By Bill Poulos
This article originally appeared on Traders Reserve. 

Exchange-traded funds (ETFs) have become immensely popular in the past few years. The growth in ETF trading has outpaced many other investment vehicles as more and more investors are flocking to what they see as “safer” investments than stocks. But ETFs entail a much greater risk than many investors realize — especially if they are not trading them properly.

I’ve discovered that many people involved in ETF trading are losing their money over time. They may not be losing as much, due to the reduced stock-specific risk in ETFs, but they are still coming out on the wrong end of their trades. I believe there are some deep misconceptions surrounding ETF trading, so I’ve outlined the five reasons why most people are not successful when trading ETFs. In addition, I’ll give you five ways to improve your ETF trading approach to help you to overcome the challenges in today’s market.

Let’s look first at what so many traders do wrong:

Trading ETFs the Wrong Way

1. Utilizing an outdated and obsolete “buy-and-hold” approach.

The buy-and-hold theory is flawed for two main reasons. First, it assumes that you can’t properly time the market (entry and exit points). Second, it assumes that the market will consistently grow on an annual basis. If there’s one thing we’ve all learned in the past decade, it’s that the markets don’t always go up and when they crash it can be in a very BIG way.

2. Trading with an incomplete method (or worse yet, no method at all)

Investing and trading, much like professional sports, is all about execution around a specific game plan. If you don’t know what your edge is or what your limits are, then you’re not actually trading at all, you’re simply gambling.

3. Going after profits first and thinking about risk second (if at all)

Losing traders and investors let their greed get the best of them. They get so enamored with the potential windfall that they start taking unnecessary risks.

4. Trying to capture entire market moves

The only way that a trader or investor is able to capture an entire market move is by sheer luck. There is just no clear definable strategy or indicator to pinpoint these exact positions on a chart.

5. Trying to trade in every market regardless of condition

Not every market is ripe for trading. Non-deliberately trading markets greatly reduces the traders’ chances for success because market movement is indistinguishable. The best trading method in the world will yield little to no results in a market like this because the odds of success are stacked against you. It’s not your trading style; it’s simply the market.

To correct these ETF trading mistakes, let’s look at how you can change the way you approach trading (and this isn’t limited to ETFs).

Trading ETFs the Right Way

1. Action-oriented, engaged approach

To avoid the pitfalls of the “buy-and-hold” investing strategy, I recommend a more engaged approach to investing. An active investor does have the ability to gauge when they should enter and exit a market. It’s simply a matter of understanding how the market is currently moving and knowing the right time to get into and out of a trade. All of which can be learned through proper education, disciplined trading and practice.

Buy-and-Hold Strategy = 7.8% Loss
Money tied up for six months with no exit strategy

Action-Oriented Strategy = 10.7% Profit
Money tied up for two months, clear and defined exit point, avoided the major market reversal

2. Utilizing a complete method

A professional trader knows the next move that he/she will make is based on market activity. Trading ETFs, or any investment vehicle for that matter, is all about setting yourself up to win, getting the odds in your favor before investing, and managing risk tolerance while in the trade. A sound trading strategy will employ at a minimum four primary points:

• Specific Setup Conditions
• Entry Rules
• Initial Stop Rules
• Exit Strategy Rules

If your trading strategy does not employ these four components at a minimum you need to reevaluate that strategy because your risk exposure is too high.

3. Risk management first, trading second

Professional traders know that if you want a successful career in trading, risk control has to be the first component of your trading strategy. When you trade with a risk management strategy, you shield your portfolio from undue, potentially huge losses. Moreover, there is an understanding of how much loss may be incurred before the trade is ever placed. This understanding of the potential loss leads to the acceptance of the risk and ultimately removes all emotion from the decision-making process. If you can remove emotion entirely from the decision-making process, then your chances for success are greatly improved as is the potential for profits.

4. Trade the “sweet-spots”

Rather than focus on major market movements or events caused by news events, I recommend trading the sweet spots of a move. These are the middle one-third of a market move. When you go after the middle one-third of a market move, the probability of being able to know the direction of the prevailing trend is substantially higher. This gives you a trading edge.

5. Trade deliberate markets

Deliberate markets display a clear, identifiable pattern in their movements. You can confidently make a trade within these markets because you know that they odds are in your favor that they will continue to move accordingly. These are the markets where your trade and investment dollars will do the most work for you. The key, obviously, is to know when to get out and/or the movement pattern has finished. You can easily see the difference between a deliberate and non-deliberately trading market below:

Non-Deliberately Trading Market

Market is choppy; there are long stemming candles and shadows. This tells us that the market doesn’t know what it wants to do. There is too much risk involved with a trade like this — steer clear of these markets at all costs.

Deliberately Trading Market

Market moves in a consistent pattern. Candles and shadows are relatively short and there are little to no gaps in one day’s close and the next day’s open. This is a safe and reliable market in which to invest your money.

The difficult part for a trader/investor who is looking at moving their skill set to the next level is the time and effort it takes to learn and practice the discipline. That is why I designed an educational course entitled, “The Portfolio Prophet.” A brand-new video presentation reveals everything here.

For more trades, ideas and strategies, visit Traders Reserve.