -- not just the immediate reaction, but data over a few sessions -- one can learn the market verdict. There is an important lesson:

Even if you are correct in your fundamental assessment, the market may disagree.

In such cases it may be better to live to fight another day. Meanwhile, our method smooths out the trading blips from a day or two. It remains bullish, and we will watch to see if the verdict changes.

Weekly TCA-ETF Rankings

We got back into the market this week, and the timing was not good. The S&P was about even while we lost some ground (two percent), especially since foreign markets did not catch up on Friday. We expect more accurate marks on our foreign ETF's on Monday.

We provide these ratings as information for readers who may not trade as frequently as we do. Those signing up for our free weekly email update can also get the entire list.

As noted above, the macro market indicators are in the penalty box, and most other ETF's are in the penalty box. Based upon the current model signals, we have moved to a bullish posture in the Ticker Sense Blogger Sentiment poll.

Here are the top sectors from our expanded universe of 280 ETF's. The list also includes the values for the broad market ETF's and their inverses. While the list is, as usual, from the prior day's close (Wednesday), the Friday output is not dramatically different.


Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation. Before turning to the current rankings, let us undertake a review for readers new to this series.

Our Method. In this past article, we described our basic methodology and why we believe the rankings are useful for fundamental traders and technical traders alike. While we urge readers to check out the entire article, the key point is that ETF's pose challenges and opportunities different from investment in individual stocks. The fundamentals may be more difficult to assess. Even with a good grasp on fundamental trends, there is a lot of technically-based trading in ETF's. This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves. Here is an article on that point.

The system synopsis. We look at Trending sectors, Cyclical Sectors, and build in an element of Anticipation for both entry and exit -- thus the name of the model, TCA-ETF. While we do not reveal the exact methodology for spotting trends and cycles, the system is not a "black box." The basic elements are used by many, and widely reported. We even discuss the need for human analysis as opposed to black box trading.

We report the rankings each week, now on the weekend with a one-day delay, using the Thursday output from the model. We monitor and trade this daily, and offer a free report (request via the email address on the top left of the site) for those interested in our weekly trading program.