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Four Keys To Investing Success In Today's Volatile Markets

By Leland B Hevner

In over a decade of teaching personal investing I have never seen the market so fraught with both promise and danger. And I have never seen individual investors at such a loss on what to do.

A market that falls 50% and then rises 50% in the span of a little more than a year is uncharted territory and unfortunately the investing public is not prepared to handle volatility like this. In these unique times, it has become apparent that many conventional investing methods no longer work, buy-and-hold being one of them. A new, more proactive approach to personal investing is needed.

What problems do we need to solve? First, the world of personal investing today is too complex and confusing. We are overwhelmed by the sheer volume of information and the number of investing choices. Second, we are forced into a risky buy and hold strategy because we don’t know when or how to adjust our portfolios on our own. Third, many of us don’t have a lot of time to devote to the investing process. And finally, because of these barriers we simply let financial advisers take charge of our financial security. This is not acceptable. You must regain control.

The first step toward this goal is to open an account with an online broker. This enables you to change your portfolio at any time from the comfort of your home and gives you the tools needed to implement the four keys to a better investing approach.

Key 1. Use ETFs. We must reduce the complexity of the investing world without sacrificing returns potential. Fortunately an investing vehicle called an Exchange Traded Fund (ETF) enables us to do so. ETFs hold baskets of stocks or bonds just like a mutual fund but can be traded like stocks. An ETF exists for just about any market index. So, for example, you can buy the entire stock market using SPY, an ETF that holds all of the stocks in the S&P 500. You can own the entire bond market with AGG or invest in gold using GLD. Using only ETFs you can build an efficient portfolio by buying one ETF for each of a diverse set of markets. I suggest considering these markets: Total U.S. Stock, Total Foreign Stock, Total Bond, Gold, Energy, Agriculture Commodities, Real Estate and Emerging Markets. With one ETF for each you will have only eight investments in your portfolio and they need never change! No more sorting through thousands of stocks, bonds and funds. The world of investing just got a lot simpler.

Key 2. Use Charts. Working with only eight investments you can focus on when to buy and sell. For each of the ETFs you consider, bring up its price chart using your online broker’s tools and look at the price trend. You can detect the trend by simply “eyeballing” the chart or by using a simple moving average line. For example, if the price line is above the 50 day moving average line then the intermediate trend is positive. I also like to check if money is flowing into the ETF or out. A simple indicator called On Balance Volume tells you this at a glance. When you initially set up your portfolio only include only ETFs currently in a price uptrend.

Key 3. Use Trailing Stop Orders. After buying an ETF you need to control the risk of owning it. This is easily done using an order type called a Trailing Stop. Here’s how it works. Let’s say you want to buy SPY at the current price of $100. You would place a market order to buy at $100 and at the same time set a trailing stop of, say, $8 (you can also use a % stop loss). Now, if the price drops to $92, without first going up, the system automatically sells your position at $92. But if the price rises to $110, the trailing stop moves up with it to $102, maintaining the specified $8 drop. Yet if from $110 SPY’s price moves down to $106, the trailing stop stays at $102. This is the beauty of a trailing stop; it goes up but never down. In this manner it limits losses and lets profits run. To determine where to place a trailing stop look at the ETF’s price chart. Choose a stop loss amount that is outside the range of normal daily volatility.

Key 4. Use Automated Alerts. Virtually all online brokers offer an automated alerts capability that sends you an email when certain conditions are met. Use alerts for two purposes. The first is to take profits. Using our example from above, if you buy SPY at $100 you may decide to consider taking profits if it gains 8%. You can set an alert at $108 and when SPY hits this price you will get an email. This will prompt you to look again at the chart to see if the price trend is still positive. If not, sell and take your profits. If so, you may leave all, or a portion, of your position in place and simply increase the alert price. The second use of alerts is for ETFs that you did not initially put in the portfolio because they were not in a price uptrend. You can place these in a “watch list”, offered by virtually all online brokers, where they are automatically monitored. For each ETF you can be alerted when its price starts to move up. A simple alert condition would be “send me an email when the price line crosses above the 50-day moving average”. This will prompt you to look at the price chart and decide if now the ETF is a “buy”.

This new approach accomplishes our goals. We reduced the complexity of the investing world by working with only 8 specific ETFs. We made the purchase decision easy by looking at trends on simple price charts. We limited the risk of each purchase without sacrificing profit potential by using trailing stops. And we don’t spend a lot of time monitoring the portfolio after initial set up as we only need to pay attention when we get an email alert.

Now you have the tools and approach to take advantage of rising markets while avoiding downdrafts. You are empowered to regain control of your portfolio.

Leland Hevner is a leading figure in the world of personal investing education and has been for more than 10 years. He teaches personal investing classes at the college level and has written 12 investor education publications. He is the founder and president the National Association of Online Investors (NAOI). A noted media source, Hevner also provides consulting services to financial organizations around the world. He is the author of The Perfect Portfolio: A Revolutionary Approach to Personal Investing.

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