How I Used ETFs to Move $40 Million a Day

You already know about the strategy I used to manage over $200 million… now let’s talk about how I selected the right ETFs for it.

This is a conservative trading strategy, which involves maintaining a portfolio of the top-performing ETFs at any given time.

We’d start by identifying a list of ETFs we could invest in. Because we could be making trades of $40 million or more in one day, we needed to ensure the funds were liquid. (By liquid, I mean that we could place our trades without moving the markets.)

As individuals, our liquidity demands are lower. Among the smallest ETFs is the iPath Series B Carbon ETN (GRN) with about $60 million in assets. This is liquid enough for most individuals to trade, so liquidity won’t be a constraint. But for multimillion-dollar positions, it’s not suitable.

Now that we have an investment universe to analyze — liquid ETFs — we need a procedure to determine what to buy…

6-1 Momentum

Here, the rule is simple. We buy the ETFs that score highest on 6-1 momentum. That’s pronounced “6 minus 1”.

To find 6-1 momentum, you calculate the ETF’s return over the past six months and subtract the return from the past month.

The six-month return identifies the strongest ETFs. By subtracting the one-month return, we avoid ETFs that spiked higher on news and are likely to experience a decline in the coming weeks.

I calculate 6-1 momentum and sort highest to lowest. The top 10 of the list are the ones to buy.

We hold as long as the ETF remains ranked in the top 10% of the investment universe. When it falls out of the top 10%, we sell it and replace it with the highest-ranked ETF not currently in the portfolio.

To see how this works, assume we have a ranked list of 200 ETFs, based on the 6-1 rule. We buy the top 10.

The next week, the ETF originally ranked 10th falls to 12th place on the list. Since the top 10% consists of 20 stocks, we still hold the ETF at rank 12. We don’t sell until it drops to 21 or lower.

This selling strategy avoids one of the biggest problems with many trading strategies: whipsaw trades.

A whipsaw trade is one where a quick, unexpected move forces you out of a position.

Let’s look at how that could happen.

If we simply bought the top 10 and sold when an ETF dropped out of the top 10, we would have sold that ETF which dropped to number 12 in the earlier example. It’s possible it could rally back to the 10th-ranked ETF the next week. We would then have to sell another ETF to buy back the one we had sold the previous week.

By giving the positions room to make small changes in the rankings, we limit those short-term trades.

That’s the strategy. It’s simple but extremely effective.

It puts you in position to capture the biggest gains from specific market sectors, and gets you out when the conditions that produce those gains change.

Optimized Portfolio

I want to address one more question before wrapping up. Why buy 10 ETFs instead of 3 or 9 or some other number?

That’s based on a formula that determines the optimal number of positions to hold in a portfolio. Formulas like this are found in portfolio theory which isn’t a widely followed field of study.

Based on the historical performance, the formula finds the right number of holdings to maximize long-term profits when risks are considered.

The best way to maximize profits would be to buy the one ETF that will deliver the largest gain over the next ten years. To minimize profits, we could buy an equal dollar amount of each ETF in the universe.

There is no way to know which single ETF will be the best one in the long run. So, we can’t do that.

We also don’t want to minimize profits, so we won’t buy every ETF.

The formula uses the percentage of winning trades and other variables to find the optimal number of holdings.

In the case of this strategy, it’s 10. That can change over time. In the long run it does vary between seven and ten. But I always monitor performance to adapt the portfolio to the current market conditions.

That’s it. Now you know the strategy we charged well-heeled investors a 2% annual fee to participate in. It’s less volatile than the broad stock market and delivers market-beating returns in the long run, as you’ll see in the coming weeks.

Regards,
Michael Carr signature
Michael Carr, CMT, CFTe
Editor, One Trade

Chart of the Day:
Gold Isn’t Showing Up to Work

Turn Your Images On

(Click here to view larger image.)

Gold isn’t showing up to work.

What is gold’s job? Well, if you ask the last few generations of investors, gold is supposed to protect wealth during stock downturns and times of inflation. It hasn’t in 2021.

With the Consumer Price Index (CPI) up over 5% since last August, gold has fallen nearly 15% in that same span. In other words — cover your ears, gold bugs — you’ve done better holding U.S. dollars than holding gold.

And with the S&P 500 down 3% from its high, gold has spent that whole downturn just waffling around, losing 3% in the same span.

So, that brings me to the action this morning. Gold rose 1% on the bad jobs report and it’s making headlines.

Well, I don’t buy it. Gold is in a downtrend unless it breaks its local high at around $1,800. It’s clear as day on the chart.

If you want to keep holding physical gold, knock yourself out. I think a tiny exposure is appropriate and will always be relevant.

But if you’re looking to trade the gold stocks — a volatile bunch — I’d say you’re looking to buy put options around the $1,800 handle.

Regards,

Mike Merson
Managing Editor, True Options Masters

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