No. of Recommendations: 2
If one were interested in investing/trading bond funds, the single ETF for ‘bank loans’ is a good place to begin building a set of entry/exit rules.

As you can see from a chart, Friday's closing price is mostly flat when compared to its inception. But if entries had been done off any of the lows, some cap-gains could have been captured. If you pull the price history, you’ll also see that BKLN pays roughly a dime a month in dividends. So, despite the fact that price has gone almost nowhere since inception, owners of the fund made decent money. So, you’ve got choices. You can invest/trade in a price insensitive manner for ordinary income, or in a very price sensitive manner for cap gains profits (with any divs received being a bonus), or in a manner that attempts to steer a middle course between capturing as much of the dividends as possible without taking too much of a beating from loss of principal. Said another way, you’ve got three choices:

(1) You can buy BKLN --and, by extension, any bond fund -- on the basis of a time-and-price insensitive asset-allocation scheme in hopes of obtaining a total average return that at least matches prior total average returns. This is the approach advocated by Modern Portfolio Theorists and their camp followers. When markets are normal, decent money can be made using this scheme. But its assumptions make it a fragile choice. (Explaining that is a post for another time.)

(2) You can think like a short-term trader and focus solely on price action, buying BKLN --and, by extension, any bond fund-- at its short-term lows and selling at its short-term highs. This can be a robust choice. You capture cap-gains profits when they are available, and you sidestep price declines, thus preventing capital-losses. Meanwhile, while you own the fund, you collect the dividends. Also, you could go short on declines. But then you’d be responsible for the dividend. So going short bond funds (or stocks that pay dividends) has to be done with care.

(3) Lastly, you could think and act like a “traderly investor” and buy and sell BKLN --and, by extension, any bond fund-- in a leisurely, disciplined manner according to a set of rules you’ve created for yourself that attempts to balance the money to be made from dividends against the impact of losses that come from things like rising interest-rates. In other word, though you might get into a fund on the basis of asset-allocation considerations, you’re not going to lay down on the train tracks and fall asleep. At a point that you set in advance of buying the fund, you’ll cut your losses and get out. To do this, you will set a hard stop --however wide-- and you will honor it. That’s the “traderly” part of this investing choice. When markets decline, you don’t respond with moral outrage that “I’m an investor” and hope that prices will come back. You regard ‘prices’ as a valid signal, and you respond appropriately, so you can preserve capital.

There are lots of places on the Web where charts for bond funds can be created. But offers a good enough palette of tools, and its charts are linkable. So let’s do our work there. Here’s a default chart of BKLN. surprisingly, just from looking at where the 50-day Moving Average would have gotten you in and out of the fund, you might not need to do any further work. So your rule set would be simple:

(1) BUY when ‘price’ crosses above the simple 50-day moving average (SMA50).
(2) SELL on a reverse of that signal (i.e., when ‘price’ crosses below ‘SMA50’).

The problem with using technical analysis (TA) is that just because a particular setup might work for one stock and time-frame, that doesn’t mean it will work for all stocks and all time-frames. Through sheer randomness, the picture drawn might appear to be meaningful. But the utility of the picture might be due to sheer chance. So let’s do some testing. Let’s get rid of everything on the chart except our two variables of ‘price’ and ‘SMA50’, as well as look at a longer chunk of time. Looking good so far, right? The two rules get you in and get you out just about where you’d like to have made your moves. So let’s step back and review this chart.

Let’s assume that --for whatever reasons-- we got long BKLN at its inception, which, on average, isn’t a good idea. The studies on IPOs conclude that buying them results in losses due to the market markers pulling price support once the initial support period elapses. In this case, because there was no prior price history, a SMA 50 couldn’t have been used as a stop. But let’s assume that problem was bypassed (or endured) and that by April and May 2011 we were long (or still long) BKLN. We’d have been kicked out of our position late May by a cross of prices below the SMA50, which is exactly what we’d want. We would have been whipsawed into and out of BKLN a couple of times late July for some scratch losses. We’d have been put back into BKLN mid-October. Possibly, we’d have been whipsawed again mid-December on the consolidations. But we’d have been put back on for the second leg of the measured move that ran prices from 22.60 to 23.60 and then kicked out again, avoiding the vee- plunge down of mid-May 2012, whereupon we’d have been put back in late June and rode prices up to about 24.50, then avoiding another plunge, and then put back in again, where we’d now be long again.

If the preceding seems like too much trading to you, then it is for you. But for those who are intrigued, I’d suggest you do this. Download the full, daily, price history for BKLN into a spreadsheet (included dividends paid), create your entry/exits rules, and then compute the following facts: total trades, ratio of winning trades to losing trades, ratio of gross profits (all sources) to gross losses, average/ shortest/longest time in trade, max/min/average profit or loss per trade, and lastly, how the result of following your rules would compare to a Buy-and-Hold strategy in terms of gross money that could be spent at the grocery store. I.e., which tactic offers the better absolute returns, never mind a sophistication like 'risk-adjusted returns'?

As I mentioned in another thread, I want to double-check my numbers before I post this investing/trading system, as well as extend it, so that it can be applied to any bond fund. But it looks as if using a slightly modified version of the two previous rules would result in doing a mere six round trips over the course of two years --or one investing/trading decision roughly every four months, which isn’t a frantic work pace--- and would have offered a 30% gain in total profits (i.e., cap gains plus dividends received) over Buy-and-Hold, even after backing out commissions. That’s enough of an edge to be worth pursuing, considering that 'time in the market’ --hence, ‘risk’-- would be far less than B&H.

But now, it's time to go walkin'.

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