High Probability ETF Trading: Strategies for Overbought Markets

If the trading strategies of ETF traders were a perfect reflection of the world we live in, health care reform would be doomed and gold would be headed for $2,000 an ounce.

The two most overbought exchange traded funds (ETFs) in the market right now are the Health Care Select Sector SPDRS ETF
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and the Market Vectors Gold Miners ETF
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.

How overbought? XLV is so overbought that it has closed with a 2-period RSI of more than 90 for four days in a row. The ETF, which includes stocks like Johnson & Johnson
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and Pfizer
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, has closed higher for six consecutive trading days.

XLV

GDX has been a bit more volatile, but has also closed in the most extreme “above 90” 2-period RSI overbought territory for four days in a row (six consecutive in overbought territory in general.

GDX

High probability trading in the short term is about buying markets after they have pulled back and avoiding — or selling short — those markets after they have made new short term highs. This mean reversion approach to short term trading in ETFs has resulted in ETF trading strategies that are accurate more than 80% of the time in our simulated testing. These tests go back to inception — 1993 in the case of the S&P 500 SPDRS ETF
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— in a wide variety of equity index, country, sector and even commodity-based exchange-traded funds.

Larry Connors’ new book, High Probability ETF Trading includes 7 quantified strategies for trading ETFs. Click here to order your copy today.

So what do high probability trading strategies and mean reversion tell us about these ETFs — XLV and GDX?

Most importantly, they tell us that now is not the time to buy them. Buying new short term lows, not new short term highs, have consistently been the better bet.

But what they do suggest is that an opportunity to buy them might be closer than it seems. The more overbought these ETFs — or any ETFs — become, the more likely they are to experience profit-taking, a correction, a pullback. And if that ETF has become very extended, overextended, to the upside, the potential for that pullback to be sizeable is worth paying attention to.

When it comes to ETF trading, using our high probability trading strategies or ETF PowerRatings strategies, the biggest gains will tend to come from those ETFs that have pulled back the most.

It is impossible to know exactly when the next pullback in these — or any — ETF will be. High probability trading strategies aren’t about predicting the future. High probability trading strategies are about knowing an overpriced market — and sale – when you see one. And because those sales often follow markets as overextended as XLV and GDX, opportunities for high probability and ETF PowerRatings traders could be arriving sooner than later.

The highest rated ETF PowerRatings ETFs have made positive, short term gains more than 75% of the time. Click here to start your free, 7-day trial to ETF PowerRatings today..