Money is an emotional topic, and many have allowed emotions to get the better of them when handling investments. To help keep one’s cool in any market condition, exchange traded fund investors should have a methodical strategy in place.
According to the researchers from the Brazilian School of Public and Business Adminstration, the University of California Berkley and San Francisco State University, emotional excitement can add fuel to an asset bubble, writes Sheyna Steiner for Bankrate.
“Our underlying motivation is the hypothesis that, once started, real-world bubbles generate excitement and that excitement further inflates and sustains the bubble,” the researchers wrote in the paper, “Bubbling with excitement: An experiment.”
In the academic study, participants either watched an exciting, scary or calming video and were then told to trade fictional assets for real money. In the scenario, participants who watched an exciting video saw assets rise faster and hit a higher peak than asset prices after watching scary or calming videos. The researchers found that excitement helped bubbles grow bigger and more quickly.
While it is fun to chase after high-flying stocks, traders may get burned if the securities suddenly take a turn. Consequently, investors should have a plan in place to keep emotions in check and invest on predefined indicators.
For instance, at ETF Trends, we try to stick to three rules that should help keep most investors out of trouble: First, investors should maintain an 8% stop-loss on ETF positions. Second, people should keep an eye on the trend – if an ETF dips below its 50-day average, investors should begin to monitor holdings more closely, and if the ETF falls below the 200-day average, then it is time to sell. Lastly, don’t chase after hot areas of the market.
The first and perhaps most important screening process for ETFs is knowing the 200-day moving average of each candidate and where it stands in relation to it. We look for uptrends, and then examine those trends using fundamental analysis. Once a position is entered, we stay in the investment until the trend turns sour or declines below its trend line.
In some cases, where trends have moved steeply to the upside, the corresponding ETF may be more than 10% above its moving average. In those cases, we impose an 8% stop-loss. If you buy an ETF trading 15% above its 200-day moving average, it’s best to sell if it drops 8% from a recent high. That way, you take control of when you are leaving position and preserve as much profit as you can.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.