Leveraged ETFs Offer Buying Opportunities

After opening higher on Monday, SPDR S&P 500 ETF (NYSE: SPY) ended the day down 0.12% and most other ETFs tracking major market indexes also showed small losses. The down day followed an up day on Friday when SPY was up 1.1% and other indexes posted similarly large gains.

Based on the price action in VIX on Monday, volatility seems to be increasing in the stock market. VIX, the volatility index that tends to rise when stock prices fall, was up 6.25% on Monday, a surprisingly large move given the relatively small change in SPY.

If market volatility increases, leveraged ETFs can provide short-term traders with large potential gains. By using leverage the ETF can gain or lose 2-3 times as much as the index it is designed to track. It is important to remember that leveraged ETFs are designed to track their underlying index for one day so they are generally not suitable for long-term investments. Over longer time periods, the ETF might or might not track the trend in the underlying index because the ETF will be adjusted to meet its objective on a daily basis.

Heading into Tuesday’s open two leveraged ETFs are potential buys using PowerRatings. ProShares Ultra Oil & Gas (NYSE: DIG) and Market Vectors Double Long Euro ETN (NYSE: URR) have PowerRatings of 10, the highest possible rating. The table below shows there are additional ETFs with PowerRatings of 9 that could also be considered as potential buys.

PowerRatings are based on the relationship between price and the 5-day moving average (MA) of price. The further prices move away from the 5-day MA, the stronger the tendency to snap back becomes. PowerRatings uses the 5-day MA and several other components to identify high probability trade entry points. This strategy was thoroughly back tested and the history of over 4 million trades was analyzed.

We know from back testing that PowerRatings can be used as the basis of a trading strategy. Detailed back testing has confirmed that the higher the rating, the greater the one week historical gain has been for stocks and ETFs with that rating. For best results, enter trades on stocks with a PowerRatings of 8 or higher with a limit order 3-7% below the previous day’s closing price. Higher % limit entries have historically shown a greater percentage of winning trades but higher % limit orders also reduce the chance of trade execution.

As an example of a trading strategy that can be used, in the past, buying stocks with a rating of 10 on a 3% pullback the next day and selling after the stock closes above its 5-day simple moving average has been profitable 75% of the time with an average gain of 5.9%. Other entries and exits also show high winning percentages and large average gains.

 

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All data is as of the end of day on 10/6/2014.