With stocks and commodities advancing in the first few hours of trading, now is a good time for ETF traders to review trading strategies for exiting an ETF position.
This is important for all ETF traders, whether you trade ETF PowerRatings, our High Probability ETF Trading strategies or simply use our research to help guide your own short-term, ETF trading. Knowing how to exit an ETF position is as fundamental a skill as entering an ETF trade. And in the same way that there are a variety of ways to take a trade on an ETF after it has pulled back, there are also a number of ways to properly exit an ETF trade. Being a discipline, professional-caliber trader means being as comfortable taking trades as exiting trades.
For a refresher on tactics for entering ETF trades, click here to read Larry Connors’ Trading Lesson of the Day, “How to Correctly Trade Stocks and ETFs, Part 2”.
Now let’s look at a pair of strategies on how to exit an ETF trade.
The 5-Day Moving Average
The 5-day moving average exit is one of our most popular ways to exit an ETF trade. By waiting for an ETF bought on pullback to rally and close above its 5-day moving average, high probability ETF traders are exiting the ETF trade on strength – the goal of every mean reversion trade. Remember, as Larry Connors says, high probability trading is about “buying the selling and selling the buying.” This means that when an ETF bought on pullback, or bought when its ETF PowerRatings was 8, 9 or 10 recovers and shows strength, it is time for the high probability trader to exit the ETF trade, lock in any gains and move on to the next opportunity.
After pulling back into oversold territory, ^SPY^ rallied to close above its 5-day moving average soon afterward, providing an excellent opportunity to exit the ETF trade profitably.
The 2-Period RSI
Using the 2-Period RSI as a tactic for exiting an ETF trade is perhaps our favorite approach. While the 5-day moving average exit is an excellent way to exit an ETF trade, there can be instances in which the 5-day moving average exit will call for an exit sooner than the 2-period RSI. In this way, in addition to being relatively simpler to use, the 5-day moving average also can be a relatively conservative approach to exiting ETF trades.
In this example with the ^EWZ^, waiting for the ETF to close with a 2-period RSI of more than 70 to exit helps improve gains on the trade. The numbers 8, 9 and 10 reflect EWZ’s ETF PowerRatings during the pullback.
To exit an ETF trade using the 2-period RSI, high probability traders should wait for the ETF that have taken a position in to close with its 2-period RSI above 70. In exiting the ETF trade after the RSI has closed above 70, traders are waiting for the previously oversold ETF to become overbought. This is another way of “buying the selling and selling the buying.” Because an overbought market represents a market that has become saturated – if not supersaturated – with buyers, waiting until that moment to exit an ETF trade is an excellent way to “sell the buying” and to the resumption in demand for the ETF as an opportunity for profit-taking.
High probability ETF trading requires a few things. But having a quantified, disciplined approach to entering and exiting ETF trades is near the top of the list. Sticking to a coherent strategy that allows you to enter and exit ETF trades the same way every time is key to being a winning, successful high probability trader.
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David Penn is Editor in Chief at TradingMarkets.com.