In the current investment environment, the old way of thinking may do more harm than good. Exchange traded fund investors need to have a strategy in place before dipping into these choppy market waters.
Investors tend to deviate from a rational thought process but there are ways to reduce the influence of the errors, writes Samuel Lee for Morningstar’s latest monthly ETF newsletter.
“Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ,” investment guru Warren Buffet famously said. “What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
Investors as a whole tend to be overconfident. Studies on active managers show that they have a hard time outperforming the benchmarks while retail investors usually underperform the overall market on a risk-adjusted basis before trading costs.
“Your chances of being a truly skilled investor aren’t 50% (the fraction that’s above average in the famous normal distribution, or bell curve) but closer to one out of 100,” Lee says.
There is a popular train of thought that past performance may provide a baseline for predicting future behavior, at least to a minimum degree. Investors would consider historical averages as a baseline and shift away from it depending on new facts or evidence.
Here at ETF Trends, we focus on the 200-day exponential moving average as our baseline. We try to follow funds that move above their 200-day average, which signals a potential buying opportunity. This way we are investing on a momentum opportunity instead of just relying on some primal gut feeling.
For more information on trend following, visit our trend following category.
Max Chen contributed to this article.