Stock markets were broadly higher on Monday with 80% of the volume to the upside on the New York Stock Exchange and 78% of the volume to the upside on NASDAQ. More than 7 out of 10 stocks ended the day higher. After a sharp rally like that, traders are likely to find few stocks or ETFs that are oversold. This is true for any indicator they use.
Inverse ETFs move in the opposite direction of the index they track and as major stock market indexes become overbought, inverse ETFs will generally become oversold. After a strong up day, traders will often find a number of inverse funds are oversold. The PowerRatings web site provides a list of inverse, leveraged ETFs. This list can be sorted by the PowerRating to find attractive trading candidates.
At the close on Monday, nine inverse ETFs had PowerRatings of 8 or higher and should be considered 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 8, on a 5% pullback the next day and selling after the stock closes above its 5-day simple moving average has been profitable 72% of the time with an average gain of 3.9%. Other entries and exits also show high winning percentages and large average gains.
In a market decline, traders can turn to the PowerRatings web site to find lists of double-leveraged ETFs and triple-leveraged ETFs. We would expect to see ETFs tracking indexes become oversold with higher PowerRatings in a broad market selloff. These lists will help traders spot some of the most promising trading opportunities at a glance.
All data is as of the end of day on 8/18/2014.