One advantage of trading systems is that the trades are based on logical decisions rather than emotions.
Most investors think fear and greed are the emotions that lead to bad trades. But there are actually other emotions that can interfere with trading, including hubris.
Many of us are confident in our abilities to find good investments, and that self-confidence can interfere with our decision making. For example, selling might be especially difficult when we are confident that we have picked a long-term winner.
This is why many traders "double down" on a position that has turned against them. Confident in their analysis, these traders are insistent that the market is wrong and they are wisely buying when most people are selling.
In the long run, their analysis may be right, but it can take years to see a significant return on investment. In the meantime, these investors are missing other opportunities to grow their wealth, simply because they have become more interested in being right than making money.
With a system, any opinions I have about a market or a stock are simply that -- opinions. Predetermined rules that have a history of success will determine what and when I buy or sell. The system I write about each week is based on the 26-week rate of change (ROC) indicator and is designed to buy only ETFs that are going up. Doubling down and other unprofitable ideas are not allowed.
Right now, my 26-week ROC system is saying that it's time to sell Guggenheim Timber (CUT). So even though I personally feel that hard assets like timber still seem safe, I'm listening to my system.
Timber is the favorite asset class of famed value investor Jeremy Grantham, co-founder of Grantham Mayo van Otterloo (GMO), an investment firm that manages more than $106 billion.
Grantham publishes a quarterly forecast for asset class returns over the next seven years. To make his forecast, Grantham analyzes the fundamentals of the market. For some time, timber has been his favorite asset with the highest projected returns.
In the most recent forecast, released earlier this month, Grantham cut his outlook for timber, but still expects it to be the best performer over the next seven years. He is now predicting timber and emerging market stocks to both deliver a real return (after inflation) of just under 6% a year.
Rather than attempting to forecast the demand and supply factors of timber and other markets around the world, I use the 26-week ROC system to time buys and sells. And right now, the system is saying that CUT is a sell.
In fact, it is actually saying the entire alternative asset class is a sell. That has become the pattern of the system over the past year as sell signals have coincided with a signal to hold cash rather than rotate into another ETF. This happens when risk is high and the current level of market risk seems unusually high. At times like this, cash really is the right investment, like it has been in the precious metals market.
The 26-week ROC system has been in cash instead of metals since September, when we sold SPDR Gold Shares ( GLD) at about $167. GLD has fallen 15% since then, and other metals are down as well.
It can be frustrating to hold cash, especially at the low interest rates that are available now. However, this signal to stay out of metals has prevented us from experiencing a large loss, and has preserved wealth that can be reinvested when the system signals that the bear market in that sector has finally ended.
CUT gained 14% while it was in the portfolio (from the open on Dec. 14 through the close on April 25) and slightly outperformed SPDR S&P 500 ( SPY), which gained 11.4% over that time.
Recommended Trade Setup:
-- Sell CUT at the market price
After selling CUT, there will only be two positions left in the 26-week ROC portfolio. Both positions remain buys for now.