ETF’s vs Stocks
I recently received an email from a beginning trader and he questioned why I prefer trading ETF’s over stocks nowadays. The rest of this post is the email I sent him in reply. I thought I would share it here with all my readers since it may be of use to others. Share it with your friends if you like it.
When you trade stocks the first thing you need to do is examine the markets and determine if they are going to go up or down. If you think the market is going up, you go “long” (basically means you buy) on stocks. If you think it is going down you go “short” (sell stocks) on stocks. Makes sense?
OK, so now that you have determined direction of market and how you are going to trade, you have to find a stock. There are over 8,300 stocks. Which one is good?
Hopefully you spent hours researching and now have a stock, AND you think market is going up so you BUY. Now here is the kicker.
WHEN THE MARKETS GO UP, 25% OF STOCKS WILL FALL (on average)
Your stock could be in that 25%. There is no guarantee.
Now lets compare this to ETF Trading.
Just like above, you need to determine the direction of the market. Is it going up or down or even sideways? If you think it’s sideways, stay in cash. So you make a determination it is going up or down.
With ETF Trading, once you determine market direction, there are only 2 ETF’s to choose from (unlike 8,300 stocks to choose from).
One ETF is GUARANTEED to go up if the market goes up (unlike stocks). The other ETF is GUARANTEED to go up if the markets go DOWN. This ETF that goes UP when the markets go DOWN is called a “Contra-ETF”.
So you have an ETF and a Contra-ETF. I like to use leveraged ETF’s to triple my gains and losses. For the S&P 500 the ETF is UPRO and the Contra-ETF is SPXU.
Let’s look at an example. In the last 12 months the S&P went up about 23% I think.
Since the S&P 500 went up 23%, UPRO is guaranteed to go up 3x that and as you saw, it went up 79%! Nice.
Had the markets gone down 23%, then SPXU would be up 79% guaranteed. Instead, the markets went up and thats why SPXU went down, AS IT SHOULD.
So you asked me a question, with SPXU down 59% why would I invest in that?
Here is the reason why. From 2000 to 2012 the S&P 500 returned 0%. That’s right. it went nowhere for 12 years. Buying UPRO and holding 12 years gets you a (0% return x 3) = 0% return for UPRO.
But we both know that in those 12 years, the markets went way up, then they went way down, then they went back up. Up down, up down.
So here is what I did:
On 7-9-2012 I thought market going up so I buy UPRO.
On 7-19-2012 I thought market going down so I sold UPRO for a 5% profit and bought SPXU.
On 8-2-2012 I thought market going back up so I sell SPXU for 2% profit and buy UPRO.
On 9-12-2012 I though market going down so I sell UPRO for 17% profit and buy SPXU.
On 9-26-2012 I thought market going up so I sell SPXU for 0% profit and buy UPRO.
On 10-5-2012 I think market going down so I sell UPRO for 6% profit and buy SPXU.
On 10-24-2012 I think market going up so I sell SPXU for 11% profit and buy UPRO.
Now I could go on with my results but lets stop here and tally this up. That is a 147% gain from 7-9-2012 to 10-24-2012.
Now lets see what the S&P did during the same time: the S&P started at 1352.36 and ended at 1408.75 for a 4.2% gain
147% vs 4.2%
6 trades all winners. This is actual results from last year, starting at this same time of the year. I expect to do the same this year.
In closing… I know you are skeptical and you are probably going to say “this only works if you are correct with market direction”. True. Same with stocks. But when you are correct, you see the bigger returns, AND you make money in up and down markets.
Now, if you understand odds, let’s look at this from a mathmatical perspective.
I average 50%-75% winners. Let’s use the low end of 50% winners. Anyone can throw a dart at a board and get the same results since you have only 2 choices, UPRO or SPXU. No special skill.
But the results show that my 50% winners return 14% each. While the 50% losers average 7% loss each. If you do the math (14 – 7 = 7 or 3.5% per trade) you see thats an average 3.5% gain per trade. Average # of trades per year is 18 giving me a 63% annual return (on average) NO MATTER WHICH WAY MARKET MOVES.
That is the important part, even if market crashes I average 63% gain.
So I hope this helps you understand why I love ETF’s. If you would like to follow what I’m trading, click here now for more details.