Most people are followers rather than leaders. When a huge majority believes something, the market has a habit of doing the opposite. Sophisticated and experienced traders, as well as top corporate insiders, continuously trade in the opposite direction of the general public. And often they have a very high batting average in their trades, yielding handsome profits. They know very well that following the crowd can be detrimental to making money.

The most important approach to trading is to do the opposite of any hyped up market. Remember October 3-4, 2011. You may recall the atmosphere of fear and despair at that juncture when we at ETF Trade Advisor kept insisting on buying the equities at extreme lows. That was when fund investors and flock traders were piling up into cash and Treasuries, clearly the turning point in the market.

Also be very aware of media hype and the flavor of the day articles. This noteworthy article was published on May.05.2012 by Mary Anne & Pamela Aden: “The stock market is looking good.”

The timing of the above article encouraged readers to invest at the top. This could not have been worse advice at the peak of equity prices with no room to go up higher, as you have noticed since May 05, 2012. Investors should be ever so careful with media articles. We were shocked to see this article issued, when VIX was at a dangerously low level, indicating complacency and no room for a rally to continue as well prior heavy insider selling during the months of March and April.

You may also recall the Aden sisters publishing the following article on January.03.2012: “In the New Year Stick to Safety.”

Following this recommendation, the investor would have completely missed the rally that started in October and intensified in February 2012. We were fully invested and anticipating a powerful rally which caught everybody by surprise.

On January.03.2012 Very few people were able to overcome their emotions and do the opposite of their friends and family. But that is precisely what they should be doing. Otherwise they end up buying high and selling low.

Equities worldwide are still laboring under the heavy load of being too popular with average investors and traders. As the bear market progresses, we will experience repeated extended declines. Once too many investors finally have succumbed to the idea that downtrend will continue indefinitely, that will be the time to start buying equities again.

Experienced traders aggressively buy the oversold and undervalued assets into the most extended weakness. That is the key to success. When we aggressively buy or add to our existing position, for example an oversold ETF such as HDGE, during stock market rallies, we recognise the fact that this inverse ETF could go down lower within the next few weeks. However, we have our focus in the mid-term horizon. It is no different than when we were buying risk assets in August and September of 2011, and the market made its turnaround on October 4th. We even received emails from our subscribers calling us reckless when fear in the market was at a very high level. The point is that we subsequently had a powerful rally. We were confident that eventually we would be right.

The timing of entry into any asset is not about being perfectly right. Rather it is about going with the most reliable and proven leading signals of the market. Since we don’t know when the market will move, or by how much, it is extremely important to ensure that we have as many signals in our favor as possible, at all times.

At the end of the day, amateur investors will continue to buy high and sell low. Even in the long-term, during extended market uptrends of equities, most investors lose money over a period of years or decades. Our strategy is to always buy or sell before any major market move rather than after it has already begun.

Any stock market rally during the next few days has nothing to do with an improving economy. As a result, most investors and flock traders are becoming fearless and optimistic, adding to their equity positions simply because they are feeling good about the market again and emotionally it is a lot easier to follow the crowd rather than logic.

It appears that the S&P 500 is forming a topping pattern in the low 1400s. Anyone who tries to chase after a trend, identify breakouts in either direction, or tries to invest based upon long-term fundamentals, is going to be rudely disappointed in the near future. Be very alert and consider selling now even though you may not be making a profit.

In case stocks have any additional false spikes upward, we will add to our short ETF at favorable prices. These intraday spikes will really confuse the day traders, chartists, momentum investors, and high frequency traders.

Eventually as the prices of our focus equity ETFs reach compelling low levels, we will start buying them again. This will happen at some point during the next few months. In our opinion that will be the final rally for this year.

After an entire quarter with only a few down days, equities are finally running out of steam. This is most likely the start of a correction which will probably end after a couple of months. We will then have a strong rebound rally which will most likely achieve the highs of 2012. This final rally may end up forming higher highs for lagging indicators, i.e. SPY and QQQ; and lower highs for leading indicators such as SMH and hard-asset ETFs. We will be watching out for this topping pattern very carefully.

During the final rally flock investors will be selling their safe haven assets such as TLT (long dated US treasuries). At that time, when nobody wants TLT, we will start buying this ETF.

Within the next few trading days, we are looking for an opportunity to take position in HDGE, which as you all know is a pure short position ETF. We’re anticipating an important mid-term bottoming process to take place within the next couple of months and HDGE is an import and ETF to park a small portion of our cash.

ETF Trade Advisor has decided to trade a Short ETF called Active Bear ETF (symbol: HDGE). The launch of this fund on our Member’s page is crucial as we are of the view that HDGE will be a strong performing fund during the next few months. We have been looking hard to find a pure short equity ETF and we feel confident about this choice.

This is an ETF of pure equity short positions which is actively managed and has an annualized expense ratio capped at 1.85%. The manager portfolio management team implements a bottom-up, fundamental, research-driven security-selection process. In selecting short positions, the Fund seeks to identify securities with low earning quality or with aggressive accounting which may be intended on the part of company management to mask operational deterioration and bolster the reported earnings per share over a short time period. In other words, this inverse ETF is the opposite of an actively managed fund where analysts exhaustively research the best opportunity. These traders instead look for the worst investments on Wall Street to take a short position.

The lead manager, John Del Vecchio, has an impressive track record. He is a forensic accountant by training, who worked to identify companies that were aggressive in their accounting while masking deterioration in their business. Here is the link for his interview with John Nyaradi.

The expense ratio is high compared to most exchange-traded funds, but is justified given the frequent trading activity of the fund managers and their expertise in picking through the companies that overstate their earnings. The manager makes specific equity selections and allocations rather than following an automated program which is a passive and inefficient manner of investing in our view.

Based on our observation of this fund, it should perform best when the highest-beta equities are in free-fall. Hence, allocating a small percentage of our portfolio to HDGE should reward us handsomely during market down-turns, especially when TLT is not at a favorable price.

It may feel safer to be in a crowd. But remember that most people act emotionally rather than rationally.

During today’s trading the leading indicators did not move in tandem with general equity indices, which are the lagging indicators. When normally high-beta ETFs gain less than the S&P 500 in trading, such as occurred today with SMH (semi-conductors) and KOL (coal producers), we historically experience a strong equity sell-off sooner than later.

The current buying frenzy is trend chasing, which is the activity of many hedge funds and momentum players, as well as some flock investors, getting greedy. They cannot stand the idea of not making money from this trend. This is all because of the upside breakout of the S&P 500 index. These are the same investors who sold out their positions at low prices, due to fear and foolishness, during August and October lows of last year. In contrast, insiders and experienced investors finished their selling a few weeks ago. As usual they are ahead of the crowd as they buy and sell long before the hedge fund, chartists, computer software traders and momentum players. The least experienced investors are the last to join the party.

During the past several years, nearly all upside and downside breakouts were later proven to be false causing those trend chasers to lose money over and over again.

At the end of the day, try to respect the market’s schedule; it’s not going to respect yours.

On Friday March 16, 2012 VIX reached an astonishing low level of 13.66. This demonstrates an incredible complacency toward the possibility of a bear market even though we had a terrible one in 2007-2009 and smaller slumps in 2010 and 2011. We have not had the VIX at this low level since June of 2007. Savvy investors usually consider a reading below the 16 level as a bearish indicator for the stock market.

On Tuesday of last week, some of the widely followed equity ETFs (e.g. QQQ, SPY, and IWM) experienced their highest percentage gains in several months. Whenever these lagging indicators (versus leading indicators such as raw material producer ETFs) develop a vertical ascent near the end of the day, it is usually a sign of an upcoming bear market.

Those who primarily track the widely popular indicators, and create a critical mass by all buying or selling simultaneously, can hardly be expected to pay attention to the increasing negative divergences. It is also important to note that these divergences are currently intensifying just as most investors believe that the market is getting strong and gathering momentum.

Most people act emotionally rather than rationally when it comes to trading. Highly experienced traders have witnessed the following pattern over and over again: when the fear is low (VIX) a bear market is around the corner; when the fear is high the market is ready to advance.

When the financial markets are forming the most extreme highs and lows, ETF Trade Advisor can generally make substantial gains with our market timing strategies.

The following article relates to our present investment strategy.

Market Keeps Rising, but Who’s Doing All the Buying? By: Jeff Cox CNBC.com Senior Writer

Most financial analysts, wealth managers and media do not understand the importance of tracking negative or positive divergences in the leading indicators of the market which includes insider’s buy and sell, the VIX (the volatility index) and the leading commodity ETFs. Since it is impossible to know when a market downtrend or a rally is going to happen, identifying these divergences ahead of a trend change is vital to profitable asset allocation and preservation of capital. The discipline of investing with an eye on the divergence factor is mentally and emotionally challenging even for the best of us.

For example, consider the recent risk asset rally that was preceded by a 20% plunge. Prior to the August 2011 plunge, we observed the negative divergence from April through July which prompted us to buy into TLT and TIP, which are safe-haven assets. When the plunge happened, from August to December 2011, we positioned ourselves in risk assets because we noted a mounting pattern of positive divergence. These subtle developments cannot give you an idea as to the exact date of a bear market or a bull market. Frankly, it doesn’t matter because eventually it just happens. And when it does, most of the market participants will lose money. The market just has a way of punishing short term traders who do not exercise patience to monitor and adjust for these factors.

What does matter is to adjust your asset allocation ahead of the trend change in order to benefit from the rally in that asset class before the good news is confirmed by the media and the charts. Keep in mind that all the chart slaves, momentum players, and hedge fund managers as well average investors tend to wait for confirmation of a trend change. Only savvy, experienced, and not so greedy investors are usually rewarded by positioning themselves in advance of a trend change.

Here at ETF Trade Advisor we constantly look for these patterns of divergence in order to issue the most profitable buy and sell signals for our subscribers and our own portfolios.

In recent weeks flock investors have been busy buying equity funds in a significant manner. This net inflow is happening after valuations had already become way too high. The media have been bombarding flock traders and amateurs with exciting news such as Apple going to $1000, S&P 500 (SPY) going to 1,450, Dow to 13,000, QQQ reaching an intraday high of $65.07, and the mighty NASDAQ hitting the 3,000 mark.

If you look back at the previous market alarm warnings (i.e. 2007, 2008, 2010, and 2011), increasing negative divergences of leading versus lagging indicators, as well as massive insider selling, were extremely pronounced during each occasion. It is unlikely to be any different this time. The only difference might be that if the optimism of average investor intensifies then the correction will be more dramatic. You should get used to this semi-annual up and down pattern. We are of the opinion that this pattern will most likely persist for a couple of more years.

What should you do? Keep focused on the important and reliable signals and not the media. They are in the business of writing about what is hot and the flavour of the month. It is imperative to be ahead of the crowd. Patterns of negative divergence should be your focus as well as having cash on hand to invest when fear sets in the street. There will be an intermediate-term buying opportunity soon allowing us to take advantage of a short term up swing. We are ready for whatever the market gives us.

In the last decade Commodity ETFs have been leading indicators of market advances and declines, specifically XME (raw materials), SLX (steel), and KOL (coal). These ETFs have started rolling over, demonstrating lower highs and lower lows. Not many professionals are noticing this trend. However, the rolling over of another well respected indicator, transportation stock, has been noted by market analysts. In contrast, lagging indicators such as the Dow Jones Industrial Average and the S&P 500 have continued to form higher highs, enticing average investors to participate.

Whenever we are having intense insider selling, such as during the month of February, then the chance of a meaningful equity rally will be extremely low. In the short term a euphoric upward wave is still possible but it will be short lived. The heavy insider selling and the increasing divergence of leading versus lagging indicators demonstrate that the clock is ticking

In this present market, the most difficult action for many investors is to simply do nothing. The next significant equity low is coming and we will have the cash to buy low and make another 20%. Just try to exercise patience!

Some subscribers are having a hard time doing nothing. They find trading to be exciting or somehow validating to the ego. Those who enjoy the excitement of trading will keep making mediocre decisions because they cannot bear the thought of just staying put. Once again remember that cash is a position in and of itself.

We do not trade for fun. We do it when and if there is a compelling reason to do so, such as times of great value, extreme fear in the market, or a high ratio of corporate insider buying compared to selling.

In the interim, here is an intelligent article for your reading pleasure. It was published recently on the MarketWatch website.

Riding the Elliott Wave to amp up gains.