In the previous lesson, we learned about the AIP strategy for ETFs and how totake a profit on a position.
I believe that you are now able to understand the basics of how to reduce the probability of premature profit-taking and increase your efficiency when taking profits.
In this lesson, we'll learn something more important – trading strategies for ETFs.
1.Two main forms of ETF trading
There are two common forms of trading: ETF AIP and ETF single trading.
In the previous lesson, we focused on what an ETF AIP is and what an AIP strategy is. So, what is an ETF single trade?
An ETF single trade, as with ordinary stock investment, is a single purchase and sale, a single entry and exit. Compared with AIP, the requirement for timing a single trade is higher and you need greater trading skills.
An important reminder: this kind of investment is more suitable for investors who have some investment experience in the stock market.
Today I’m going to focus on sharing with you the two most common ETF single trading strategies: the pyramid trading strategy and the grid trading strategy.
2. Pyramid trading strategy
(1) What is the pyramid trading strategy?
The pyramid trading strategy, also known as the pyramid buy-sell strategy, was first proposed by one of the most successful stock traders in history - Jesse Livermore.
As a master speculator, Livermore never expected to buy at the bottom and sell at the top. He believed that if a person could consistently eat the middle of the fattest part of a profit, then a few years down the road they would become a market predator.
The pyramid trading strategy mainly consists of two trading directions: "buy" and "sell." To summarise this trading method: buy in the upward-pointing pyramid, sell in the reverse pyramid.
(2) Buy in the upward-pointing pyramid
Buying in the upward-pointing pyramid: When investing, buy large quantities at low prices. The greater the decline, the greater should be the amountinvested. The way to do this is to wrap an equilateral triangle around the net falling value curve of an ETF.
For example:
Let's look at thenet asset value or the NAV as it's known. Let's say the NAV of an ETF is now $3 and you purchase 1,000 shares. When the market continues to fall and the NAV of the ETF drops to $2, buy 2,000 shares. When the NAV falls to $1, buy another 3,000 shares.
Of course, it's up to you to decide where you want to start, whether you want to buy three or four times, and how many shares you want to buy at a time.
Through the pyramid buying method, investors can quantify the NAV of the ETF decline and the number of shares to buy so as to prevent indiscriminate buying and a loss of investment discipline when the market falls sharply.
Pyramid buying also helps investors pool more money at the bottom of the market, greatly reducing the overall cost of buying ETFs.
(3) Sell in the reverse pyramid
Selling in a reverse pyramid: In contrast to the upward-pointing pyramid trade, as the NAV per unit of anE TF rises, the number of shares sold gradually increases to take more profit.
Here's how it works: Wrap an inverted triangle around an ETF's rising price curve. Set the first sale at the apex of the inverted triangle. Assume that the NAV of the ETF is now $1 and that 1,000 shares are sold.
When the market continues to rise and the NAV of the ETF rises to $2, 2,000 units are sold. When the NAV per share goes up to $3 per unit, we continue to sell another 3,000 units.
Similarly, the starting point, the number of sell orders, and the number of shares in each sale of the inverted pyramid can be determined according to your risk appetite and capital.
Through the inverted pyramid selling method, investors can better control when to sell an ETF, timely stop out with a profit, and use investing methodsto grow profits.
3.Grid trading strategy
Pyramid trading is better suited for markets that go up and down in bull and bear markets, but what if an ETF moves sideways in a range and doesn't have much room to trade either on the left or right side?
Can you find a short-term investment approach suitable for markets that are “range bound”? Let's talk about grid trading strategies and how these can be adopted.
(1) What is the grid trading strategy?
The grid trading strategy was created by the "father of information theory" Claud E. Shannon. With it, over the course of his career, Shannon achieved an annualised return of close to 30%.
His investment approach is actually very simple: use 50% of your capital to buy an initial position, then when the price rises to a certain point, sell a part of the position to cash out some profit. When the price falls again to a certain point, buy back a part of your original position.
To put it simply, buy low and sell high in a "grid" pattern, pocketing the difference along the way (see chart).
(2) The operation steps of the grid trading strategy
Step 1: Make a grid plan
Let's say you have $10,000 that you plan to invest in an ETF. If each position is $1,000, you can set up a 10-grid trading system.
Set the NAV of the ETF to be invested at present as $10 / share, and calculate a rise or fall of 10% for each cell, so that values from $10 to $3.87 can be covered.
Step 2: Buy ETF shares according to the grid
From the starting level of $10, each time the price falls, buy using a corresponding amount of money. As an example of the table below, buying 100 shares at $10 would cost $1,000. If the NAV of the ETF drops to $9, buy 110 ETFs, and so on.
The more the NAV of the ETF drops, the more shares the same funds can buy, until the NAV of the ETF is $3.87 at which you’re able to buy 250 shares.
*The above datais for example only，dividends, commissions and other transaction fees (currency exchange fees) are excluded.
Step 3: Selling ETF shares according to the grid
Starting from the price you paid for the shares, sell a position every time the price rises by one square. In the above table, for example, you buy 250 shares at $3.87 and sell them when the NAV returns to $4.20. Buy 230 ETF shares at $4.20 and sell 230 shares when the net value returns to $4.78, and so on.
Using the grid trading strategy, we can test the final profit result. We purchased $9696.50 worth of shares as the price fell from $10 to $3.87. Then we sold for a total of $10,763.90 on the way up from $3.87 to $10 for a final gross profit of 11%.
On the way down and on the way up, the ETF didn't hit a new high, but with the grid trading strategy, even if it only returned to our original position, we could have made a return of nearly 11%, far more than with a buy-and-hold strategy.
（3）How to improve the efficiency of the grid trading strategy
A word of warning: Grid trading strategies are not appropriate in all situations. When using this approach, you need to take into account the following three issues:
A. Judge the current market conditions.
The most suitable market for a grid trading strategy is a volatile market. In a bull or bear market, building a grid can be difficult. A unilaterally rising market will lead to the grid method not allowing you to buy shares at lower prices, and falling markets can easily break through the bottom of the grid, leading investors to burn through all their cash prematurely.
Therefore, in order to use the grid trading strategy and improve your trading efficiency, it is necessary to prioritise whether the current market conditions meet your need for volatility.
B. Selecting a combination of bottom position + grid trading strategy.
The difficulty in constructing a grid is that it covers just one complete down and up curve.
In other words, the more points in an oscillating curve that can be covered by a grid, the more frequently the difference is cashed out and the more profits are cashed in. But, often in reality, a volatile stock market does not give you a perfect volatility curve.
When using the grid trading strategy, investors often get knocked out by the ETF volatility curve. Grid trading is very inefficient.
If you're having trouble figuring out the spacing of your grid, you can always consider a "bottom position + grid” trading approach. That is, before starting to grid trade, buy a portion of the bottom position. You’ll have to use your judgement to pick the bottom position of the market, 30% to 50% for example, and the rest of the funds will be used for grid trading.
C. Try to choose ETFs with higher volatility.
The yield of grid trading depends on the volatility of an ETF. The higher the volatility, the easier it is to reach the buy and sell levels, and the frequency of acquiring the bid-ask spread will also increase.
Therefore, when using the grid trading strategy, try to choose high-volatility varieties such as stock ETFs and alternative asset ETFs. If you choose low-volatility bond ETFs or currency ETFs, the efficiency of your trading will be greatly reduced.
On the Tiger Trade app, click on 'Quotes' and then click on 'Stocks.' Scroll down the page to see the ETF List. In the case of the Nasdaq 100 ETF (QQQ), click on ‘Analysis’ to see the official diagnostic data from Tiger. In this data, ETFs with high volatility and liquidity have better applicability for grid trading strategies.
4. Do’s and Don’ts of grid trading
When using a grid trading strategy, you should be aware of the following:
A. Breakdown of the grid
The first risk is that the bottom has broken and your account has little available cash left in it. Another is a breakout through the top and then a continued rise.
If the bottom breaks down and your account doesn’t have much cash in it, you should use your judgment based on market conditions. At this time, you can expand the spacing between each grid. Be more careful each time you cover a position, and remember not to shoot your last bullet.
Where there’s a breakout through the top, you also need to carefully assess the market. But at this point, it’s not good to chase the trade higher. A better approach is to wait patiently for the market to fall back and then lay out a new grid strategy.
B. Who are suitable candidates for grid trading?
The grid trading strategy requires investors to have a certain subjective “feel” for the market, as well as moretime and commitment to construct the grid and follow through with grid trading operations. It is not a very suitable strategy for someone that can't spare the time to commit to this strategy as the market needs to be closely watched.
And with that, we've come to the end of this class. ETFs are relatively low-risk compared to other investment products, but they do have certain hidden pitfalls, whichI'll tell you about next time.
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Disclaimer:
The information herein was prepared for educational purposes, and does not constitute an offer, recommendation or solicitation, nor does it constitute any prediction of likely future stock performance. In preparing this information, we did not take into account the investment objectives, financial situation or particular needs of any person or affiliated companies. Before making an investment decision, you should speak to a financial adviser to consider whether this information is appropriate to your needs, objectives and circumstances. Tiger Brokers assumes no fiduciary responsibility or liability for any consequences financial or otherwise arising from trading in securities if opinions and information in this document may be relied upon.This advertisement has not been reviewed by the Monetary Authority of Singapore.
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