How To Trade ETFs On Their Highs
Recently the SPDR Dow Jones Industrial Average (DIA) hit new all-time historical highs and the investing public largely yawned over the feat. It has been over five long years since DIA hit its last all time high back in 2007 and we all know the roller coaster ride that has ensued since the 2008 debt crisis and subsequent recovery. Most of the rebound over the last 4 years has been attributed to aggressive quantitative easing by the Federal Reserve which has kept interest rates artificially low and money cheap.
The question now though is: Is it time to ring the cash register and go to cash or stay in the game?
If there are two lessons' I have learned over the last 5 years, they are: (1) Don't fight the Fed and (2) Don't fight the trend. Right now the long-term trend in stocks is still clearly intact and therefore I would not be aggressively selling positions to raise cash until we have something substantive to be alarmed about.
There is no sense trying to pick a market top as long as stocks continue their winning ways. I have seen portfolio managers try to pick market tops and bottoms and it rarely works out well for them. Instead take a closer look at your asset allocation and start to make some gradual changes before the next big market move (either up or down).
If you have highly appreciated positions, it may make sense to continue to ratchet up your stop loss or sell discipline to lock in gains. That way if the market does decide to change course you are protected on the downside. In addition, if you are over-allocated to certain sectors of the market this may be an excellent opportunity to lighten up into strength and rebalance your portfolio.
One of the exchange-traded funds that I track closely is the iShares Transportation ETF (IYT). So far this year the fund has been one of the strongest performing sectors of the market, with gains of over 16% through 3/25/13. Investors in this fund have done quite well, but if we start to see a rise in energy prices or slowdown in positive economic statistics, it may be susceptible to a swift decline. IYT is the type of position that you should be ratcheting up your stop loss on or even considering taking a portion of your profits off the table and looking to re-allocate those funds to sectors of the economy that may be less cyclical.
In an article I wrote recently titled "Low Volatility ETFs Continue to Gain Steam", I made the case for investing in funds that provide steady returns, lower price fluctuations, and health dividends as an advantage to reduce your portfolio volatility.
If you do believe that the next move is going to be downward then you can start to rotate your portfolio into more quality holdings like cash and bonds while still maintaining enough of an upward bias to profit if the market continues higher. One such bond fund that may provide a safe haven in the event of a market correction is the iShares 20+ Year Treasury Bond ETF (TLT). Historically this fund has been a shelter during periods of volatility as we see a flight to quality from stocks to Treasury bonds.
In any event, your goal should be to make sure your capital is positioned to take advantage of opportunity while still keeping an eye on risk.