High Probability Trading Report: Overbought Country Funds Bounce Higher (EWA, EWZ, EWQ, SPY, IWM)

The strong – and very overdue – rally on Wednesday was a welcome sight to many traders.
But perhaps not for the reasons you might think.

As of Wednesday’s close, the number of exchange-traded funds (ETFs) in overbought territory
below the 200-day moving average soared. This means high probability traders who have been
patiently waiting for the proper conditions before selling short the current market have
just moved a little closer to the starting block.

Of the ETFs that have become overbought below the 200-day moving average, a sizable number
are country funds. Recall that when it comes to the mean reversion tendencies of high
probability trading, country funds and equity index funds (essentially U.S. country funds
like the ^SPY^ and the ^IWM^) do
the best job of rallying from short term oversold conditions above the 200-day and pulling
back from short term overbought conditions below the 200-day.


One good example of the oversold bounce in country funds is the continued rally in EWA.

EWA  Chart

Up another 2% intraday on Thursday after a strong move higher on Wednesday, EWA has closed
higher for two consecutive trading days. In fact, for the past three days, EWA has closed
in overbought territory below the 200-day. The last time that EWA was as overbought below
the 200-day as it is presently was in late June. Within five days, EWA had dropped by more
than 6%.


EWZ Chart

Up four days in a row below the 200-day is the iShares MSCI Brazil Index Fund ETF. Like
EWA above, EWZ was last at overbought extremes early in the second half of June and, also
like EWA, the fund pulled back strongly after those extreme levels of overbought were


Given all the consternation financial deliberations in the Eurozone are causing traders and
investors in the rest of the world, why not take a look at some of the overbought ETFs of
Europe for potential opportunities to the short side?

EWQ Chart

EWQ closed in overbought territory below the 200-day on Wednesday and is moving deeper into
overbought territory intraday on Thursday. The fund was last in overbought territory in
mid-June, shortly before a significant sell-off that took the fund down more than 6%.

Remember, trading ETfs to the short side using high probability trading strategies relies
on the same “buy the selling, sell the buying” principle – only in reverse. Here, we are
looking for “buying” below the 200-day moving average, “buying” which historically has
resulted in significant reversals to the downside in the near term.

For more tips on trading exchange-traded funds using high probability strategies, click
to pick up your copy of
High Probability ETF Trading by Larry Connors and Cesar
Alvarez. Or click here to learn more about our
High Probability ETf Trading Software,
which includes all 7 of the quantified, professional, high probability trading strategies
in Larry and Cesar’s award-winning book

David Penn is Editor in Chief at TradingMarkets.com.