At a time when all investors are trying to recoup some of the losses witnessed in 2008, a sound investment strategy with the utilization of exchange traded funds (ETFs) can be a key component of any portfolio.

Recently, Fidelity Investments backtested our trend following strategy over three years and five years and concluded that our strategy outperformed the 50-day and 200-day buy-and-hold test.

We suggest that investors identify trends by using a simple moving average.  The strategy is fairly straightforward and includes the following rules:

  • Buy the ETF the following day after it crosses above its 200-day exponential moving average (EMA) at the market close
  • If the ETF goes up 5% above the 200-day EMA, use the moving average as the sell point; therefore, sell when it crosses below the 200-day EMA
  • If the ETF goes below its 200-day EMA prior to going 5% above the 200 day EMA, then sell the position when it goes 3% below its 200-day EMA

Investors who are more active traders can utilize the 50-day or 100-day EMAs, which generally identify shorter-term trends, with the idea that one buys above the average and sells below it.  One caveat for traders using a shorter trend line period: there will be more trading involved with shorter time periods.

Although this strategy works, one must keep in mind that an investors has to be there to buy and sell when the time comes.  If you have the discipline to monitor your positions and stick to a trend following plan, you will be rewarded.

For a more detailed explanation of the strategy and to learn more, take a look at our new book: The ETF Trend Following Playbook.

Kevin Grewal contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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