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Profitable ETF Trading Strategies: understanding the stealth trade


Behavioral psychologists have pointed out that people do not act like rational actors when it comes to investing and trading in the stock market. In addition to fundamental factors like the business cycle, there appear to be psychological motivations at play that help to explain market performance and price fluctuation.

A short term or intermediate-term trader can take advantage of the power of human psychology to improve their trading practice with respect to timing market entry and exits.

One strategy that can be very useful is the idea of the stealth trade.

The stealth trade occurs when a market sector that is represented by an ETF for example, is in a position where it is no longer the worst performer in the market but has not yet rebounded strongly enough to be considered as a new headline story.

Newspapers, magazines and television shows that cater to traders make their money with exciting news stories and headlines. Headlines sell advertising, so there’s always a hunt for the newest and most interesting story.

Consider what might happen to a sector such as semiconductors that is beginning to outperform all other market segments dramatically. The headlines will talk about semiconductors as the way of the future and momentum money will chase this sector until there’s nobody left to buy. Semiconductors will then be at an intermediate high and then begin to lose ground as people try to lock in profits or avoid further losses if they are the latecomers to the party.

Once semiconductors have lost their shine and are beginning to descend back into the pack or lower, they are no longer news and no one is talking about the. They will probably continue to fall until they find something like a natural level where only value players are interested. There may be some headlines concerning semiconductors if they achieve bottom rung status by being the worst performing sector available. That is news  and they will be back in the headlines.

Now suppose that they have started to attract value investors. Because of their buying pressure, the panic selling will be clearly over. There’s nothing exciting about semiconductors anymore as they start putting in a bottom. Institutional money is probably quietly buying at these price levels in such a way as to avoid attention. Only after semiconductors have started to move back into the pack will you start to see headlines about the rebirth of semiconductors.

The trading psychology cycle will begin once more. Institutional money which acquired semiconductors at a value price is now unloading those positions in measured amounts to momentum money that is chasing the sector once more.

The stealth strategy then is simply trying to find the sectors that used to be the worst performers which are now not quite so bad but before they have become headline news one. Still traders are acting like institutional money, taking the other side of the trade from the masses.

This is an attractive way to use ETFs since you are able to offset or avoid individual company risk while playing the larger macro economic trends.

The difficult part of the stealth strategy is in selling a position that is now finally beginning to catch fire and you should be selling to momentum money. The temptation is always to overstate your wealth of insight that sector but this is a nice problem to have.

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