One of the true testaments that a nation’s equity markets have arrived is the diversity of ways for traders and investors alike to speculate in its stocks through ETFs. In addition to the widely-traded iShares FTSE/Xinhua China 25 ETF (NYSE: FXI), active investors now have opportunities to gain specific exposure to Chinese real estate by way of the Guggenheim China Real Estate ETF (NYSE: TAO), Chinese small caps by way of the Guggenheim China Small Cap ETF (NYSE: HAO), and even Chinese infrastructure (the Emerging Global Shares China Infrastructure Fund (NASDAQ: CHXX).
But heading into trading on Wednesday, the diversity of ways to trade China is trumped by the reality that all of these funds (and a few more like the PowerShares Golden Dragon Halter USX China Portfolio ETF (NYSE: PGJ) are driving further into overbought territory, and the likelihood of a reversal in the near-term has grown significantly.
FXI has finished higher for five out of the past six days after gaining another 2% on Tuesday. The fund has closed in overbought territory for each of those five days. The same is true for HAO and PGJ, but not for TAO – the real estate-related fund. Shares of TAO have closed higher for six days in a row, adding more than 1% in Tuesday’s session.
The last time these funds were as overbought as they are heading into trading on Wednesday was back in late November. Then, three out of four finishes in overbought territory were enough to bring on a sell-off that sent TAO, for example, lower by more than 3% over the next five days.
Traders who would rather buy than sell short to take advantage of short-term overbought conditions in Chinese stocks should consider inverse leveraged ETFs like the ProShares UltraShort FTSE/Xinhua China 25 ETF (NYSE: FXP). Leveraged two-to-one to the inverse of the daily performance of the FTSE China 25 Index, FXP allows traders and active investors to participate in any downside in Chinese equities without having to borrow shares to sell short.
Keep in mind that FXP is leveraged two-to-one, and traders who use the ETF for short-term trading should consider reducing their position sizes accordingly.
Note: The Daily Battle Plan Model Portfolio is short FXI.
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David Penn is Editor in Chief of TradingMarkets.com.