How to Fade the Rally in Financials

No sector was more rattled by the potential for a meltdown in the Eurozone than the financials. When China coughs, it may be the materials stocks that catch a cold. But when it comes to the potential exposure to a multi-nation debt crisis (and potential breakup of one of the most widely-traded currencies in the world), financial stocks are uniquely positioned to face the pain.

It’s also been pointed out that short selling restrictions in Europe have prevented many short sellers from knocking down the share prices of European banks with the assertiveness they would otherwise. Instead, they’ve used American banks as proxies, selling short in the States what they cannot sell short on the Continent.

But in recent days, a growing sense that worldwide financial institutions and central banks may be rising to the challenges in Europe has led to a veritible run on the bank stocks. Shares of Goldman Sachs (NYSE: GS), for example, are up more than 9% from a week ago. JP Morgan Chase (NYSE: JPM) has gained well over 13%. Morgan Stanley (NYSE: MS) added more than 17% over the same period.

And because these gains are happening in bear market territory, a growing number of traders, investors and analysts have begun to look at these increasingly overbought stocks with suspicion. At least in the short term, the likelihood of a sell-off is significant and growing.

For many traders the easiest way to take advantage of potential opportunities like this is not necessarily through selling short either financial stocks or financial ETFs. Instead, buying inverse leveraged ETFs like the ProShares UltraShort Financial ETF (NYSE: SKF) and the Direxion Daily Financial Bear 3x Shares (NYSE: FAZ), allows traders and active investors to gain short term exposure to the downside, without having to borrow shares to sell short.

Additionally, trading leveraged products allows traders to use less capital. For example, a trader trading the FAZ, which is leveraged 3 to 1 to the Russell 1000 Financial Services Index, could cut position sizes by a third compared to trading a regular, non-leveraged ETF.

Given the ratings of 7 out of 10, additional selling will be required before either fund is at levels where traders have been lured off the sidelines, historically speaking. Additional buying in the bank stocks at the beginning of next week, higher ratings for funds like SKF and FAZ, and a significant short-term correction is the current forecast for the financials – depending on what happens in Europe, that is.

The stocks and 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