There are basically two approaches investors can take when analyzing the stock market: fundamental analysis and technical analysis.

Making an investment decision based on past performance of a stock, or volume, or a moving average all fall under technical analysis, and the big Wall Street firms will all tell you this is "voodoo". What they fail to mention is that they all have technical-analysis departments of their own.

I believe a mix of fundamental and technical analysis is the best approach for the average investor. Using fundamental analysis to find solid companies and then charts to determine when to buy and sell. However, there are plenty of investors that rely on pure technical analysis when making their decisions.

First ETF Based on Technical Analysis
Until now, the world of exchange-traded funds (ETF) and technical analysis did not co-exist. In March, PowerShares, an ETF company, and Dorsey Wright & Associates, an investment advisor and research firm, launched the PowerShares DWA Technical Leaders Portfolio ETF (NYSE: PDP).

The product is a pioneer in its field because it is the first ETF to be based solely on technical analysis.

The ETF is based on the Dorsey Wright Technical Leaders Index, which is comprised of approximately 100 stocks. When choosing the 100 stocks for the index, DWA begins with a universe of the 3000 largest U.S.-listed stocks and compares them against the major indices as well as sectors and sub-sectors. This is done quarterly and the results are put into a proprietary algorithm to determine the 100 stocks and their weightings.

The goal of the index, and thus the ETF, is to identify a stocks that demonstrate high relative strength versus its peers. Stocks with high relative-strength readings are often outperforming the market and have strong charts. This type of investment strategy goes well with the "follow the trend" theory of investing. According to Mike Moody, a senior portfolio manager at Dorsey Wright, "This is a portfolio that isn't very highly correlated to the S&P 500." For investors looking to further diversify their portfolio PDP offers that due to the low correlation to the market.

As long as the market leadership remains constant, PDP should be able to easily outperform the market. If the leadership begins to rotate, it could see the leaders of the past drop quickly and PDP will likely take a hit during the rotation. The good news for investors is that the portfolio is rebalanced and reconstituted quarterly. According to PowerShares the annual expense ratio will be capped at 0.6%, a reasonable number for a unique product.

Breakdown of PDP
As of March 31 over three-quarters of the ETF fell into the mid-cap asset class (53% in the mid-cap growth and 23% in mid-cap value). The mid-cap stocks have been able to outpace the overall market for years, and that is the reason for the large allocation. While the ETF is heavy in the mid-cap stocks, the sector breakdown is quite diverse. Not one sector makes up more than 17% of the allocation and only four are 10% or more. The financials and industrials lead the way with 17% each, followed by materials and consumer discretionary at 15% and 13%, respectively. As long as the trend continues, the ETF will continue to allocate with the best performing areas such as materials and industrials.

With 100 stocks composing the ETF it does not allow one stock to become over weighted. The current top five consists of Holly Corp (NYSE: HOC), Titanium Metals Corp (NYSE: TIE), NII Holdings (Nasdaq: NIHD), American Tower Corp (NYSE: AMT) and Allegheny Technologies (NYSE:ATI). HOC and TIE are the only two stocks with a weighting over 5%, indicating diversification is in the allocation.

Does Past Performance Equal Future Performance?
All of the top five except AMT are up a minimum of 20% year-to-date, well above the gain of 4% in the S&P 500. Because PDP only went public in March 2007, it's impossible to do a long-term comparison of the ETF versus the market. However, PowerShares backdated the index and over the last ten years the index more than doubled the S&P 500.

1878-PDPchart.gif

Past performance is never a guarantee of future performance, but trend-following and relative strength has increased in popularity in the last few years. As long as the trend continues and PDP is able to determine the leadership in the market, it could be in line for continued success.

Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: iShares JPMorgan USD Emerg Markets Bond

    Learn about the iShares JPMorgan USD Emerging Markets Bond fund, which invests in bonds of sovereign and quasi-sovereign entities from emerging markets.
  2. Mutual Funds & ETFs

    ETF Analysis: SPDR Dow Jones International RelEst

    Learn how the SPDR Dow Jones International Real Estate exchange-traded fund (ETF) is managed and for whom the ETF is most appropriate.
  3. Active Trading Fundamentals

    How Hedge Funds Front-Run Index Funds to Profit

    Understand what front running is, and learn how hedge funds use this investing strategy to profit from the anticipated stock buys of index funds.
  4. Mutual Funds & ETFs

    ETF Analysis: Schwab US Large-Cap

    Discover how the Schwab U.S. Large-Cap exchange-traded fund is managed, the index it tracks and the investors for which it is most appropriate.
  5. Mutual Funds & ETFs

    ETN Analysis: Rogers Intl Commodity Energy Total Return

    Learn more about the Rogers International Commodity Total Return, which is an exchange-traded note that tracks a broad index of commodity futures.
  6. Technical Indicators

    Understanding Trend Analysis

    Trend analysis is the use of past performance to predict future price movement of a security.
  7. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  8. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraPro Nasdaq Biotech

    Obtain information about an ETF offerings that provides leveraged exposure to the biotechnology industry, the ProShares UltraPro Nasdaq Biotech Fund.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Europe Financials

    Learn about the iShares MSCI Europe Financials fund, which invests in numerous European financial industries, such as banks, insurance and real estate.
  10. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Insurance

    Learn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  4. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  5. Indicator

    Indicators are statistics used to measure current conditions ...
  6. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
RELATED FAQS
  1. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  5. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!