Technical ETF: If You Believe In the Approach But Want Pros to Execute

PowerShares has just released another exchange traded fund (ETF) and added yet another twist on what many people say has become a crowded market. The PowerShares DWA Technical Leaders Portfolio (PDP) tracks and index of 100 stocks that are assembled by the team at Dorsey Wright & Associates. What makes this ETF different is that it is built using entirely technical measures without consideration for fundamentals like cash flow.

The theory behind this approach is that it will remove all emotion from the equation and as many will agree, trading on emotion can have a negative impact on returns. Although last year the underlying index trailed the S&P 500 by 4 percentage points, it has outperformed the S&P 500 from 2001 to 2006 by 8% (annualized average). Mind you, relying on back-testing has gotten a lot people in trouble before so this ETF shouldn't be purchased purely on that data.

The ETF's expenses are capped at 0.60% which, although a little high for an ETF, is still better than many mutual funds. And despite expectations that turn-over will be high given the many trades and quarterly rebalancing, it will remain tax-efficient due to the nature of how exchange traded funds work.

Trades will occur when certain signals become apparent. Namely, a calculation is done everyday, to determine relative strength of stocks from a pool of 3000. A stock that is outperforming its peers is considered to be issuing a buy signal. All of the outperformers are then grouped together from which the top 100 are selected for inclusion in the index and ETF. This approach has the greatest change of having a positive impact when the market is moving up or down, but should languish when the market is moving sideways.

The interesting feature, to me anyway, of this ETF is that it isn't tied any particular sector or market cap. It will, quite simply, buy in to whatever is doing well at the moment. As such, there's a good chance it will not correlate to the movements of the S&P 500 making it worthy of consideration from a diversification perspective. The choice is, of course, yours to make.