As I write this column, Bloomberg TV is showing pictures of the riots in Bangkok, specifically a burning storefront. Famous short sellers and doom and gloomers are making the rounds on the financial news and former Treasury Secretary Paul O’Neill just informed me that the United States “could be the next Greece.”
Ash clouds over Europe. Oil in the Gulf … Politically, victories by the left (Joe Sestak in Pennsylvania) and right (Rand Paul in Kentucky) have raised new fears of not just a growing “throw the bums out” mentality (not just for the Tea Party any more), but of political polarization as far as the eye can see.
So is it any surprise that with this kind of news backdrop, markets are plunging here at midweek?
Above: The ^EWJ^ earned top ETF PowerRatings on the way down last week. Smart short-term traders should wait for similarly high PowerRatings this time around before considering a trade to the long side in EWJ.
For short term traders, especially those trading top PowerRatings stocks, exchange-traded funds (ETFs) and leveraged ETFs, the potential rewards and risks at times like these are significant. Here are some tips to help keep the best edges on your side at a time of heightened volatility in the markets.
Stay Above the 200-Day Moving Average
One of the areas where our research has been most consistent is that buying top-rated stocks and ETFs when they are above the 200-day moving average outperforms buying stocks and ETFs when they are below the 200-day moving average.
Keep Your Scale-Ins Above the 200-Day
Staying above the 200-day moving average is a quantified good idea for short term traders who are scaling in to positions, as well. If, for example, a trader buys one unit of a stock that has pulled back and that stock closes lower AND below the 200-day moving average, the trader should not add that additional unit.
Stick With Top Rated Stocks and Funds
When markets are selling off severely, short term traders who are looking to take positions can afford to be selective and look for the highest rated stocks and ETFs they can find. This means the 9s and the 10s. Our research indicates that this is where the edges are the greatest and where the best stocks and ETFs to trade every day are to be found.
Sell Short Low Rated Stocks and ETFs
Traders looking to sell stocks or exchange-traded funds (ETFs) short should focus on those stocks and ETFs that have PowerRatings of 1 or 2. Based on our quantitative testing, we learned that 1-rated ETFs, for example, made short term gains less than 21% of the time. This makes these low-rated funds the ideal candidates for traders looking to sell ETFs short. The results for low-rated stocks and leveraged ETFs are comparable.
Consider Reducing Position Size
If you are concerned about the volatility of the market, then reduce your position size by 25% or a half. The most important thing about short term trading is having the capital to trade another day. So be wary of committing too much to any individual trade.
This is always a good rule to follow, even when volatility is much less than it is of late. Remember that professional trading is about building a business rather than winning the lottery.
Below: The ^EEM^ is another country/regional ETF that has not earned top PowerRatings upgrades as it has moved lower in recent days.
One of the important things that quantified trading, trading that is based on data and not emotions, provides is a consistent and steady approach to knowing if and when to take a position in the markets. Note for example that while markets have pulled back in recent days, the number of top PowerRatings ETFs has not skyrocketed as expected. In part, this is because a number of funds have fallen below their 200-day moving averages – as well as other factors.
This is one of the ways that quantitative strategies in general and PowerRatings in specific can “talk to you” as a short term trader. When markets are selling off, yet the number of top PowerRatings stocks and ETFs have not climbed significantly, there is a message of patience for short term traders.
Above: Sector funds like the ^XLF^ may provide better potential set-ups than many country ETFs during the current decline.
And whether the next great opportunities for short term traders will be on the long side or the short side, be assured that PowerRatings will be there to spot them.
Find out more about what Ultimate PowerRatings can do for you and your trading. Quantified ratings for stocks, ETFs and leveraged ETFs – all in one place.Click here to launch your free, 7-day trial to our Ultimate PowerRatings today.
David Penn is Editor in Chief at TradingMarkets.com.