ETF Asset Allocation Model Trading With The Moving Average

I’ve been reading about a very interesting investing strategy; have you heard of the Ivy Portfolio? This strategy comes from a book with the same name written by Mebane Faber and Eric Richardson. They studied how the most prestigious American Universities such as Harvard and Yale manage their pension plans. Here’s how the Ivy Portfolio works;

What is the Ivy Portfolio?

The Ivy portfolio mixes a strategic ETF asset allocation model traded according to the moving average of each ETF. The investment strategy is relatively easy to put in place as you must take into consideration only 2 factors:

#1 A tactical ETF asset allocation mix

#2 Trading according to the moving average of each ETF.

Therefore, once you have made enough research to get a good ETF asset allocation mix, your Ivy Portfolio will surf along on a very simple and easy to understand trading strategy: you buy when the ETF crosses the moving average in a uptrend and you sell when the same ETF crosses the moving average in a downtrend.

What is the goal of the Ivy Portfolio?

If you simply make an ETF list and buy them using a classic buy and hold technique; you will enjoy the rides up and suffer the market crashes. If you rebalance your portfolio to respect your asset allocation mix, you will eventually make money but you will also be tempted to sell your ETFs during bad times and wondering when to get back in during a bull market. However, by building an Ivy Portfolio; you are making your life much easier:

#1 The Ivy portfolio makes trading decisions fairly easy

Trades are not triggered by fundamental analysis, trader’s perceptions or investor’s emotions. Trades in the Ivy portfolio are triggered by the moving average. Therefore, it is just a matter of setting up an alarm that will tell you when one of your ETFs crosses the moving average. Automatically, you buy or sell the ETF according to your model.

#2 The Ivy portfolio avoids most of the crashes

As I have previously discussed, the biggest (in theory) advantage of trading with the moving average is that you avoid the biggest part of any stock market crash. Therefore, as soon as the ETF dropped enough to break the trend, you get rid of it and stay in cash until it goes back up high enough to break the trend again. This will prevent your portfolio from suffering severe losses.

#3 The Ivy portfolio captures most of the gains

Here again, this statement is based on the moving average theory. Instead of wondering if the recession is really over or if we are heading towards a double dip recession, you simply follow the moving average. Therefore, when the current trend hike is strong enough to break the trend, you have your answer. This allows you to get in on board without waiting on the sidelines too often.

#4 The Ivy portfolio is a cheap way to build a solid asset allocation

Through trading ETFs, the Ivy portfolio is the best solution for an investor who doesn’t want to lose his money in management and trading fees. Since you are following strong trends, you are not encouraged to trade often. I’ve seen an example of an Ivy portfolio that sat cash for 600 days with its international ETF since the markets were bad during that time.

The Ivy portfolio is not perfect

I see a major problem behind the Ivy portfolio theory; the investor behind the asset allocation mix! The problem is that you have to follow each ETF and its moving average to make sure you don’t miss a trade. This could take some time or will require one to invest in a trading system providing alerts within those parameters.

There is also another thing that bugs me with the Ivy portfolio; how to select the correct ETF asset allocation model? I’ll try to answer this question in another post ;-)

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My apologies, I was been pretty quiet last week. I was on vacation and I failed to put enough articles in draft! I guess this is what happens when you take back-to-back vacations right after the Holidays!

So today, I’ll continue my series on trading ETFs using a moving average. Back in January, we explained what the moving average is with an example. Today, we will see how to use this technical analysis tool.

What is the purpose of trading ETFs using a moving average?

As you know, an ETF is a group of stocks or commodities created in order to replicate a specific index. It can be bonds, a stock market, a sector or simply a commodity (such as oil or gold). Since they are not guaranteed, ETFs are subject to fluctuations. As an investor, you want to capture the gains and avoid important losses. While this seems like a perfect trading fit, it is almost impossible to achieve since we don’t have a crystal ball. However, it is possible to use the 200 days moving average to predict important ETF movements.

Therefore, it becomes easier to capture ETF gains and avoid most of the losses.

A practical example of trading an ETF using a moving average

I’ll continue with my ETF example from the previous post and will work with a graph of the past 5 years of the SPY, an ETF following the US stock market.

SPY ETF Graph:

Trading according to the moving average is pretty easy. In fact, you have to follow 2 simple rules:

#1 Buy the ETF each time the ticker price crosses the 200 moving average in an up trend.

#2 Sell the ETF each time the ticker price crosses the 200 moving average in a down trend.

Trading ETFs has never been so easy, right?

So following the same graph, here is where you should have triggered a buy (green circle) and a sell (red circle):

As you can see, this technique allows you to capture most of the gains while avoiding most of the losses. But how come you can simply trade ETFs according to such a simple rule? While the technique is not perfect, here’s the reasoning behind it:

Understanding how to trade ETFs according to the moving average

The stock market can be compared to a huge stomach: it gets all kind of information and it tries to separate the good from the bad while digesting. Based on the moving average definition, it shows the average ETF price for the past 200 days. In other words; it shows the strong trends of the ETF. Therefore, if the ticker price at closing crosses the 200 moving average in a up trend, it confirms that the price is pushing strongly in a up trend. Hence, chances are that we are in a bull period.

Since there is a huge psychological factor in trading, trends are very important. When an ETF starts going up, it gathers more and more attention. Then, more investors buy it and the price keeps rising. It is the same thing when investors hit the panic button and start selling.

Going back to the graph, you will notice that this method would have helped you make good returns while avoiding most of the downfall. In the upcoming post, I’ll push the example a little bit further by providing a full ETF asset allocation model trading with the moving average.