Does the Europe Sell-Off Pave the Way for New Buying?

Just when you thought it was safe to wade back into the market for European shares …

ETFs representing European stocks broke down below their recent trading ranges on Thursday to finish in oversold territory heading into the final trading day of the week. Down more than 4% were both the iShares MSCI Germany Index Fund ETF (NYSE: EWG) and the iShares MSCI France Index Fund ETF (NYSE: EWQ). The iShares MSCI Italy Index Fund ETF (NYSE: EWI) dropped by more than 6%.

Short term traders who had been watching the broader market climb deeper into overbought territory in recent days may be among the few market participants gratified by the late sell-off on Thursday. Although stocks had been under selling pressure for most of the session, it was not until negative rumors began to swirl in the afternoon (actually, they were rumors that the morning’s rumors were untrue) when momentum to the downside truly accelerated.

What is especially interesting about the sell-off on Thursday was how it has returned so many funds to oversold territory so quickly. The EWQ, for example, was trading at overbought levels as recently as Wednesday’s close. The same is true for the Italian ETF noted above. And with any additional selling only driving these funds deeper into oversold territory, the potential for these funds to begin attracting buyers again is greater than many may think.

It is typical for traders to want to fight “the last war” which in this case means simply selling European ETFs every time they rally. This has been a very profitable way to trade European funds for much of 2011. However, with these funds becoming so oversold so quickly, traders and investors should be prepared in the event that other traders respond to these newly oversold conditions by entering the market to buy.

Not only would continued buying make the rallies in these funds trickier to sell short, but if the buyers remain on the offensive long enough, it is possible that many of these funds – to say nothing of ETFs like the iShares MSCI United Kingdom Index Fund ETF (NYSE: EWU), which is closer than its peers to bull market territory – could end up back above the 200-day moving average and trending higher before the end of the year. From here, the game of selling the rallies would likely be over and the game of “buying the selling” about to begin.

The ETFs in today’s report were drawn from the data and research available through PowerRatings. To find out more, click here.

David Penn is Editor in Chief of