For exchange traded fund investors, the importance of sticking to their strategy and not trading on emotions becomes even more important when markets are swinging wildly.
In fact, basic behavioral finance shows that individuals behave irrationally when their investments are on the line, according to Reuters. Instead, it is better to adhere to a predefined strategy.
For instance, an investor who follows the contrarian school of thought would watch for key metrics, like the American Association of individual Investors, the Consensus Index or Market Vane, that track market sentiment. The contrarian wouldtrade in the opposite direction when investors feel overly bullish or bearish about the market.
“It’s the perfect contrary indicator, and has been for a long time,” Keith Springer, president of Springer Financial Advisors, remarked. “The public is always wrong. They always act on emotion – to buy when they feel the best, to sell when they feel the worst.”
Last week, the AAII Index was hovering around 30% bulls. If the Index dips below 20%, it would suggest a “screaming buy,” Springer added.
While a sentiment indicator is a good gauge to follow, investors should also look to some other market tools. For instance, look to long-term trends. We use strategies based around the 200 day-moving-average and other indicators, which helps mitigate risk. Trend following is a long-term and dependable strategy. [An ETF Trend Following Plan for All Seasons]
“The stock market doesn’t turn on a dime,” Springer commented in the Reuters article. “But it could suggest that we’re within range of a sizable rally.”
For more information on following the trends, visit our trend following category.
Max Chen contributed to this article.