High Probability Trading Report: Edges in Leveraged Funds at Oversold Extremes (QLD, ERX, TYH)
At the heart of our research into how stocks and exchange-traded funds (ETFs) work is this finding: when markets become overextended in the short term, they have a tendency to bounce or pull back in
order to move back to more typical levels. This tendency is known as mean reversion and is a key part of what makes high probability trading strategies work.
This approach goes against the grain of much conventional wisdom when it comes to short term trading – which tends to be dominated by momentum and breakout-based strategies. And while we agree
that there are as many ways to trade in the short term as there are traders to trade them, we stand behind the data that tells us consistently that, in the short-term, mean reversion works for
stock and ETF traders.
For traders new to mean reversion trading, one conservative approach to getting started is to look for only those markets that are at their most extreme levels. Using tools like the 2-period RSI (as well as other strategies discussed in the book by Larry Connors and Cesar Alvarez, High Probability ETF Trading – click here to learn more), new high probability traders or simply those who are more conservative in their trading can readily scan the market for those markets that are at levels from which, historically, they have tended to make sizable moves.
Tuesday’s sell-off provided traders with additional markets that were exceptionally oversold. Midway through trading one session later, many of these markets – particularly ETF markets – have
begun to bounce as a result of reaching those extreme levels. Here, we’ll take a look at those funds that may have begun to rally, but still may be worth watching by high probability traders looking for funds that have plunged into oversold territory in recent days.
The QLD had closed lower for seven consecutive trading days going into Wednesday’s session. In fact, for the past four days, QLD has had a 2-period RSI of less than 5.
QLD is up by just over 1% midway through Wednesday’s trading, but is still in oversold territory. This is a testament to how oversold the fund was heading into trading on Wednesday. Also related and oversold are funds like the ^TQQQ^ and the ^QQQQ^.
Closing in oversold territory for six straight sessions ahead of Wednesday’s trading was the ERX, which was up well over 2% on Wednesday at midday, but still in oversold territory.
Like many other oversold ETFs, ERX is trading at levels not seen since the second half of May. In that case, those oversold conditions set the stage for a 5-day rally in the fund of more than 9%.
If you thought that the oversold extremes in Nasdaq 100 related exchange-traded funds might mean that there were similarly oversold extremes to be found among technology ETFs, then you would be
right. In fact, among those oversold funds bouncing on Wednesday that are still in oversold territory, few are as oversold intraday as the Direxion Technology Bull 3x Shares ETF.
TYH intraday has a 2-period RSI of less than 8 – less than 11 over the past seven consecutive trading days. For traders looking for markets that may still have some upside to their oversold
reactions, funds such as TYH may be worth a look. Also in this group, ETFs like the ^USD^ and the ^ROM^ remain oversold despite modest midday, midweek bounces.
David Penn is Editor in Chief at TradingMarkets.com.