Among the more impressive rallies in recent days has been the advance in a pair of India ETFs – the ^INP^ and the ^EPI^. Both funds had earned ETF PowerRatings of 9 late in February and have gained more than 7% through Wednesday’s close.
With markets in general overbought and becoming more overbought, the first order of business is knowing that these conditions are unsustainable and a reversal to the downside increasingly likely.
If this reversal comes, then the game plan for high probability traders will be clear: start looking for the biggest, sharpest pullbacks in stocks and ETFs trading above the 200-day moving average. If you trade PowerRatings, then begin adding 9s and 10s to your watchlists. These are the stocks and ETFs that, based on our research, are most likely to outperform the market over the next few days.
But what do traders do until that reversal happens? Markets pulled back somewhat on Wednesday (although overbought conditions in ETFs remained prevalent, especially among equity index funds). But traders have been quick to pounce on recent weakness, requiring more than a little patience for traders looking for the sharpest, deepest pullbacks.
One option, of course, is to look to the short side of the market. As a high probability trader, you are looking for those stocks and funds that are overbought below the 200-day moving average. These are markets that are being bid higher along with the broader market. But their presence below the 200-day moving average, according to our research, suggests that their advances are most vulnerable to short term reversal.
Another option lies in trading inverse leveraged exchange-traded funds. When a market, for example, such as Semiconductors, is becoming more and more overbought, another market like the ^SSG^ is becoming more and more oversold. And scaling into oversold inverse leveraged ETFs is a great way for traders who are looking for edges when the regular market is in runaway bull mode.
When that bull takes a break and profit-taking sends the market lower, inverse leveraged ETFs have historically surged higher.
A last option is to remain patient on the sidelines, and for many traders that is often the best solution. Even when markets seem like they will race higher forever, the potential for a pullback is always right around the corner. But for traders who want to take advantage of some of the many edges available using high probability trading strategies – including PowerRatings – inverse leveraged ETFs can provide a major opportunity in the short term.
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David Penn is Editor in Chief at TradingMarkets.com.