Friday, December 4, 2009

Getting A Handle On ETF Trading Strategies

By Patrick Deaton

As an investment vehicle that can promise a consistent -- and sometimes exceptional -- rate of return on investment (ROI), exchange traded funds can really deliver. Getting a handle on ETF trading strategies will be necessary, though, before jumping into investing in ETF's in any meaningful way. There are a few things to know, first of all, about exchange traded funds.

In a way, an ETF is similar to a mutual fund in the way it is constituted and run by a fund manager. Usually, though, almost every exchange traded fund limits its membership to what are known as institutional investors. This means large investors capable of buying and selling big blocks of stocks known as creation units. There are ways, though, for small investors to get in on the action through a trading system.

Imagine corporate stocks and how they are traded or bought and sold and you will have a good idea of how exchange traded funds are also moved through the markets. Almost every exchange traded fund establishes its operations so that it can track one or several of the major market indexes. For example, many track the S&P 500. This makes it easier to follow trends and set up trading strategies.

There are more strategies out there that can probably be counted, though they usually fall into a couple of major categories; fundamental and technical. For those with the savvy, or patience, to sit down and learn technical strategies, the rewards can be quite lucrative. Most traders using technical indices believe they can discern patterns or shapes in a stock chart, basically.

For those with the ability to pick out shapes and patterns in market movements -- by analyzing a stock chart -- the possibility of good income is very real. These movements can signal upward and downward movement in markets that can be timed through technical analysis, with the correct buy and sell orders put in at the right times.

One of the most common technical trading strategies used by many traders is what is called a "moving average cross." Moving average crosses try to match up a short-term evolution in the price of the stock and superimpose that over a long-term trend in that same stock or market. By tracking a short-term up-and-down movement over-- to 25 days, it may be possible to establish a moving average line.

After that moving average line has been created, most traders will superimpose that over an analysis of the short-term movements in an attempt to discern the actual movement the price of the stock or stock held in the ETF will take once it crosses the moving average line. Long-term trendline analysis, which is the second element, takes a 50 day moving average, which can damp the short-term trend.

In this way, ETF trading strategies involving the long-term trend can be used as what industry experts call a "moving support line." A typical strategy by most traders in this instance would be to purchase a stock or an asset in the ETF when it is in the beginning of an uptrend or if the stock price goes back up after it either touches or barely penetrates the 50-day moving average. One could short the stock also.

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