A Simple Core Trading Strategy

Technique

It's easy to take a leisurely approach to buying and selling mutual funds if you can determine whether to be bullish or bearish. It's trickier than it sounds. Short term movements can be misleading, but attempts to dampen the effects of short term movements by techniques such as moving averages can be slow to reveal crucial information. In my opinion, price channels provide a safer and easier form of analysis.

Consider the following chart of the Fidelity Dividend Growth Fund:

The black line is the price of the fund. The dotted line is the average price over the last 20 days. The upper blue line is the highest price in the last 20 days and the lower blue line is the lowest price in the last 20 days.

Looking at this chart, some simple rules of thumb appear plausible.

As long as both blue lines are moving upward, the condition is bullish. But even in a bullish environment, it is possible to reduce your return by paying too much. So, one rule this suggests is to never buy when the black line is above the upper blue line. A much more stringent rule would be to buy the fund only when the black line drops below the dotted line, such as in November and late January in the graph, but that could cause you to miss some serious market advances.

The blue lines also suggest selling strategies. When either blue line drops, that is at least a cautionary sign. When both blue lines are in decline, the condition is bearish. As with buying, there are any number of tactics for determining exactly when to sell once conditions are bearish.

In my experience, trying to get too sophisticated means a lot of work and very little additional reward. Buying when conditions are bullish, but not outlandishly so (black above blue), and selling when conditions are bearish, but not outlandishly so, is sufficient to give impressive returns.

Application

If you try to apply this general technique to mutual funds, you will find that most mutual fund companies discourage the kind of trading this can cause. Most mutual funds have trading restrictions in place which require you to keep a fund for a minimum of 30, 60, or 90 days, or else suffer a penalty. This isn't the end of the world, but you can do better for using one of the few funds that are intended for traders. These are the funds offered by Profunds and Rydex. In their fund families, you can trade most of the major stock indices, as well as more exotic stuff such as precious metals, petroleum, and currencies. They even offer inverse funds (short funds) which can provide nice rewards when markets trend down. Long or short, stocks or commodities, they all trade the same and can be traded with the same techniques.

Does this technique really work for stocks? Yes, but stocks tend to be more volatile, so it's quite unusual to find stocks that have a bullish price channel chart.