Monday, June 29, 2009

Mistakes even the best of us make: Not keeping the trading vehicle in mind..

Reading Wall Street Cheat Sheets excellent article on beginners’ trading mistakes today inspired me to write this little thought dump for all of us to benefit from, beginner and expert traders alike.

1) When I first joined Stocktwits in the beginning of April 09 many traders were using technical analysis on the Direxion Triple ETFs, which reflect triple the daily price movements of indices of specific sectors or markets. FAS and FAZ of the triple financials were favorites. The issue arises from the fact that the math behind the movement of these vehicles creates false chart patterns and misleading technical indicators. These ETFs will not return to the same values when the underlying index does due to the asymmetrical up and down movement of the ETF prices. This is one of many issues that make these ETFs not amenable to technical analysis. For further details refer to the prospectus of these ETFs. Hopefully this will save people some money and agony.  There is an art to trading these leveraged ETFs in addition to day trading vehicles, and I may do another post on how to trade these.  Meanwhile, if your money manager is someone who held these for a long time for whatever reason, consider getting another money manager is not responsible enough to manage your money. 
Only use the underlining index of these triple ETFs for charting and technical analysis.

2) The second and most recent issue that is popping up on stocktwits is related to commodity ETFs. The issue comes when traders look for the ETF volume as a valid TA signal especially during a chart breakout as we do for stocks. This is not correct as the volume of the ETF trading vehicle simply means that more traders are interested in buying the ETF itself and does not in any manner reflect the economics of supply and demand of the underlying commodity (volume of the ETF may inadvertently cause pricing issues for the commodity, but this issue is not the scope of this article). Simply said: Volume breakouts of an ETF chart bears no information other than interest in the ETF itself.  The only information that is relevant in TA is the actual commodity price and chart when evaluating your ETF purchase based on TA.
Study the underlying commodity for TA to trade the corresponding ETF and not the ETF charts themselves.

I hope this was educational and helps clear up some of the common misunderstandings of trading ETFs. I usually tweet my stock research around midnight Pacific time, but you can always find my setups on stocktwits and sometimes charts posted on when time allows.

Peace & profits to all,

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