Everyone knows that the market for exchange-traded funds is exploding. And while some commentators (paging Jim Cramer) often suggest that ETFs are the root of all evil, a growing number of traders are finding out new ways to make ETFs part of their daily trading strategies.
But for all the talk about the opportunities that ETFs offer traders, precious little analysis has been conducted on just what are the best ways to actually trade ETFs. For example, a popular refrain is that ETFs can be traded “just like stocks”. But does that actually tell anyone anything worthwhile about actually trading ETFs?
It probably depends on your trading strategy. We have long been advocates of buying weakness and selling strength as a primary, high probability trading strategy for short term stock traders. Our research has shown not only that this is a valuable way for short term traders to profit from the markets, but also has pointed to a variety of techniques that short term traders can use to actually buy low and sell high.
What is particularly nice about these techniques is that they apply not only to stock trading, but to ETF trading, as well – at least with some adjustment due to the relatively lower volatility of ETFs.
For example, our research found that stocks that were trading above their 200-day moving averages tend to outperform in the near term when their 2-period RSIs drop to 2 or less. This outperformance has been established in one-day, two-day and one-week time frames and is the result of buyers becoming attracted to severely oversold markets.
Something very similar works for exchange-traded funds. When ETFs that are trading above their 200-day moving averages, we look to see low 2-period RSI values of less than 30. Again, the structure of ETFs means that what constitutes oversold for an ETF is different from what constitutes oversold for an individual stock. Thus while a 2-period RSI of less than 2 signals oversold for stocks, we require only a 2-period RSI of less than 30 for an ETF to be considered oversold.
So when we are looking for ETF trading opportunities to the long side, one of the primary things we look for is 2-period RSI of less than 30. This signals an oversold market that has already sold off and may be increasingly attractive to both new buyers and those who took profits at higher levels.
Buying ETFs after they have sold off and are displaying oversold 2-period RSIs is what makes it possible to sell them, often at a profit, when their value recovers.
While our approach to trading ETFs in the short term may seem new, buying weakness and selling strength has long been the preferred trading strategy of professional traders. To find out more about how we trade ETFs – and how you might too – be sure to attend Larry Connor’s free, online presentation on Wednesday, March 11 on high probability ETF trading strategies. The presentation will introduce traders to a special 2 1/2-day course we will be offering later this spring geared toward helping traders take advantage of the truly unique opportunities in ETF trading. For more information, click here.
David Penn is Editor in Chief at TradingMarkets.com.