PowerRatings, Patience and Profit-Taking

The rally in stocks continued on Tuesday after a one-day pause, pushing the S&P 500 and Dow industrials in particular even deeper into overbought territory below the 200-day moving average.

Looking at the PowerRatings for the most widely-traded ETF proxies for the Dow, S&P 500 and Nasdaq Composite — the DIA, the SPY and the QQQQ — we still are seeing the sort of low Short Term PowerRatings that let us know that now is likely not the best time for short term traders to be buying stocks. Both the DIA and SPY have earned Short Term PowerRatings of 2, while the QQQQ has a slightly higher PowerRating of 3.

All of these are what we call “consider avoiding” Short Term PowerRatings.

So if the PowerRatings are warning us away from buying into the major markets, how do the prospects look for trades to the downside? For the past week I have been pointing out potential opportunities in those ETFs that have high Short Term PowerRatings — namely, many of the short or inverse ETFs offered by ProShares and Rydex. As of the Tuesday close, for example, all but 2 of our Top 25 PowerRatings stocks are short ETFs with Short Term PowerRatings of 8 or 9.

This means that despite the fact that buyers continue to overwhelm sellers, the edges for short term traders are still in betting against overbought stocks. And for us, rather than trying to figure out which overbought stocks are the most vulnerable, we use Short Term PowerRatings to help us spot those short ETFs that will allow us to take advantage of a reversal to the downside while avoiding the potential hazards of trading individual stocks to the short side.

All the high Short Term PowerRating ETFs from my last column continue to be worth watching for potential short term trades insofar as their PowerRatings remain high. Of the four ETFs in yesterday’s column, for example, three have Short Term PowerRatings of 9 and one has a Short Term PowerRating of 8.

In the meanwhile, we are waiting for traders to start taking profits on what has already been an impressive rally off the lows from March 9. The higher stocks go, the more likely this profit-taking is to be aggressive, potentially sending the markets lower than those who are still bidding higher might imagine. As I have counseled frequently in the past, this is part of the patience game of trading. And as uncomfortable as it might be to own short ETFs in the face of a rising market, remember that this is essentially the same strategy have successfully deployed before over the past several weeks and even months and will remain our approach when we see high Short Term PowerRatings short ETFs pulling back and the average stock becoming more and more overbought below the 200-day moving average.

Our highest Short Term PowerRatings stocks have outperformed the average stock by a margin of nearly 17 to 1 after five days. Click here to start your free, 7-day trial to our Short Term PowerRatings!