ETF Trading, Correlations and "Good Stock Picking"

First, a correction from yesterday. In his interview with me, the CEO of ProShares was correcting a few of the misnomers of the ProShares created by the media in general - not cable television. Again, the interview is being transcribed and will be published in whole once it’s completed. I’m sure you’ll enjoy it.

Let’s now talk further about market correlations and how they impact your trading today. As I’ve mentioned, most equities and equity ETFs (including country ETFs) are highly correlated to the US indices today. In fact the correlations are among the highest in history. Think a stock in Spain is going to rise? Guess what? It has a better chance today of rising if the US indices rise than it does if the US falls. No matter how well that company does, its stocks' fortunes today will be tied closely to where the US is at.

Is this always true? No. Correlations are dynamic, meaning they are constantly changing. 9 months ago many other countries were far less correlated to the US than they are today and if we look ahead 9 months from now that may again be true. But today, March 4, 2009, everything is tightly wound.

In the US stock market the same is true. Look at Monday. The market sold again. 16 out of every 17 stocks dropped with it. As the overall market went, so did most of the stocks.

This leads us to is a question we’ll answer over the next few weeks. If the US indices are driving everything, why not simply focus your attention on predicting the direction of the US market instead of trying to find the next "great stock"?

There are a lot of very smart people who spend their entire day looking for great stocks. Look at the gentleman who runs the Fidelity Contra Fund. First, I’m sure he is a smart man. Fidelity hires the best. Second, Morningstar gives his fund 5 stars. That’s their highest rating. And the Wall Street Journal did an article on him the other day telling us how good a stock picker he is. So how did someone with all these accolades perform last year? If you had given him $1 million of your retirement money early last year, how much would you have had by year end? About $650,000. That’s right, more than 1/3 of your investment was gone. And 9 weeks into 2009, even more is gone.

Good stock picker? According to Fidelity, Morningstar and the Wall Street Journal he is. But that doesn’t help you retire comfortably (or even retire at all)..

We know the market drove his stocks down. It is no different than if you invested money with Warren Buffett 10 years ago. Good stock picker? Many people say he’s the best. But a negative returns after inflation is not wealth creation. It’s the opposite; its wealth destruction.

Give this some serious thought. Spend more time learning how to predict the direction of the stock market and the sectors with ETFs, and less time picking stocks. Stock picking has proven to be a lucrative game for those charging fees, but it’s been a losing game for those whose money has evaporated over the past 14 months. Correctly predict the direction of the market and/or sector and you’ve not only lowered your risk, you’ve also increased the likelihood of further building your wealth.

Every day in our Battle Plan we’ll provide you with incisive, before-the-bell commentary and analysis on the day’s markets to help put your trading in context. We’ll give you suggested entries and exits for short term trading opportunities in stocks, ETFs and options that may be only hours away. And we’ll give you what many other people can’t: model-driven percentages so that you know the historical win rate going back to 1995 for every single trade idea—long and short.

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