Lesson 4: ETF Automatic Investment Plan and Stop Profit Strategies

Last time, we learned how to select the right ETF in seven key steps. So, how do you trade an ETF after you've chosen one?

In this lesson,I'm going to introduce you to one of the simplest ETF trading strategies: Automatic Investment Plan orauto-invest plan.

1. The simplest ETF trading method: Automatic Investment Plan（AIP）

（1）What is an Automatic Investment Plan?

An automatic investment plan (AIP) is an investment program that allows investors to contribute money to an investment account at regular intervals which will then be invested in a pre-set strategy or portfolio. Funds will be debited from your Tiger account when the AIP is set up. To ensure there are enough funds available for your AIP, consider setting up a direct deposit from your bank account to your Tiger account.

In short, an Automatic Investment Plan (AIP) is an investment made over a fixed period of time with the same or different amounts of funds.

For example, if you have $1,000 and you're bullish on anETF, you can either buy $1,000 in one lump sum or you can buy $250 a week for a month.

The latter method is called an Automatic Investment Plan.

（2）Why the AIP?

There are two main advantages to an AIP:

First, reduce timing risks and spread investment costsin the bear market.

Second,diversify your investment and make potential savings.

Let's start with the first advantage.

You might ask, “Why wouldI want to divide my investment into four parts and take a month to complete it when I can buy $1,000 all at once?”

I'll give you an example:

Let's say you use $250 a month to make an AIP. If the net asset value (NAV) of the first “bet” (the price of theETF) is $2, you can buy 125 ETFs on your first order.

In the second month, the NAV of the fund drops to $1.25, at which point you can buy 200 shares of the ETF; in the third month, the NAV of the fund drops to $1, so you get 250 shares; and in the fourth month it goes down to $0.50 and you buy 500 shares.

So, what's your average cost now for each of the ETF shares you bought?

You bought it four times, which is 250 x 4 = $1,000. The number of shares of the ETF you bought those four times is: 125 + 200 + 250 + 500 = 1075 shares. Calculating $1000/1035 shares, tells you that you bought each ETF at an average price of $0.93.

Compared to buying the entire position at $2 per share in one go the first time, you’ve reduced your average cost by $1.07 per share!

From the above example, you can see that an Automatic Investment Plan can help you reduce the cost of buying an ETF in a bear market, and once the market rebounds, the cheaper ETFs will be the first to gain better returns. This is known as the “smile” curve.

*Only US ETFs are available for auto-investing.Dividends, commissions and other transaction fees (currency exchange fees if applicable) are excluded.

Let's now look at the second advantage:

In addition to reducing risk,an AIP can also act as a "piggy bank." If you can't afford to put up a lump sum of moneytowardsinvesting, an AIP is an option for you to consider.

Because the capital threshold for an AIP is so low, you can contribute a small percentage of your salary each month. This will not only reduce the risk of entering the market by diversifying your investments, but you will also gradually accumulate assets and achieve your financial goals.

2. ETF investment strategy

AIP is not "Trading for Dummies." There are many commonly used trading strategies for ETF AIP. Below,I will tell you about three of them.

（1）Regular quota strategy

This strategy is simple: put your money into a specific number of ETF shares for a fixed period at a fixed amount.

For example: You have $1,200, and you want to buy an ETF that you like. Assuming that you intend to gradually complete the transaction over a period of six months, the amount you should put in each month is 1200 / 6 = $200.

In this case, you just need to set the period (monthly) and amount ($200) in the Tiger Trade app, and the system will deduct $200 at a fixed time to put into the ETF.

The purpose of the regular quota strategy is to reduce your average cost per ETF share by continuously buying at a lower NAV in a bear market, which means using the same amount of money to buy more shares.

So, when your ETF account is losing money,you don't need to cut your losses right away. Instead, perhaps consider buying cheaper 'chips' to reduce theaverage cost. However, this action should be based on your own financial situation.

Conversely, if the market keeps rising, your average cost will rise with each ETF share that you buy. This situation requires you to judge the market, take your profit promptly, pocket the money, and wait for the next big drop.

(2) Regular non-quota strategy

Unlike the regular quota strategy, the amount of the deduction in this strategy is different each time. To put it simply, when the market falls sharply and the NAV of the ETF plummets, the amount of deduction should be gradually increased, which can be 1.1 times, 1.2 times or 1.3 times your usual deduction. Assuming regular investments of $200 each, the regular non-quota strategy would deduct $220, $240, and $260, in turn.

In other words, the more the NAV of the ETF falls, the greater the amount of the deduction.

What if the ETF suddenly surgesjust in time for your deduction? Obviously, when the cost increases, normally you don’t want to double up on the shares,and one of the right things you may consider is to reduce the amount of the deduction. For example, 0.9 times, 0.8 times, 0.7 times, which would be equal to $180, $160, and $140.

If market fluctuations don’t bother you, try to find some "reference points" to help you make a decision. For example, you can focus on theETF yield indicator. When the ETF yield is 5%, set the deduction amount to 0.9 times, and when the ETF yield is 10%, set it to 0.8 times. Conversely, when ETF holdings yield -5%, set the deduction at 1.1 times, and set it at 1.2 times when the yield is -10%.

These are just examples. Of course, you are free to set the exact amount of your deduction as you see fit. In addition to using the yield on holdings to help you make a decision, you can also use the valuation of the ETF. It’s a similar principle that I won't go into here.

（3）AIP + covering strategy

This strategy is an ETF strategy that utilises subjective judgment on the basis of AIP and actively adds positions when markets fluctuate.

For example, let's say you're going to invest $1,200 regularly in a fund you like, and you're going to use an AIP +covering strategy. So, what you do is divide $1,200 into two parts of $600 each. In one case, you plan to make a regular payment of $100 each time over a period of six months. The remaining $600 is held in cash, waiting for the opportunity toadd to the position.

Let's say that in the second month, the market is bearish and the NAV of the ETF moves sharply downward. At that point, you can voluntarily buy $100 worth of the ETF, thereby reducing your average cost per share.

There are two important points to note with this strategy:

A. Look for references to assist in judging the time to add to your position;

The difficulty with this strategy is knowing when to manually cover positions, which can be difficult for investors who aren't sensitive to market volatility. If a valid reference can be found, then the accuracy of your transactions will be greatly increased. Looking at yields on holdings as an indicator will assist with your decision.

When the ETF yield reaches 0%, the NAV is at your baseline cost, which we call the "freezing point." When the holding yield continues to break through the freezing point, reaching -5%, you can cover the first portion of the investmentof, say, $50. When the yield continues to fall, reaching -10%, consider covering $100, and so on.

Of course, the choice of position yield and the amount of funds to cover need to be assessed according to your own budget. The above is just an example.

B. Be cautious about your last bullet

It’s been proven that many investors are too optimistic about the market when using the fixed investment and covering strategy and quickly use up all the money they have to cover positions. At that point, if the market continues to move down, you can only sit and stare at your screen but can't do more to reduce your average cost.

So, for investors using this strategy, it's important to remember this iron rule: never fire your last bullet.

3. How to take profit on your automatic investment plan

Finally, let's talk about how totake a profitin an AIP. There is a popular saying in the stock market: “The one who knows how to buy is the apprentice, the one who knows how to sell is the master.”

Knowing when to sell is sometimes more difficult than knowing when to buy. Below, I will introduce you to two ways to potentially make profits so that you can quickly master using the stop-profit strategy for your AIP:

（1） Market sentiment method

To put it simply, the market sentiment method is about assessing the stage of the market by judging the mood of investors, such as optimism or pessimism about the stock market, greed or panic. Investment guru Warren Buffett says: “The right investment is to be greedy when others panic, and panic when others are greedy.”

When investors are extremely optimistic and greedy, the stock market often peaks. At this point, as a smart investor, it is time to start gradually begin stopping out profits.

So, how can you tell if investors in the market are optimistic or pessimistic? You can look at the VIX.

The VIX index, also known as the VIX fear index or volatility index, is one of the indicators used to reflect market sentiment and expected future volatility of the stock market.

In general, when the VIX fear index is rising, the S&P 500 is likely to fall. If the VIX fear index is stable, the S&P 500 is relatively stable. When the VIX rises to an extreme, the S&P 500 may bottom out and then rise. When the VIX is low, the S&P 500 may have downside risks.

Using the VIX index to judge when to take profits mayassist in increasing the accuracy of your stops.

(2) Targeted return method

The targeted return method sets multiple profit targets. In a bull market, most investors fear selling too early and missing out on profits. It can be very depressing to sit and watch your ETF continue to rise after you’ve sold it. Is there a scientific way of stopping profit to maximize your gains?

This method is called the targeted return method. When you have bought an ETF that has made a good profit and there are signs of a short-term market top, at this point, you can set a profit target for yourself. Please note that this targeted gain couldbe set in a “stepped” pattern.

For example, if you plan to start taking the profit on your ETF shares when you’re up by 30%, consider selling half of the fund and keeping the other half. If the price continues to rise and reaches your second stop, let's say 35%, you can sell half of your remaining position again. In other words, every time the market rises, you sell a portion of your remaining ETF shares.

The advantage of this method is that if the market continues to rise, you still have a portion of your shares left to enjoy additional gains in the market. When the market suddenly drops, most of the gains will already be in your pocket, and you won't lose much of your profit.

And that brings us to the end of our time together today. Wasn’t this class chock full of good information?

Next time, I’ll take you through another type of ETF trading strategy so that you can gain more knowledge.

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See you then!

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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