How to Play This Market With ETFs

Investors' emotions are running high: They're bolting out of stock funds (including stock exchange-traded funds) and into gold and bonds—especially treasuries. A great way to keep that emotional-investing habit in check is to have a strategy, says Tom Lydon, president of the Newport Beach, Calif., firm Global Trends Investments and coauthor of the book iMoney: Profitable ETF Strategies for Every Investor (he's also a blogger at ETF Trends).

The strategy Lydon preaches hinges on an ETF's moving average, which represents its average closing price over a set period and can be found here. In less dire market conditions, investors would use an ETF's 200-day moving average to pinpoint the best time to buy or sell. (A fund trading aboveits 200-day moving average is a "buy" candidate, and vice versa.) But since most ETFs are currently trading far below that bar, Lydon says those looking to jump into the market might want to instead use a 50-day average. Recently, U.S. News asked Lydon to explain this strategy and highlight any ETFs that currently pass the test. Excerpts:

What advice do you have for ETF investors in this market?
First and foremost, if you got caught up in the excitement of ETFs over the past three years and got into areas like emerging markets, commodities, and energy, there's sure been a heck of a lot of volatility. It's important to make a decision: Are these long-term positions I'm going to hold for five to 10 years? Or is this a short-term strategic move? If that's the case, it's important to protect the downside.

How do you know when it's time to jump into such a beaten-up market?
These are cautionary times. Protecting the downside is a way of avoiding risk in some volatile areas. A very simple rule anyone can implement is to look at the 200-day moving average of every ETF in your portfolio. For example, if you've got a commodity ETF trading below its 200-day average, the translation is that it's in a downtrend. If you're not going to buy and hold, and you're looking for short-term opportunities, that opportunity may have passed and what you want to do is protect principal and sell until it goes back above that trend line.

However, there's really nothing except a few currency ETFs that are currently trading above their [200-day moving average]. Some ETFs are 20, 30, and 40 percent below, which means they'd have to have momentous gains to get back above that trend line. For savvy investors that have portions of their portfolio on the sidelines and looking to take advantage of beaten-up sectors, a great disciplined approach to buy into the market these days is to use a 50-day moving average, which provides a quick picture of short-term trends. In this case, an investor would hold onto the stock as long as the ETF stays above its 50-day moving average.

What sectors or ETFs are you looking at right now?
We're getting geared up so if we happen to see stability in the marketplace, we're thinking about how we'll put our money to work. There are probably are some bargains in the marketplace today. For investors with discipline and intestinal fortitude, this market provides an opportunity to buy so much lower.

There are a couple of areas in the past year that have been beaten up, including financials and housing stocks. People may say that's ridiculous and that we'll continue to see deterioration over the next few years in that sector, but when everyone is throwing the baby out with the bathwater, it's usually a good time to buy. If you're looking to take full advantage of trends, this is the way.

Which ETFs are trading above their 200-day moving averages right now?
That would be foreign currency ETFs, because we've seen a stronger dollar and a stronger yen. The ticker symbol for the dollar ETF [PowerShares DB US Dollar Index Bullish] is UUP, and FXY is the yen ETF [CurrencyShares Japanese Yen Trust].

What would you tell investors looking for safer ETFs?
Unfortunately, the issue now is that yields are low. There are some short-term treasury ETFs folks looking for safety might consider. Fixed income is an area in the ETF space that's gaining a little more traction lately as people move to safety. Obviously, there's a lot of talk about safety in money market funds. If you have a brokerage account and you're concerned about safety, look to U.S. government money market funds. They yield less than most conventional money markets, but since they're made up of just treasuries, in this environment, they're much safer.