Time to Sell the Buying in High-Volume ETFs?
There may be a point in every rally when the combination of short-covering hedge funds and performance-chasing money managers creates short-term overbought extremes in virtually every equities market.
Heading into Wednesday’s trading, four of the top 10 highest volume exchange-traded funds have earned our lowest “consider avoiding” ratings of 1 out of 10. This means that of all the ETFs in the market, some of the funds that are most likely to underperform over the next few days are also some of the most widely traded and held by traders and active investors alike.
What funds am I talking about? No less than the S&P 500 SPDRS ETF (NYSE: SPY), which began earning downgrades on the final trading day of November as it climbed deeper into overbought territory. Up five out of the past seven and also very overbought below the 200-day moving average is the iShares Russell 2000 Index Fund ETF (IWM), representing the world of small cap stocks.
And sectors as different as the financials and the industrials are equally overbought heading into trading on Wednesday. The Financial Select Sector SPDRS ETF (NYSE: XLF), also among the top 10 highest volume ETFs, has finished higher for four out of the past five trading days. And the Industrial Select Sector SPDRS ETF (NYSE: XLI) has closed overbought for seven days in a row. Other funds among the top 10 are also very overbought with ratings of 2 out of 10 or 3 out of 10. There is no doubt that a growing number of exchange-traded funds are at or near levels where buyers historically have become sellers in the short term.
Traders should not mistake the potential for short-term weakness in these ETFs, or in the markets they represent, as anything more than that: the likelihood of a brief pullback. The potential of these funds to head lower in the short-term says nothing about whether a short-term pullback might turn into a more extended downturn – or whether a brief retreat is simply a profit-taking moment within a longer advance.
What is important is that statistically speaking, these low-rated, “consider avoiding” ETFs have a much higher than average chance of selling off over the next few days.
For those looking to trade to the short side, this presents a potential opportunity to take advantage of a possible reversal lower. And for those wanting greater long exposure to markets like the small caps or industrial stocks, there’s a growing chance that the funds that represent these markets will be available at lower levels.
All of the ETFs in today’s report were available from research and data available through PowerRatings. To learn more, click here.
David Penn is Editor in Chief of TradingMarkets.com