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Exchange Traded Funds (ETFs)

Trade like hedge fund managers

With the S&P 500 up 11%, and the NASDAQ up 15%, so far, at least, 2010 has been a good year for stocks.

That said; those who played in sectors that many U.S. investors don’t think about much reaped even bigger profits. For example, consider precious metals. So far this year, silver is up 70%, and gold mining stocks have gained 60%.

While Europe struggled, emerging market stocks such as Thailand, up 57%, and Peru, up 55% were hot. Commodities such as coffee, up 50%, and tin, up 51%, were another hot sector.

In the U.S. some industries did produce eye-popping numbers in 2010. An index of networking equipment makers gained 43%, and leisure and entertainment stocks returned 39%.

About ETFs
You can use exchange-traded-funds (ETFs) to participate in these market segments, plus dozens more. In the beginning, ETFs were similar to index mutual funds in that they replicated the returns of predefined stock indexes, such as the S&P 500. Most ETFs still fall into that category, although ETF sponsors have created funds that track just about every conceivable index. You can find ETFs that track value stocks, Russian stocks, oil stocks, healthcare stocks, insurance companies—you name it. Going beyond stocks, commodity ETFs track the price of everything from corn to platinum to crude oil either by trading futures, or, in the case of precious metals such as gold, by buying and storing the actual metal.

Unlike mutual funds, ETFs trade just like stocks. You can buy and sell them in the same day, and you pay the same trading commissions as you would for stocks. At a minimum, ETFs give you a way to invest in industry sectors without having to research individual stocks. Moreover, with ETFs you can take positions in foreign stocks or commodities not readily available to most U.S. investors.

An ETF Momentum Strategy
Considerable research has found that stocks that have outperformed the market in recent months are more likely to continue their winning ways than stocks that haven’t. Recent studies have found that the same holds true for ETFs. 

ETF Screen.com
You can use ETF Screen.com (etfscreen.com), a free site, to spot strong ETFs. From its homepage, select Performance (top menu) to see a list all ETFs meeting certain qualifying requirements, sorted with the ETFs that had recorded the highest one-day returns at the top.

By default, ETF Screen omits ETFs with low trading volumes, as well as leveraged and short funds. Leveraged ETFs, designed more for day trading than for long-term investing, attempt to double or triple the returns of the underlying index in both the positive and negative directions. Short funds bet against an industry by, in effect, taking short positions in the underlying stocks. You can use the ETF Performance report controls to include or exclude leveraged or short funds.

Use Relative Strength
Besides for the one-day returns, the report lists returns for each fund ranging from one-week to one-year. You can sort the list based on any of those timeframe returns by clicking on the column header. The report also lists ETF Screen.com’s proprietary Relative Strength (RSf) Trends indicator for each ETF. The RSf indicator rates each fund’s performance over the past year, but gives the most weight to recent results. The Rsf ratings range from zero (lowest) to 100 (highest).

Click on RSf to sort the ETF list with the strongest players at the top. When I looked last week, ETFs tracking commodities cotton (BAL) and sugar (SGG), precious metals silver (SLV) and palladium (PALL), and silver (SIL) mining stocks dominated the list.

Researching  ETFs
Finding information about ETFs requires some digging. ETF Screen.com doesn’t offer any descriptive or portfolio information beyond the fund name. In fact, besides for quotes and charts, which are readily available, I haven’t found any site that does a good job in that regard.  MSN Money's Snapshot Report often gives you a short rundown on the ETF's strategy. Its Top Holdings report may or may not list the top stocks making up the index that the ETF is tracking. Morningstar (www.morningstar.com) rarely tells you about the ETF's goals or strategy, but its Portfolio report is a better source than MSN Money for a list of holdings . Often, the fund sponsor’s website is the best resource for information.

Exchange-traded-funds give individual investors a way to invest in difficult to access markets. But the strategy I’ve outlined of jumping on hot sectors requires keeping a close watch on your holdings. It’s not for buy and hold investors.

published 12/19/10 

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