Day Trading Rules For Rookies: Don't Play It By Ear!

The prospect of making quick money lures many to the world of day trading. The participants in this game, besides professional traders, can be retirees, executives, teachers, small business owners, housewives, etc. who try and make a fortune through their computer screens.  Remember, the profits which may draw you to day trading are virtual and it’s your trading style that can transform them into real gains--a daunting task, especially as a rookie.

There are rules for every game, even day trading! If you are a new player, it’s important that you are mindful of the basic set of rules. These rules are certainly not binding, but they can help you to make some crucial decisions and give broader guidelines.

1) Knowledge 

“Knowledge is power.” Knowledge here includes information about the basic trading procedures and tools, information about stocks you plan to trade (like company financials, reports and charts), knowing the latest in the stock markets, keeping track of events that affect stocks, etc. Day trading can become more difficult and risky in the absence of knowledge. As a rookie, do your homework; make a list of stocks which are on your wish list, keep yourself informed about the selected companies and general markets, scan a business newspaper and visit reliable financial websites on a regular basis. An informed decision is a better decision.

2) Being Realistic

Being realistic about profits is important. As you gear up to trade, make sure that you don’t lose out on decent gains in the greed for more! Markets are tricky and it’s better to settle down for a smaller profit than ending up losing heavily. Don’t repent losing out on a chance. If required, you can always buy the same stock when it dips. Every small profitable trade will help boost your confidence and also give you a chance to try out the strategy again.

3) Margin Trading

Trading on margin means that you are borrowing money from a brokerage firm to trade. When used properly, margins help to amplify the trading results; amplification is just not of profits, but of losses as well, if a trade goes against you. As a rookie, keeping control on the amount of indulgence is vital and trading with cash-in-hand helps to achieve that. To begin with, indulge in day trading without using margin. The high margin requirements for day trading on margin also act as a barrier for many to trading on margin.  

4) Entry & Exit 

Knowing the price at which you wish to enter at and exit can help you book profits as well as save you from a wrong trade caused by unnecessary confusion. Don’t play it by ear; you must have some pre-fixed levels in your mind for every stock you plan to trade. In case the markets are not favorable, exit to cut losses.

5) Number of Stocks

As a beginner, it is advisable to focus on a maximum of one to two stocks during a day trading session. With just a few stocks, tracking and finding opportunities is easier. If you simultaneously trade with many stocks, you may miss out on chances to exit at the right time.

6) Rush Hours

Many orders placed by investors and traders begin to execute as soon as the markets open in the morning, and thus contribute to price volatility. A seasoned player may be able to recognize patterns and pick appropriately to make profits. But as a novice, it is better to just read the market without making any moves for the first 15-20 minutes. The middle hours are usually less volatile while the movement again begins to pick towards the closing bell. Though the rush hours offer opportunities, as a novice it’s better to avoid that time to trade.

7) Set a Amount Aside

Day trading is risky and there is a high chance of losses. As a rookie, set aside a surplus amount of funds that you can trade with and are prepared to lose (which may not happen) while keeping money for your basic living, expenses, etc. This will ensure that you are not increasing the risk quotient by neglecting your day-to-day needs whilst day trading.

8) Time

Above all else, day trading requires your time. Don’t consider it as an option if you have limited hours to spare. The process requires a trader to track the markets and spot opportunities, which can arise any time during the trading hours.

9) Avoid Penny Stocks

Keep away from penny stocks as a beginner in day trading. These stocks are highly illiquid and chances of hitting a jackpot are often bleak. Don’t trap yourself in a trade which is difficult to exit!

10) Limit Orders

When you place a market order, it is executed at the best price available at the time of execution. Thus there is no “price guarantee” in a market order.A limit order, meanwhile, does guarantee the price, but not the execution. Limit orders help you trade with more precision wherein you set your price (not unrealistic but executable) for buying as well as selling.

11) Unreliable Sources

Don’t trust any SMS, mail, advertisement, etc which claim about super normal profits. It’s not that all such sources are bogus but authentication is required. As a rookie be sure not to be tricked by someone who for a commission lands you with a bad trade.

12) Emotion

There are times when the stock markets test your nerves. As a day trader you need to learn to keep confidence, greed, hope and fear at bay. The decisions should be governed by logic and not emotion. This may be hard for a beginner but only someone who can learn to control his or her emotions can be successful. Before plunging into the real time arena, it can be a good idea to try a simulation exercise. (Investopedia has a stock simulator here.)

The Bottom Line 

Day trading requires time, skill and discipline. Skill is developed over a period of time as you participate in the markets and trade with discipline by devoting your time. A sound understanding of some good day trading strategies can provide a foundation to this endeavor.  Self learning is the best way to learn and as Jesse Livermore, a legendary trader said, “I know from experience that nobody can give me a tip or a series of tips that will make more money for me than my own judgment.” 

How to choose the right ETFs

The goal of most investors is to manage risk, seek income, and achieve long-term growth. These goals, of course, need to be built on a solid foundation: the “core” of a portfolio. The idea of the core is to establish the right mix of exposures and investments, at an attractive price point, that seek to drive value over the long term.

With over 5,000 ETFs to choose from, building your core with ETFs does require a framework. Institutional investors have extensive due diligence processes for selecting investment products and in many cases, a whole staff to do the work. Based on my extensive work with institutions I propose using a simplified approach when selecting ETFs for the core of your portfolio. Here are the five key questions you should be asking:

1. Provider – How well do you know your provider?

Consider both the ETF provider’s experience in the ETF market, as well as the provider’s size, scale, track record and level of commitment to the ETF industry and to managing exposures versus a rule or an index. Different ETF providers have different investment philosophies. Importantly, your ETF provider should offer value add services, including a user-friendly web site with tools to help you build your core. For example, iShares utilizes the interactive Core Builder tool to help investors navigate possible ways to achieve this objective.

2. Exposure – Can you get the exposure you want?

​ETFs, even within a particular asset class or segment of the market, can vary significantly. Pay attention to the index and ask your financial advisor questions about differences between products and its ability to track a core index or benchmark. Understand the exposure you want and ensure the ETF you select is capturing that.

3. Structure – Are there risk & cost implications from the ETF structure?

Look for ETFs whose product design balances desired exposure with cost and tax efficiency, as well as liquidity. In general, the ETF structure can help minimize the unintended tax consequences. Generally speaking, ETFs tend to have lower turnover relative to actively managed funds, which can help minimize annual capital gains taxes.

4. Liquidity – Can you trade when you need to?

Because ETFs trade on exchange, liquidity is a huge factor in why many investors utilize them. Even for core holdings, which are by definition more long-term in nature, you still want to ensure you have the ability to trade when it’s time to dial up or down your exposure. However, be sure to examine the liquidity of the ETF itself, as well as liquidity of underlying securities.

5. Costs – What is the total cost of ownership?

Expense ratios are important, however all implicit costs including trading and market impact, should be factored in. Your financial advisor can help you estimate the impact of your trade before it’s placed.

How to Calculate the Value of an ETF

ETFs, like mutual funds, are a good way to get exposure to many individual stocks without taking positions in any one of them on an individual basis.  But unlike mutual funds, ETFs trade throughout the day, just like the underlying holdings. So while making an investment in an ETF is a good way to get broad exposure to stocks, bonds or commodities without taking on specific risk, calculating performance may be a bit tricky.  

Net Asset Value

Both mutual funds and ETFs calculate NAV, or net asset value, at 4pm EST.  The NAV is the value of each share measured by the value of all the fund’s underlying holdings at their closing prices.  However, because the ETF trades throughout the day, there are times when the NAV and the actual market price differ, although the differences tend to be minuscule.  Therefore, for calculation purposes, the most readily available measure to use is the NAV but if you need to calculate more precise performance, then you can use the intraday net asset value (iNAV) if available. 

Calculation

Let’s use an example of an investment in EFT A.  The NAV of ETF A is $100 and you buy 50 shares for a total cost of $5000 ($100*50).  Three months later, the NAV is $115.  Your 50 shares are now worth $5750 ($115*50) for a profit of $750 ($5750-$5000).  Your holding period return is

($5750-5000)/$5000=15%

The Bottom Line

The performance displayed on a brokerage statement for an ETF held in your portfolio may differ slightly from the calculation you make from NAV because the market value may be marginally different than the NAV.  However, these variations should only be slight and minimally impact your total performance.  One of the benefits of investing in an ETF is that it is actively traded which should compensate for the minimal dispersion between the actual bid/ask spreads and traded bid/ask spreads that make up the variance between market value and NAV.  

Is Now The Time For Momentum Stocks?

In active trading, there are various avenues to take when picking stocks. In some cases, traders will take positions in stocks that are trading within strong trends in anticipation that the crowd will be caught on the wrong side and that the price will drastically swing in their direction. This type of trader is known as a contrarian. Deciding when the trend will reverse is the hard part of such a strategy, and some traders will invariably find themselves holding onto a losing position while the momentum continues.

As of late, traders waiting for a reversal have only seen stocks climb higher, which is why there has been a rise in popularity in a style known as momentum trading. The theory used by momentum traders is that the ‘trend is your friend until it ends.’ Momentum traders will stick with their position in a defined trend until they receive confirmation from several technical indicators that suggests the trend is reversing.

For those who don’t closely follow the market, choosing a momentum stock can also be difficult because at this point in the trend many technical and fundamental indicators suggest that the stock is fully valued and ripe for a pullback. Rather than choosing a momentum stock blindly and adding it to a portfolio, it may prove wise to check out the iShares MSCI USA Momentum Factor ETF (MTUM). As you can see from the chart below, this ETF is been trading within a strong uptrend ever since its inception on April 16, 2013, and it doesn’t look like it is about to reverse any time soon. 

Looking at the Components of MTUM

The iShares MSCI USA Momentum Factor ETF tracks large- and mid-cap U.S. stocks that exhibit strong price momentum. The fund currently has $307.7 million in net assets and holds 125 different stocks. The ETF is relatively liquid and carries a reasonable expense ratio of 0.15%. In terms of sector weighting, the MTUM ETF is heavily weighted toward health care, industrials and Information technology, which as suggested in previous articles, are all trading within extremely strong uptrends. Top holdings of the MTUM fund shown in the table below could be great candidates for any active trader's watch list. 

Trading the Momentum of Facebook

Facebook has been a momentum stock of choice for many traders since August 2013 when the company announced better-than-expected earnings. It showed the market that it was figuring out how to monetize mobile traffic at a faster rate than expected. As you can see from the chart below, the golden crossover between the 50-day and 200-day moving averages back in August 2013 was the signal of the beginning of a long-term uptrend. Many active traders will likely hold a position in FB until it closes below the support of its 200-day moving average. The recent tightening between the peak near $72.50 and its 200-day moving averages provides momentum traders with a more favorable risk/reward ratio and could lead to heavy buying over the weeks ahead.

The Bottom Line

When it comes to active trading, strong trends can last much longer than expected. This has led to a rapid increase in the popularity of exchange traded funds such as the iShares MSCI USA Momentum Factor ETF, which have been designed specifically to track this trading style. For traders looking for momentum candidates for their own portfolios, it could be a great idea to check out the components of the fund listed in the table above. 

Impact Investing: Making A Difference And A Profit

Most investors spend their time chasing returns. But what if there was a way to do good while also turning a profit?

Several not-for-profit organizations have recently been teaming up with money mangers and investment banks to create and market a new line of products that offer investors the opportunity to engage in what is now being touted as impact investing, a form of socially responsible investing. The goal of this scheme is to invest money in companies, organizations, funds or projects anywhere in the world that can effect a positive social change, while at the same time deliver a financial return to investors. 

One Step Further

Interest in the idea has been growing steadily over the past couple years and so have the number of products being offered. For some time, a breed of investment management companies such as Pax World Management, Domini Social Investments and Parnassus Investments have been offering mutual funds that invest in socially and environmentally conscious and responsible companies. But today’s impact investors are going one step further, looking to invest in bonds and other investment vehicles that invest directly in socially oriented projects.

An example of a vehicle used in impact investing is a microfinance loan, which help people with little or no access to capital start a new business. High-net-worth individuals, in particular, are finding these offerings attractive and are willing to take on some calculated risk to invest in them. Businesses started with microfinance loans are providing competitive returns to their investors through the bonds that back them. In some instances, impact investment vehicles have been able to garner higher returns for their investors than the broader markets did, especially during down cycles.

One example of an impact investing project is a community solar program. A platform called Mosaic allows people to invest as little as $25 to fund solar projects that save money for homeowners, schools or other institutions while reducing carbon emissions.

Not Just The Rich

What may have begun as a niche for wealthier investors is starting to get the attention of the larger retail market. Accordingly, the number of organizations offering these products is increasing. One such organization is ImpactAssets, which offers donor-advised funds and impact investing notes to individuals and advisors looking to produce positive social and environmental change. Each year, the organization publishes a list of 50 investment managers who specialize in impact investing techniques.

ImpactAssets is also closely tied to the Calvert Foundation, which offers investment and lending opportunities, such as the Calvert Community investment notes, a series of debt securities that start at a minimum investment of $1,000.

Growing Interest and Variety

Goldman Sachs has also jumped on the impact investing bandwagon. Just last year, it rolled out its GS Social Impact Fund, which deploys capital toward the physical, social and economic revitalization of disadvantaged communities across the U.S. The fund’s investment strategy is to addresses social challenges and to mobilize new sources of private capital into the social-impact arena, while also providing its investors with a financial gain.

The Rockefeller Foundation was one of the first foundations to experiment with social impact bonds in conjunction with the Global Impact Investors Network (GIIN), a not-for-profit organization dedicated to increasing the effectiveness of impact investing. The foundation also funded the development of a metrics to measure the performance of these social enterprises and impact investing funds.

And now, with the guidance of the Rockefeller Foundation, some of the biggest U.S. investment banks, including Goldman Sachs Group, Inc. (GS), JP Morgan Chase & Co. (JPM), and Bank of America Corp. (BAC), have created social impact bonds that are being applied to issues such as asthma, early childhood education, diabetes, and prison rehabilitation programs.

With investor demand for impact investing products continuing to rise as the idea becomes more mainstream, several financial institutions, such as Morgan Stanley (MS), Merrill Lynch and UBS Inc. (UBS) have also been developing impact-investing platforms that their wealth advisors can tap when clients request impact investment funds geared toward a certain cause.

Morgan Stanley Wealth Management’s Investing with Impact platform recently began offering about 100 third-party products, including exchange-traded funds, mutual funds and some other “do good” alternative investment products. It's also looking to offer private debt and equity investments to impact investors in the near future.

Returns Keep Them Coming Back

The move by these investment banks and money managers to offer more impact investing products seems to be a profitable one. A GIIN and JP Morgan study that looked at 125 impact investors who committed $10.6 billion to impact investing in 2013 found that about 91% reported that their impact investments were meeting or exceeding their financial expectations. Approximately 54% said their investments were targeting market-rate returns. The group, as a whole, plans to increase their investments in this sector by 19% this year, which would result in close to $13 billion in investments.

Millennial Next In Line

The next generation of investors is already exhibiting a desire to put their investment dollars behind projects, companies and funds that are in line with their own core valves. Millennials, or people born between the early 1980s and the early 2000s, are the latest group of investors who see impact investments as a way to stand up for their beliefs while also investing in their own futures.

Studies show that these investors are also now turning to financial professionals to help provide them with opportunities to generate a strong financial return, while creating a positive social impact. They want their advisors to offer them value-based investing products as an alternative to what is being offered to them in the general markets. And while they may be young, and low on cash at the moment, this segment of the population shouldn’t be overlooked. Millennials are expected to inherit about $41 trillion in wealth from their parents, and they are already looking for ways to invest it.  

Skewed To Wealthier Investors...For Now

More and more opportunities will continue to open up for investors seeking to align their own financial futures with their desire to make a difference in the world. For now, though, most scalable impact investing options are still geared to wealthier investors. For those investors with less than $3 million to invest, sustainable and responsible investment vehicles, such as mutual funds focused on socially and environmentally responsible investments, are still the way to go. Private deals that require a fair amount of due diligence may still be too risky for the average investor.

The Bottom Line

The desire to meld investments and social responsibility is growing at a fast pace among the rich and not-so-rich. And the groundwork has been laid for the creation of numerous products to meet the demand of a new generation of socially conscious investors. As long as such investments produce competitive returns – both financial and social – their popularity will only grow.

A Guide To Day Trading On Margin

Day trading involves buying and selling the same stocks multiple times during trading hours in hope of locking quick profits from the movement in stock prices. Day trading is risky, as it is dependent on the fluctuations in stock prices on one given day, and it can result in substantial losses in a very short period of time. Buying on margin, on the other hand, is a tool that facilitates trading even for those who don’t have the requisite amount in hand. Buying on margin enhances a buyer’s buying power by allowing him or her to buy for a greater amount than he or she has cash for; the shortfall is filled by a brokerage firm at interest. When the two tools are combined in the form of day trading on margin, risks are accentuated. And going by the dictum, “the higher the risk, the higher the potential return,” the returns can be many fold; however, it doesn’t come with a guarantee.

The Financial Industry Regulatory Authority (FINRA) rules define a day trade as, “The purchasing and selling or the selling and purchasing of the same security on the same day in a margin account.” The short selling and purchases to cover the same security on the same day along with options also fall under the preview of a day trade.

When we talk about day trading, some may indulge in it only occasionally and would have different margin requirements from those who can be tagged as “pattern day traders”. Let’s understand these terms along with the margin rules and requirements by FINRA (see official FINRA site).

A term “pattern day trader” is used for someone who executes four or more day trades within five business days, provided one of two things:

 1) The number of day trades is more than 6% of his total trades in the margin account during the same five-day period; or 
2) The person indulges in two unmet day trade calls within a time span of 90 days. A non-pattern day trader's account incurs day trading only occasionally.  

However, if any of the above criteria are met then a non-pattern day trader account will be designated as a pattern day trader account. While if a pattern day trader account has not carried out any day trades for 60 consecutive days, then the status is reversed to a non-pattern day trader. 

Margin Requirements

To trade on margin, investors must deposit enough cash or eligible securities which meet the initial margin requirement with a brokerage firm. According to the Fed's Regulation T, investors can borrow up to 50% of the total cost of purchase on margin and the remaining 50% is deposited by the trader as initial margin requirement.

The maintenance margin requirements for a “pattern day trader” are much higher than that for a “non-pattern day trader”. The minimum equity requirement for a pattern day trader is $25,000 (or 25% of the total market value of securities, whichever is higher) while that for a non-pattern day trader is $2000. Every day trading account must meet this requirement independently and not through cross-guaranteeing different accounts. In situations when the account falls below this stipulated figure of $25,000, further trading is not permitted until the account is replenished.

The buying power for a pattern day trader is four times the excess of the maintenance margin as of the closing of business of the previous day (say an account has $35,000 after the previous day's trade, then the excess here is $10,000 as this amount is over and above the minimum requisite of $25,000. This would give a buying power of 4 X 10,000 = $40,000). If this is exceeded, then the trader will receive a day trading margin call issued by the brokerage firm. There is a time span of five business days to meet the margin call; during this period, the day trading buying power is restricted to two times the maintenance margin excess. In case of failure to meet the margin during the stipulated time period, further trading is only allowed on a cash available basis for 90 days, or till the call is met.

Assume that a trader has $20,000 more than the maintenance margin amount. This will provide the trader with a day trading buying power of $80,000 (4 X 20,000). If the trader indulges in buying $80,000 of PQR Corp at 9:45 a.m. followed by $60,000 of XYZ Corp at 10.05 a.m. on the same day, then he has exceeded his buying power limit. Even if he subsequently sells both during the afternoon trade, he will receive a day trading margin call the next day. However, the trader could have avoided the margin call by selling off PQR Corp before buying XYZ Corp.

Note: Though the brokers must operate within the parameters issued by the regulatory authorities, they do have the discretion to make minor amendments in the laid requirements called “house requirements”. A broker-dealer may classify a customer as a pattern day trader by bringing them under their broader definition of a pattern day trader. Also, brokerage firms may impose higher margin requirements or restrict buying power. Thus, there can be variations depending upon the broker-dealer you choose to trade with. 

Bottom Line

Day trading on margin is a risky exercise and should not be tried by rookies. People who have experience in day trading also need to be careful when using margin for the same. Using margin gives traders an enhanced buying power however; it should be used prudently for day trading so that traders do not end up incurring huge losses. Restricting yourself to limits set for the margin account can reduce the margin calls and hence requirement for additional funds. If you are trying day trading for the first time, don’t experiment with a margin account.

It’s Time To Invest In These Three Commodities

Commodity-related companies provide investors and traders some of the best exposure to economic growth, above-average long-term returns, along with lower-than-average risk and a natural hedge against inflation. We’ll take a look at some of the strategies to track and trade some exchange-traded funds and exchange-traded notes that are used to follow commodities such as coffee, oil and gold. 

Coffee

As mentioned in a previous article, coffee has been one of the greatest investments so far in 2014. As you can see from the chart below, the iPath Dow Jones-AIG Coffee Total Return Sub-Index (JO)  has risen an astonishing 52.67% so far this year. From a technical perspective, notice how the recent pullback from its swing high of $42.87 stopped near the long-term support of its 200-day moving average. This long-term average will likely be used by many traders to help them determine where to place their stop-loss orders so that they can maximize the risk/reward of the trade. To help the bullish case for coffee traders, the recent crossover shown on the MACD indicator suggests that the next stop could be back toward the mid $40s. 

Oil

Recent articles have suggested that higher prices have recently become the reality because of conflict in the Middle East. As you can see from the chart of the iPath S&P GSCI Crude Oil Total Return Index (OIL), the price has started to pullback from its recent high and appears to be on route to test the support of its 200-day moving average. As was the case for coffee traders, most oil traders will also be looking to enter a trade as close to the 200 DMA as possible because this will maximize the risk/reward ratio for the position. Taking a look at the RSI and the MACD indicators would also suggest that there may be some more short-term selling pressure before the uptrend is able to resume. Trading signals will be generated when the two indicators create a bottom and move above the key trigger lines. In the case of the RSI, traders will want to see a move below 30 and then want to enter a long position when it crosses back above. For the MACD, a buy signal will be generated when the MACD indicator crosses above its trigger line (red line) in the upward direction.

Gold 

Gold has been on the rise over the past few weeks and the recent move shown in the chart of the SPDR Gold Trust ETF (GLD) suggests that we could see a move even higher. As was the case in the previous examples, it is interesting to see how the price action has been respecting the support of its 200-day moving average. Conflict in the Middle East, economic uncertainty and a built in inflation hedge makes GLD a very interesting pick for any active trader.

The Bottom Line

Based on the ETFs charts shown above for coffee, oil and gold, it appears that the commodity complex is nearing a key level of support. It is important for active traders to keep a close eye on the 200-day moving average along with key technical indicators such as the MACD and RSI. Bullish signals near these levels will maximize the risk/reward of any given trade and based on the charts; this could be the time to take a position in any of the commodities mentioned.

ChartAdvisor For July 4, 2014

Major U.S. indices moved higher over the past week, with the Dow Jones Industrial Average setting a new record just before Independence Day. According to the Labor Department, the economy added 288,000 jobs and the unemployment rate fell 0.2% to 6.1%, which is the lowest since September 2008 – before the economic crisis. These data point to durable signs of recovery, despite concerns about the Q1 2014 slowdown that turned out to be much more severe than initially reported.

International markets moved largely higher across the board. Japan’s Nikkei 225 jumped 1.21%; Germany’s DAX 30 was up 2.18%; and, Britain’s FTSE 100 rose 1.59%, as of the close July 3. In Europe, the European Central Bank (ECB) responded to concerns of a slowdown in its recovery by promising low rates for an extended period. In Asia, China reported a sudden surge of activity in its June PMI for the first time this year, which suggests that the region’s largest economy may be rebounding.

The SPDR S&P 500 (SPY) ETF rose 1.26% higher during the shortened holiday week. After rebounding from its pivot point at 194.42, the index moved higher to test its upper trend line and R1 resistance at 197.80. Traders should watch for a breakout from these levels towards its R2 resistance at 199.87, or a breakdown back towards its pivot point. Looking at technical indicators, the RSI appears overbought at 74.50 and the MACD appears elevated.

The SPDR Dow Jones Industrial Average (DIA) ETF rose 1.26% higher during the shortened holiday week. After breaking out from its R1 resistance at 169.45, the index moved towards its upper trend line and R2 at 171.02. Traders should watch for a breakout from these levels to new highs or a breakdown back towards its R1 resistance. Looking at technical indicators, the RSI appears overbought at 68.52 and the MACD continues to trade relatively even.

The PowerShares QQQ (QQQ) ETF rose 2.08% higher during the shortened holiday week. After breaking out from its R2 resistance last week, the index reached its new R1 resistance at 95.23. Traders should watch for a breakout from these levels towards R2 resistance at 96.56 or a move back down towards its prior trend line support and pivot point at 92.82. Looking at technical indicators, the RSI is very overbought at 83.65 but the MACD experienced a bullish crossover.

The iShares Russell 2000 (IWM) ETF rose 1.2% higher during the shortened holiday week. After rebounding from its prior R2 resistance, the index reached its prior highs just below its R1 resistance at 120.98. Traders should watch for a breakout from these levels towards R2 resistance at 123.60 or a move back down to its prior highs at around 118.00. Looking at technical indicators, the RSI appears overbought at 69.09 but the MACD remains in a bullish uptrend.

The Bottom Line

The major U.S. indices moved largely higher over the past week, but many of them appear overbought based on RSI readings and uncertain MACD levels. Next week, traders will be watching a number of important economic events, including FOMC minutes due out on July 9 at 2:00 p.m., and jobless claims due out on July 10 at 8:30 a.m., as well as any additional insights from the U.S. Federal Reserve.

Can High Fund Returns Be Deceiving?

We’ve all heard that ubiquitous warning: “Past performance does not guarantee future results.” Yet looking at a menu of mutual funds in, say, your 401(k) plan, it’s hard to ignore the ones that have crushed the competition in recent years.

On one level, it makes sense that the one-year or five-year returns of a fund tend to carry a lot of weight. Unless investors have the time and wherewithal to investigate each basket of securities on their own, they’re likely to rely on the information that’s right at their fingertips.

But are historical outcomes a good indicator of results down the road? The data would seem to indicate otherwise. One study looked at mutual-fund data over a 16-year period and found that just 7.8% of the top 100 fund managers in any given year retained that distinction the following year.

A separate report by Standard & Poor’s showed that only 21.2% of domestic stocks in the top quartile of performers in 2011 stayed there in 2012. And slightly more than 7% remained in the top quartile two years later.

Subsequent Performance of Mutual Funds in the Top Quartile in 2011

Source: Standard & Poor’s

History Often Doesn’t Repeat 

Why are past results so unreliable? Shouldn’t star fund managers be able to replicate their performance year after year?

Certainly, some actively traded funds beat the competition fairly regularly over a long time period. But the inherent unpredictability of the market means that even the best minds in the business will have off years.

A study by investment firm Robert W. Baird & Co. looked into this phenomenon. What the company found was that, even among fund managers who outpaced the market over a 10-year span, many experienced two- or three-year stretches where they trailed the pack.

Translation: If you’re looking at a fund's recent outcomes and the numbers look unimpressive, it’s hard to tell if it’s a bad manager having a bad year or a good manager having a bad year.

There’s an even more fundamental reason not to chase high returns. If you buy a stock that’s outpacing the market – say, one that rose from $20 to $24 a share in the course of a year – it could be that it’s only worth $21. And once the market realizes the security is overbought, a correction is bound to take the price down again.

The same is true for a fund, which is simply a basket of stocks or bonds. If you buy right after an upswing, it’s very often the case that equilibrium is about to bring it back down.

What Really Matters

Rather than looking at what happened in the past, investors are better off taking into account the various factors that do influence future results. In this respect, it might help to learn a lesson from Morningstar, one of the country’s leading investment research firms.

Dating back to the 1980s, the company assigned a star rating to each fund based on risk-adjusted returns. However, research showed that these scores demonstrated little correlation with future success.

Morningstar has since introduced a new grading system based on five P’s: Process, Performance, People, Parent and Price. With the new rating system, it’s looking at the fund’s investment strategy, the longevity of its managers, its expense ratios and other relevant factors. The funds in each category earn a Gold, Silver, Bronze or Neutral rating.

The jury’s still out on whether this new method will fare any better than the original one. Regardless, it’s an acknowledgement that historical results, by themselves, tell only a small part of the story.

If there’s one factor that does consistently correlate with strong performance, it’s fees. This explains the popularity of index funds and ETFs, which, at a much lower cost than actively traded funds, mirror a market index.

According to Vanguard, a whopping 68% of large-cap value funds trailed their benchmark over the past 10 years. What this shows is that, given the complexity of stock movements, it’s hard even for skilled managers to pick enough winners to make up for the higher price tag of their funds.

The Bottom Line

It’s tempting to judge a mutual fund based on its recent returns. But if you really want to pick a winner, look at how well it’s poised for future success, not how it did in the past.

Interested In Healthcare Stocks? Look At This ETF

Healthcare has been one of the hottest sectors in the financial markets over the past few months. Key exchange-traded funds in this sector have seen returns ranging from 10.54% to 18.08%. Two of the most popular ETFs used by retail investors to track this sector are the iShares U.S. Healthcare ETF (IYH) and the Healthcare Select Sector SPDR ETF (XLV).

The IYH ETF is used by many retail traders to gain exposure to U.S. healthcare equipment and services, pharmaceuticals and biotechnology companies. As of of June 25, 2014, the fund sector breakdown was divided between 68.18% pharmaceuticals & biotechnology and 31.70% healthcare equipment & services.

Performance of IYH

Taking a look at the chart of IYH, you’ll see that it has been trading within a very strong uptrend over the past five years. You’ll also notice that it is trading near all-time highs, and based on its chart, it doesn’t look like this trend will end anytime soon. Taking a look at the Relative Strength Index, the MACD and the bullish divergence between key long-term moving averages confirms that the upward momentum is likely to continue.

Components of iShare U.S. Healthcare ETF

When looking for ideas for investing in the healthcare sector, it's a wise move to investigate the top holdings of key ETFs, such as IYH. The table below shows its top holdings.

Taking a look at the chart of JNJ, which is the ETF’s largest holding, you’ll see that it is trading near all-time highs. Based on the technical indicators it doesn’t seem like this trend is about to reverse and it wouldn’t be surprising to see long-term traders protect their positions by setting a stop-loss order below the 200-day moving average, which is currently at $93.66. Given that there is no overhead resistance, the trend is definitely in the upward direction, and ETFs such as IYH will continue to benefit until key indicators confirm a reversal in the uptrend.

Another key holding of the IYH fund is Merck & Co., which is also trading near all-time highs and looks positioned to make a continued move higher. As you can see from the chart below, the 50-day and 200-day moving averages are diverging and the price is currently testing the near-term swing high of $59.39. If the bulls are able to send the price above this level on significant volume then there would be little overhead resistance that would prevent a move toward the mid $60 level. 

The Bottom Line

As shown on the chart of the iShares U.S. Healthcare ETF above, companies within the healthcare sector seem to be poised to make a move higher. Based on the analysis of key holdings such as Johnson & Johnson and Merck & Co., this sector should be near the top of any active traders' watch list.

Seven Steps to Become Financially Independent

With Independence Day just around the corner, now is the perfect time to finally set the goal of financial independence for yourself. Whether you’re trying to break free from your parents’ financial assistance, switch jobs or finally pay off that seemingly never-ending stream of debt, becoming financially independent is one of the most fulfilling goals you can set.

Although achieving financial independence is undeniably satisfying, it definitely takes a lot of time, effort and motivation to achieve. Use the following seven steps to work toward your dream of gaining complete financial freedom:

1. Cut Expenses

If you’re able to minimize your expenses, you’ll be able to save money much more efficiently. It’s important to know exactly how much money you have coming in and where you’re spending it. Make a budget listing all your sources of income on one side and all your expenses on the other. Review what you’re spending money on to see if there’s anything you can cut to add more money to your savings account each month.

2. Spend Less Money Than You Earn

For a budget to be effective, you have to stick to it. It might seem obvious, but for many Americans, spending within their means is a real problem. In fact, according to Debt.org, the average household with a credit card carries more than $15,000 in credit card debt. Make it a personal goal to never spend more money than you have in your bank account. It might be helpful to carry cash in your wallet instead of credit cards, as this makes it impossible to overspend.

3. Create an Emergency Fund

Unexpected money emergencies always seem to happen at the most inopportune times. If you don’t have the money to pay for expenses like car repairs, medical bills or the cost of living if you lose your job, you’ll probably end up putting them on a credit card. Rather than letting unplanned expenses put a dent in your finances, create an emergency fund to tide you over. Most experts recommend having at least six months’ wages saved up for this purpose.

4. Pay Off Debt

According to the U.S. Census Bureau, as of 2011, 69 percent of households had some form of debt. Whether your debt is in the form of credit cards, student loans, a mortgage or auto loans, it’s important to work hard to pay the balance off. At the very minimum, be sure to make your required monthly payments (your credit score will thank you) — but you should also do your best to pay extra on the balance each month.

5. Save Aggressively

Set aside as much money to put into savings as possible — always remember to “pay yourself first.” Try to save at least 20 percent of your gross income. If that isn’t possible right now, do the best you can — strive to deposit at least 10 percent into savings each month. If you get a raise or find a little extra room in your budget, use this to increase your contribution.

6. Initiate Automatic Deductions

Let’s face it — putting extra money into savings or toward paying off debt can be difficult. Even when you desperately want to gain financial independence, it can be hard to resist the temptation of spending the money on something frivolous. Combat this problem by setting up automatic withdrawals from your checking account to your savings and loan accounts. When the money is taken out automatically, you don’t even have the option of making irresponsible spending decisions.

7. Invest Wisely

Supplement your income by making sound investments. Consult a trusted adviser to help you create an investment plan designed to fit your needs. While it’s important to have a savings account, you’ll also need to invest funds in stocks, bonds and other financial assets.

Achieving financial independence takes a great deal of hard work — and, often, a long time, so try your best not to become discouraged. If at any point you find yourself veering off track, take the time to realign your strategy and pick up right where you left off.

Is It Finally Time For TIPS?

Once the Federal Reserve unveiled its programs of easing and bond buying designed to reignite a stalled U.S. economy, there has been a persistent idea that such money-printing would drive up inflation. Over the last few years, the consumer price index (CPI) has been pretty calm and the dire warnings about hyperinflation haven’t exactly panned out.

While we are nowhere near reaching Zimbabwe-style hyperinflation just yet, the Fed did get a bit of shocking news: prices are on the rise.

For investors, that could mean that an old standby way to preventing inflation – Treasury Inflation-Protected Securities or TIPS – could finally be a good buy in the year ahead. 

Highest Point In Years

For inflation hawks, things are starting to get a bit dicey. Namely, the price of consumer goods and services. The index for personal consumption expenditures (PCE) is at its highest level in more than a year and a half. The rate jumped 1.8% in May to reach the highest level since October 2012. This compares to just a 0.8% reading in February. The effects were felt across the board by shoppers, with the largest price increases occurring at grocery stores, gas stations and in their utility bills. Energy prices were up 5.8% last month, while food increased by 2.1%.

Meanwhile, the other measure of inflation – the CPI – also ticked higher. The Labor Department’s measure of inflation rose an unadjusted 2.1% over the past 12 months. And considering that the Fed has annual target rate of 2% for inflation, things are starting to get interesting.

That where TIPS come in.

TIPS are bonds that provide investors a fixed yield plus an “extra boost” of continually ongoing adjustments to designed offset inflation. These bonds can be used by investors as a way to play potentially high inflationary scenarios. The fact that they are designed to adjust based on changes in the CPI prevents erosion of purchasing power.

That fact also sets up an interesting play as well.

Many analysts now believe that the Fed is “behind” the inflationary curve. Its favorite benchmark – the PCE – is still below the 2% rate it needs to begin tightening. However, the CPI is above that 2% metric. Analysts believe that the CPI rate of inflation will rise to 2.29% before the Fed begins raising interest rates. Already, Fed Chairwoman Janet Yellen called the CPI metric “just noise.” That sets-up an interesting arbitrage scenario for investors in TIPS.

Already, the institutional investors have begun adding more TIPS to their portfolios. The Treasuries latest auction on June 19 was over-subscribed by 2.76 times. 

Making a TIPS Play

For investors, using TIPS as an insurance policy against future inflationary pressures makes sense given the recent jumps in PCE and CPI. And adding them has never been easier. The exchange traded fund (ETF) boom has provided all sorts of options for the asset class. The easiest of which is the $13 billion iShares TIPS Bond ETF (TIP).

The fund tracks 39 different inflation-protected securities and offers cheap exposure to U.S. inflation fighting bonds. Expenses are a rock-bottom 0.20%. Likewise, the Schwab US TIPS ETF (SCHP) offers dirt cheap exposure as well. SCHP only charges 0.07%. The only problem with these funds is their duration might actually hurt them.

Just like regular bond funds, TIPS funds do not have a "maturity date" and can lose money if interest rates rise. Bonds will longer durations – TIP currently averages 7.54 years – will be hit harder. Now, if Yellen continues to be "behind the curve” for a while, that won’t matter. But when interest rates do rise, TIPS, along with other intermediate or long duration TIPS funds, such as the PIMCO 15+ Year U.S. TIPS Index ETF (LTPZ), could fall hard.

To that end, shortening up duration risk is key. The $2 billion FlexShares iBoxx 3 Yr Target Duration TIPS ETF (TDTT) seeks to limit investor’s duration to just three years. Likewise, the Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) drops its duration down to just 2.6 years. TDTT does yield more than VTIP, as it barbells both one- and five-year TIPS to get that three-year duration. Both make ideal selections to play inflation, while addressing the risk of rising rates.

Finally, investors don’t need to stay in the U.S. to get their inflation protection fix. Rates of inflation are completely different in various parts of the world. That can lead to opportunities for U.S. investors to make some extra gains on their inflation trade. The $956 million SPDR DB International Government Inflation-Protected Bond ETF (WIP) tracks TIPS from a variety of developed and emerging market nations. 

The Bottom Line

Inflation hasn’t been a problem for the last few years, but that could be about to change. Both key measures of inflation have gone up. That could mean it’s finally time for investors to embrace Treasury Inflation-Protected Securities again.