One of the attractive features of ETF’s is that they can represent a relatively narrow sector of the market, but don’t generally have the volatility of individual stocks. This makes them ideal for some traditional investment approaches. Here is a look at a number of different etf trading strategies.

Asset allocation - The first is the classical asset allocation approach. This approach is championed by many investment advisors, especially those who embrace the efficient market hypothesis, which basically suggests that you can’t beat the markets, so the best you can do is buy and hold low cost funds, and reduce the overall risk of the portfolio by investing in assets that aren’t correlated and should not move in concert. In this case the key feature is that since you don’t think you can beat the market, all you want from a fund is the lowest cost way to purchase a portfolio of stocks in a given sector.

Market Timing - This is almost the exact opposite, where the idea is that your market timing system will capture the movement of the overall market, and what you want in this case is the lowest cost way to buy and sell the overall market. If you want to trade both the long and short sides of the market ETF’s give an good advantage, as there are bear etfs and mutual funds that allow you to effectively short the market by buying a long positon in that fund. There are also leveraged versions of both the long and bear funds to increase your exposure. One key advantage of these is that they can be purchased in a tax sheltered account like an IRA, which typically doesn’t allow short sales or margin accounts.

Sector Rotation - Our favorite approach is to use a sector rotation strategy with ETF’s. This approach is one that takes advantage of the fact that you can find many relatively narrow sectors that can be traded easily with ETFs. The idea is that there will typically be a couple that trending well. A good way to rank the funds is to use a modified Sharpe ranking, where not only the recent price strength is used to find a good sector, but to weight it as well favoring sectors with lower volatility. And of course, if there is no sector with enough recent strength then have the ability to go to cash.

You can see more on sector trading with ETFs with our ETF trading system.