Why actively trade ETFs?
- Thread starter deronwagner
- Start date
If the pair trade were to involve shorting TLT you may find it rather difficult to do at the present time. Too many people looking to short bonds it seems.
I just wanted to share some ideas on trading narrow-range consolidations, such as the one we have been seeing for the past month. Some of these ideas are basic, but will still serve as good reminders for experienced traders. If you are a new trader, maybe you will get some new ideas. This material taken from my last weekly newsletter so here it is:
As we have been discussing with our subscribers during the past week, it can be very tricky to trade the type of consolidation days we have been seeing over the past week. Simply put, the market is just plain stuck in a narrow and tight trading range. Unfortunately, light volume and range-bound days are common during this time of year and we would not be surprised to see it continue until after the Labor Day holiday has passed. Therefore, it is very important to recognize that the overall market conditions have changed during the past month and adjust your trading style accordingly. If you attempt to trade the current market in the same manner that you did during the March to June rally, which trended smoothly, you will undoubtedly subject yourself to losses that can easily be prevented by making a few changes in your style. So, what can you do to adapt? It depends on whether you are a day trader or a longer-term "swing" trader. Let's look at a few ideas for both types of traders.
For those of you who trade the markets intraday, the most obvious and lowest-risk thing to do is simply sit on the sidelines and wait it out. Like much of Wall Street, consider taking a long vacation if you are able. The market will certainly be here when you return. However, if you insist on actively trading, consider shifting your focus away from trading the broad-based ETFs such as SPY or QQQ, and instead concentrate on trading only the sector ETFs that are showing relative strength or weakness to the broad market each day. Regardless of how flat the broad market may be, there are always individual sectors such as the Semiconductors or Biotechs that are either outperforming or underperforming the major indices. If you have not already done so, I recommend you set up a quote list of the sector ETFs you trade most commonly. Here is a screenshot of the one I use on my TradeStation platform:
On the screen shot above, notice that I keep the sector ETFs dynamically sorted by percentage change from the previous day's close. This provides me with a quick overview of which sectors may be potential plays. For example, on this particular day, BBH (Biotech HOLDR) closed 2.38% higher, but XLF (Financials) closed 0.38% lower. Notice that I also track each ETF's intraday volume compared to its average daily volume (based on the past 50 days). As volume always does, this confirms institutional sector rotation and money flow out of one sector and into another. Obviously, your goal is to buy the sectors with relative strength and/or short those with relative weakness. By overlaying an intraday chart of each sector ETF with a chart of the S&P futures, you can clearly see which sectors have the most relative strength or weakness.
If, on the other hand, you initiate trades with a multi-day time horizon instead of intraday, one helpful thing you may consider doing is focusing less on studying daily charts and more on the longer-term weekly charts. During times of choppy and narrow trading ranges, the daily charts tend to display a lot of "noise" that can generate faulty buy or sell signals. However, the weekly charts remove the erratic price action of the daily bars and allow you to see a much more accurate and true picture of what is really happening. As an example, compare both the daily and weekly charts of SMH (Semiconductor HOLDR) below:
On the daily chart of SMH above, notice how erratic the price action of the past several weeks has been. Most likely, you would have been stopped out numerous times if you were attempting to take a long position based on the daily chart. However, in contrast, take a look at the weekly chart of SMH below:
Notice how much smoother the uptrend appears on the weekly chart. The choppiness of the past few weeks appears as simply a bullish consolidation at the highs instead. If you used a weekly chart to set your stops, you would be giving the trade more "wiggle room," but you would also be shooting for larger profits and are less likely to get stopped out on a little shakeout. So, my point is that you may wish to consider lengthening the average duration of time for your trades. If you typically remain in a trade for a few days and use relatively tight stops, consider focusing on trades with a time horizon of several weeks and use looser stops and larger profit targets instead. Because this would obviously cause you to incur more risk, you can compensate for that by simply reducing your share size on these trades. I have personally found weekly charts to be a great way to trade narrow and range bound markets in the past, but there are obviously some position management adjustments that need to be made first.
Perhaps the most important modification you can make to your trading style right now is to stop attempting to buy breaks of resistance and short the breaks of support. While buying breakouts and shorting breakdowns usually works well during a trending market, the technique is usually not very successful during periods of consolidation or range-bound trading action. Simply put, both breakouts and breakdowns have a common tendency to fail and create false signals during times of non-committal trading. This means that you will often find yourself buying at the top of a rally or shorting the bottom of a selloff, only to find the position immediately reverse against you. Therefore, a contrary approach is required to increase your odds of profitability.
Rather than buying the breakouts and shorting the breakdowns, you simply want to do the opposite. When an index or sector has rallied into a key resistance point, sell short into that resistance. If an index has sold off and it looks like it may break a key support level, buy the selloff instead of shorting it. We do this because we have to assume the sideways trading range will continue bouncing between its support and resistance levels until the market proves otherwise. So what if the market decides to finally break out of its range during that one time you are shorting the rally into resistance or buying the selloff down to support? No big deal! That's what stops are for! Besides, the nice thing about this technique is that it enables you to place tight stops just above or below your entry point because you want to be out right away if the breakout or breakdown is for real. This means that your loss will be relatively small if you are wrong. And, if you are right, you will have bought or shorted at the exact right moment in order to profit from the market's next oscillation within the trading range. Regardless, we still recommend you trade with reduced share size until the market breaks out of its range because there is no reason to be aggressive in the market right now during the summer doldrums.
As we have been discussing with our subscribers during the past week, it can be very tricky to trade the type of consolidation days we have been seeing over the past week. Simply put, the market is just plain stuck in a narrow and tight trading range. Unfortunately, light volume and range-bound days are common during this time of year and we would not be surprised to see it continue until after the Labor Day holiday has passed. Therefore, it is very important to recognize that the overall market conditions have changed during the past month and adjust your trading style accordingly. If you attempt to trade the current market in the same manner that you did during the March to June rally, which trended smoothly, you will undoubtedly subject yourself to losses that can easily be prevented by making a few changes in your style. So, what can you do to adapt? It depends on whether you are a day trader or a longer-term "swing" trader. Let's look at a few ideas for both types of traders.
For those of you who trade the markets intraday, the most obvious and lowest-risk thing to do is simply sit on the sidelines and wait it out. Like much of Wall Street, consider taking a long vacation if you are able. The market will certainly be here when you return. However, if you insist on actively trading, consider shifting your focus away from trading the broad-based ETFs such as SPY or QQQ, and instead concentrate on trading only the sector ETFs that are showing relative strength or weakness to the broad market each day. Regardless of how flat the broad market may be, there are always individual sectors such as the Semiconductors or Biotechs that are either outperforming or underperforming the major indices. If you have not already done so, I recommend you set up a quote list of the sector ETFs you trade most commonly. Here is a screenshot of the one I use on my TradeStation platform:
On the screen shot above, notice that I keep the sector ETFs dynamically sorted by percentage change from the previous day's close. This provides me with a quick overview of which sectors may be potential plays. For example, on this particular day, BBH (Biotech HOLDR) closed 2.38% higher, but XLF (Financials) closed 0.38% lower. Notice that I also track each ETF's intraday volume compared to its average daily volume (based on the past 50 days). As volume always does, this confirms institutional sector rotation and money flow out of one sector and into another. Obviously, your goal is to buy the sectors with relative strength and/or short those with relative weakness. By overlaying an intraday chart of each sector ETF with a chart of the S&P futures, you can clearly see which sectors have the most relative strength or weakness.
If, on the other hand, you initiate trades with a multi-day time horizon instead of intraday, one helpful thing you may consider doing is focusing less on studying daily charts and more on the longer-term weekly charts. During times of choppy and narrow trading ranges, the daily charts tend to display a lot of "noise" that can generate faulty buy or sell signals. However, the weekly charts remove the erratic price action of the daily bars and allow you to see a much more accurate and true picture of what is really happening. As an example, compare both the daily and weekly charts of SMH (Semiconductor HOLDR) below:
On the daily chart of SMH above, notice how erratic the price action of the past several weeks has been. Most likely, you would have been stopped out numerous times if you were attempting to take a long position based on the daily chart. However, in contrast, take a look at the weekly chart of SMH below:
Notice how much smoother the uptrend appears on the weekly chart. The choppiness of the past few weeks appears as simply a bullish consolidation at the highs instead. If you used a weekly chart to set your stops, you would be giving the trade more "wiggle room," but you would also be shooting for larger profits and are less likely to get stopped out on a little shakeout. So, my point is that you may wish to consider lengthening the average duration of time for your trades. If you typically remain in a trade for a few days and use relatively tight stops, consider focusing on trades with a time horizon of several weeks and use looser stops and larger profit targets instead. Because this would obviously cause you to incur more risk, you can compensate for that by simply reducing your share size on these trades. I have personally found weekly charts to be a great way to trade narrow and range bound markets in the past, but there are obviously some position management adjustments that need to be made first.
Perhaps the most important modification you can make to your trading style right now is to stop attempting to buy breaks of resistance and short the breaks of support. While buying breakouts and shorting breakdowns usually works well during a trending market, the technique is usually not very successful during periods of consolidation or range-bound trading action. Simply put, both breakouts and breakdowns have a common tendency to fail and create false signals during times of non-committal trading. This means that you will often find yourself buying at the top of a rally or shorting the bottom of a selloff, only to find the position immediately reverse against you. Therefore, a contrary approach is required to increase your odds of profitability.
Rather than buying the breakouts and shorting the breakdowns, you simply want to do the opposite. When an index or sector has rallied into a key resistance point, sell short into that resistance. If an index has sold off and it looks like it may break a key support level, buy the selloff instead of shorting it. We do this because we have to assume the sideways trading range will continue bouncing between its support and resistance levels until the market proves otherwise. So what if the market decides to finally break out of its range during that one time you are shorting the rally into resistance or buying the selloff down to support? No big deal! That's what stops are for! Besides, the nice thing about this technique is that it enables you to place tight stops just above or below your entry point because you want to be out right away if the breakout or breakdown is for real. This means that your loss will be relatively small if you are wrong. And, if you are right, you will have bought or shorted at the exact right moment in order to profit from the market's next oscillation within the trading range. Regardless, we still recommend you trade with reduced share size until the market breaks out of its range because there is no reason to be aggressive in the market right now during the summer doldrums.
As the founder of this thread, I have left it dormant for a while, but will once again be actively posting technical analysis and charts of the various exchange traded funds. Obviously, all comments are welcome and we will reply in the thread.
We began building a small short position in DIA (Dow Jones Industrials) last week, two days before the market cracked, because of what we saw in the following monthly chart of the Dow. I know most traders probably don't look at monthly charts in their analysis, but I feel it is really important in order to give you a "big picture" of what is really happening.
Although the time frame of monthly charts is too long to provide you with guidance for any detailed entry or exit points on multi-day "swing" trades, this time interval is very important in understanding the "big picture" of what is really happening in the markets. As you know, the longer the time interval of a chart, the more bearing or weighting that it provides with regard to market direction. For example, an hourly chart is more powerful than a five-minute chart, a daily chart is more important than an hourly chart, a weekly holds more weight than a daily chart, etc. As such, it is crucial to always utilize what I refer to as a "top-down" approach to analyzing the markets rather than a "bottom-up" approach. This simply means that I always begin my analysis by looking at the longer time frames and then subsequently narrowing the time intervals down to less significant levels. Doing so will occasionally cause me to miss a small move in a particular direction, but will always enable me to be trading on the correct side of the market with regard to the "big picture." On the other hand, having a "bottom-up" approach to the markets will cause you to catch many small day-to-day moves, but will often cause you to be fighting the greater trend of what is really happening. This, consequentially, prevents you from catching the big moves that could earn you very large chunks of cash that would otherwise be earned through focusing on the "big picture." If you look at the most successful traders and money managers you can think of, they all have one thing in common: they catch the big moves in the market and don't worry about the day to day gyrations. This is not, of course, to say that day trading is not a good thing. But, my view is that day trading is simply the "icing on the cake" that enables you to generate monthly cash flow, while catching the big multi-month moves build your equity and personal net worth. Let's take a look at a monthly chart of the Dow Jones Industrial Average, starting with the the low of the year 1990. Commentary on the chart's annotations is below the chart:
The first thing you will probably notice about this chart is that the Dow rallied exactly up to its 40-month moving average (the green line) and immediately reversed. Notice how resistance of this 40-period moving average marked the high of the Dow's last major rally, which ended in March 2002 and it looks like it may mark the highs of this year's rally as well. You will also notice that the 40-period moving average perfectly converges with the downtrend line from the high of May 2001 (the red line). Obviously, this convergence was powerful and contributed to the Dow's weakness last week.
More importantly, notice how the Dow is currently trading more than 3000 points above its primary uptrend line (the black line). The support of the primary uptrend line is currently around 6400. As such, I would not be surprised to eventually see the Dow head back down to support of that primary uptrend line in the coming year. If you took this a step further and applied Fibonacci to a monthly chart of the Dow, you will see that the index is trading near its 50% retracement level from its year 2000 high to its low in 2002. This 50% retracement is typically a key area of resistance for a down trending index.
I know that some of you will look at this chart and want to justify the Dow's recent rally based on the improvement in economic fundamentals, corporate earnings growth, etc. However, I am simply presenting you with an unbiased view based purely on technical analysis, without regard to any fundamentals. But, before you start getting really bearish based on my monthly chart analysis of the Dow, remember the time interval you are looking at here is quite long! Each bar represents an entire month's worth of data. Therefore, it could easily take one to two YEARS before we see this happen. Another scenario is that the Dow could enter into a sideways trading range and correct by time, rather than sell off to new lows. A correction by time would enable the trend line to eventually rise up to meet the price of the Dow without the Dow dropping down to meet it. If you think about it, a correction by time would be worse for us than a sell off because it is more difficult to profit from a sideways market than by simply shorting a down trending one.
Just our 2 cents. . .
We began building a small short position in DIA (Dow Jones Industrials) last week, two days before the market cracked, because of what we saw in the following monthly chart of the Dow. I know most traders probably don't look at monthly charts in their analysis, but I feel it is really important in order to give you a "big picture" of what is really happening.
Although the time frame of monthly charts is too long to provide you with guidance for any detailed entry or exit points on multi-day "swing" trades, this time interval is very important in understanding the "big picture" of what is really happening in the markets. As you know, the longer the time interval of a chart, the more bearing or weighting that it provides with regard to market direction. For example, an hourly chart is more powerful than a five-minute chart, a daily chart is more important than an hourly chart, a weekly holds more weight than a daily chart, etc. As such, it is crucial to always utilize what I refer to as a "top-down" approach to analyzing the markets rather than a "bottom-up" approach. This simply means that I always begin my analysis by looking at the longer time frames and then subsequently narrowing the time intervals down to less significant levels. Doing so will occasionally cause me to miss a small move in a particular direction, but will always enable me to be trading on the correct side of the market with regard to the "big picture." On the other hand, having a "bottom-up" approach to the markets will cause you to catch many small day-to-day moves, but will often cause you to be fighting the greater trend of what is really happening. This, consequentially, prevents you from catching the big moves that could earn you very large chunks of cash that would otherwise be earned through focusing on the "big picture." If you look at the most successful traders and money managers you can think of, they all have one thing in common: they catch the big moves in the market and don't worry about the day to day gyrations. This is not, of course, to say that day trading is not a good thing. But, my view is that day trading is simply the "icing on the cake" that enables you to generate monthly cash flow, while catching the big multi-month moves build your equity and personal net worth. Let's take a look at a monthly chart of the Dow Jones Industrial Average, starting with the the low of the year 1990. Commentary on the chart's annotations is below the chart:
The first thing you will probably notice about this chart is that the Dow rallied exactly up to its 40-month moving average (the green line) and immediately reversed. Notice how resistance of this 40-period moving average marked the high of the Dow's last major rally, which ended in March 2002 and it looks like it may mark the highs of this year's rally as well. You will also notice that the 40-period moving average perfectly converges with the downtrend line from the high of May 2001 (the red line). Obviously, this convergence was powerful and contributed to the Dow's weakness last week.
More importantly, notice how the Dow is currently trading more than 3000 points above its primary uptrend line (the black line). The support of the primary uptrend line is currently around 6400. As such, I would not be surprised to eventually see the Dow head back down to support of that primary uptrend line in the coming year. If you took this a step further and applied Fibonacci to a monthly chart of the Dow, you will see that the index is trading near its 50% retracement level from its year 2000 high to its low in 2002. This 50% retracement is typically a key area of resistance for a down trending index.
I know that some of you will look at this chart and want to justify the Dow's recent rally based on the improvement in economic fundamentals, corporate earnings growth, etc. However, I am simply presenting you with an unbiased view based purely on technical analysis, without regard to any fundamentals. But, before you start getting really bearish based on my monthly chart analysis of the Dow, remember the time interval you are looking at here is quite long! Each bar represents an entire month's worth of data. Therefore, it could easily take one to two YEARS before we see this happen. Another scenario is that the Dow could enter into a sideways trading range and correct by time, rather than sell off to new lows. A correction by time would enable the trend line to eventually rise up to meet the price of the Dow without the Dow dropping down to meet it. If you think about it, a correction by time would be worse for us than a sell off because it is more difficult to profit from a sideways market than by simply shorting a down trending one.
Just our 2 cents. . .
Below is a daily chart of BBH. BBH is the HOLDR for a basket of popular biotech stocks that include Amgen, Genentech, Genzyme and others. For more specific information on BBH you can check here: http://www.holdrs.com/holdrs/main/i...ding&SubAction=BBH&HoldrName=Biotech%A0HOLDRS
Most swing traders look for certain indicators on daily charts to trigger buy and sell points. You may see a pullback to a key moving average or a certain candle pattern which can make a chart jump off the page for you and signal a possible entry upon receiving confirmation the next day. Sometimes, however there are a number of signals being given at once. This confluence of indicators increases your chances for success, because quite simply, you've got multiple things working in your favor that will increase the odds of prices moving towards your target.
Exactly such a confluence of indicators happened yesterday in BBH whose annotated chart is below. Commentary on the annotations follows below the chart:
In the green circle above is the area we are looking at. The first thing to notice is that BBH had a strong reversal day yesterday. This is evidenced by the bullish hammer that was formed. Hammers form on candlestick charts when sellers take prices to new lows from the open but are fought back by the bulls to levels closer to or above that open. This clearly happened yesterday in BBH as it opened close to 129.50 and experienced new swing lows to just below the 126 level, but rallied very hard from 11:30 onward to close back above 129.
Next, notice that over the last 7 trading days BBH has become quite oversold as measured by its distance from the 20 day moving average. Although "oversold" is rather objective term, the 20ma on various timeframes is often used as a reference point because when prices become extended too far away from it, the odds are greater that they will experience a snap back towards this key moving average. The distance from the 20 (purple line) is annotated on the chart by the double headed arrow. Finally, tying it all together, you have the trendline (drawn in red) supporting prices in this area. Notice that connecting the prior swing lows from early July and early August puts the trendline right through the lower shadow of the hammer candle and supports its 'body' perfectly.
So, given the confluence of indicators in the biotech HOLDR you have a relatively low risk long entry for a swing trade. We went long BBH today on confirmation which was a break of the 130 level that was the high of the reversal (hammer) candle that formed yesterday. A stop could either be placed below todays low at the 128 area or below the low of the hammer just below 126. Although a stop below the low of the hammer would probably be too much risk, there is ample possible reward here that may justify such a loose stop. A return of prices back to the 20ma for instance would put BBH back over 135. Even a 50% fibonacci retracement of the entire down move from the swing highs of 140.42 would send BBH back to the 133 area. As this is one of the more volatile ETF's you have to give it some room to breathe so to speak when picking targets and stops.
Most swing traders look for certain indicators on daily charts to trigger buy and sell points. You may see a pullback to a key moving average or a certain candle pattern which can make a chart jump off the page for you and signal a possible entry upon receiving confirmation the next day. Sometimes, however there are a number of signals being given at once. This confluence of indicators increases your chances for success, because quite simply, you've got multiple things working in your favor that will increase the odds of prices moving towards your target.
Exactly such a confluence of indicators happened yesterday in BBH whose annotated chart is below. Commentary on the annotations follows below the chart:
In the green circle above is the area we are looking at. The first thing to notice is that BBH had a strong reversal day yesterday. This is evidenced by the bullish hammer that was formed. Hammers form on candlestick charts when sellers take prices to new lows from the open but are fought back by the bulls to levels closer to or above that open. This clearly happened yesterday in BBH as it opened close to 129.50 and experienced new swing lows to just below the 126 level, but rallied very hard from 11:30 onward to close back above 129.
Next, notice that over the last 7 trading days BBH has become quite oversold as measured by its distance from the 20 day moving average. Although "oversold" is rather objective term, the 20ma on various timeframes is often used as a reference point because when prices become extended too far away from it, the odds are greater that they will experience a snap back towards this key moving average. The distance from the 20 (purple line) is annotated on the chart by the double headed arrow. Finally, tying it all together, you have the trendline (drawn in red) supporting prices in this area. Notice that connecting the prior swing lows from early July and early August puts the trendline right through the lower shadow of the hammer candle and supports its 'body' perfectly.
So, given the confluence of indicators in the biotech HOLDR you have a relatively low risk long entry for a swing trade. We went long BBH today on confirmation which was a break of the 130 level that was the high of the reversal (hammer) candle that formed yesterday. A stop could either be placed below todays low at the 128 area or below the low of the hammer just below 126. Although a stop below the low of the hammer would probably be too much risk, there is ample possible reward here that may justify such a loose stop. A return of prices back to the 20ma for instance would put BBH back over 135. Even a 50% fibonacci retracement of the entire down move from the swing highs of 140.42 would send BBH back to the 133 area. As this is one of the more volatile ETF's you have to give it some room to breathe so to speak when picking targets and stops.
Thanks specul8r,
Peter and I will try to post at least one or two ETF charts per week, as we are able.
Deron
Peter and I will try to post at least one or two ETF charts per week, as we are able.
Deron
Quote from Specul8r:
Hey guys nice job with this thread
Just wanted to add my 2 cents to let you know that I too enjoy this thread.
I switched to trading only ETF's a couple of months ago in my IRA accounts. The reasoning is the same as what you've already mentioned. Mainly though, no obliterations that stocks can have and the smoothness.
Can't short in my IRA account but with some patience, I can always find a short term (couple of day) long trade with one of the 21 ETF's that I follow.
Looking forward to this thread continuing.
I switched to trading only ETF's a couple of months ago in my IRA accounts. The reasoning is the same as what you've already mentioned. Mainly though, no obliterations that stocks can have and the smoothness.
Can't short in my IRA account but with some patience, I can always find a short term (couple of day) long trade with one of the 21 ETF's that I follow.
Looking forward to this thread continuing.