Last week, I introduced you to the ideas behind a strategy I used for managing money.
This week, I want to show you the exact trades I’d make with that strategy if I was managing money today. I’ll be updating this strategy and explaining more of the details in the coming weeks.
The general idea is to buy strength… This is hard for many traders to do.
Individuals often prefer to buy weakness. They might believe a stock that’s already fallen 50% can’t really decline much more.
The truth is, that stock can still fall 100%. In fact, it’s likely to fall further after dropping 50% because the stock is in a downtrend.
Traders should know to avoid stocks in downtrends. They say things like “the trend is your friend,” because trends are important.
Yet, many buy downtrends anyway. They ignore that trend because value investing requires buying at a discount.
Stay on the word “discount.” A discount on a sweater at Macy’s means the price is marked down from its base value. We love a discount when we’re shopping, but we also know the reason they’re marked down is the store wants to be rid of them.
The problem is that markdowns in stocks are often a sign of problems. However, investors tend to think these stocks automatically offer value, because they’re “cheaper.”
But Macy’s doesn’t discount its top sellers. The sweaters on sale are the ones that no one wants…
The same applies to stocks. The ones on sale are often the ones no one wants to buy. And we know this because sellers wanted to get out of their positions so badly that they didn’t wait for better prices. They sold into the decline so they could take their loss and move on. This tells us they believe the worst is yet to come.
Despite these facts, many traders buy downtrends… and then wonder what went wrong.
Years ago, my research showed me what went wrong.
Trends are simply more likely to continue than to end.
Think about that and you can see it makes sense. Trends last for weeks, or months, or sometimes even years. Being on the right side of the trend is the key to long-term profits.
This was the insight I used to manage more than $200 million.
A Simple, Sound Strategy
We simply picked the ETFs with the strongest uptrends.
To me, that means the ones that have gone up the most in the past six months. This might sound simple, but following this strategy beats the market. This has been known since 1967.
That’s when Robert Levy published a paper called Relative Strength as a Criterion for Investment Selection. It’s a short paper, just 16 pages and nine footnotes. The paper was a summary of Levy’s PhD dissertation.
He found that a portfolio of stocks with the highest relative strength over the past six months tended to beat the stock market. He calculated relative strength by comparing a stock’s current price to its 6-month moving average. His paper showed stocks that were trading well above their 6-month MA were most likely to continue moving higher.
Levy’s calculation is just one way to calculate relative strength. As I explained in Smarter Investing in Any Economy, there are at least 10 ways to calculate relative strength. The simplest calculation, the 6-month rate of change, was often the best-performing method of stock selection. That’s how I managed money, and that is what I still follow.
The reason for using ETFs is simple: ETFs are less volatile than individual stocks. Less subject to outlier influences, like an earnings report. Once an ETF enters a trend, it takes more for it to break that trend one way or the other.
This quality makes them dependable trades. That’s why I focused on them when I was managing money.
In the next couple of weeks, I will share new trade ideas using this precise strategy. I’ll also write about how many positions to hold and when to sell.
I encourage you to trade these ideas with small position sizes, if you’re able, to test it along with me. And let me know what you think of this strategy at TrueOptions@BanyanHill.com.
The ETFs I Would Buy Right Now
My top two picks this week are the Global X Lithium & Battery Tech ETF (LIT) and the Global X MSCI Argentina ETF (ARGT).
Both are volatile, and vulnerable to news. Lithium could fall if the tax credit for electric vehicles is changed. Argentina has careened from debt crisis to debt crisis for decades.
I really don’t know how current events will affect either of these trades… because this is based on a technical strategy rather than news. These two stocks are showing the strongest trend. Here’s LIT, for example:
Neither of these is a comfortable buy. But we aren’t seeking comfort. We’re seeking returns.
Besides, an old floor trader once told me the best buys come when you see the ticker and feel like puking on your shoes.
These two could make some traders feel that way. But they both offer potentially exceptional returns.
Editor, One Trade
Chart of the Day:
Bitcoin Is Back On!
Bitcoin is breaking out!
Let’s talk about it…
The King of Cryptos woke up last night, bucking its monthlong downtrend (purple) right after grazing its long-term support line (pink). This pink support extends all the way back to the COVID crash, when bitcoin was trading as low as $4,000. Bitcoin came close to breaking its long-term trend earlier this week.
To have real confidence in this break, though, I’d like to see bitcoin close above the top yellow horizontal, and take out $50k not long after. With a bullish cross looking fairly certain on the MACD, those odds seem high to me.
A lot of people are banking on a strong crypto surge in Q4… And this move could be what sparks the momentum. I’d add to my favorite cryptocurrencies on any dips, so long as we don’t break $40,000 in the next few weeks, and so long as bitcoin remains strong.
Managing Editor, True Options Masters