Why Swing Traders Should Sit Out the Stock Rout
Sellers routed buyers again on Wednesday, as a second breakdown late in the trading day sent the markets reeling in another historic decline.
As I wrote a few days ago, markets like these are a momentum trader’s dream. They are also the sort of markets that trend traders — who often have a difficult time of it when it comes to stocks — especially relish. These types of traders may only get 50% of their stock picks correct, but when their correct picks come as part of the sort of large moves we’ve seen in stocks recently, that 50% correct can end up representing far more than 50% of a momentum or trend trader’s portfolio.
Obviously, our approach to stock trading is different. We like to work in the short term, taking advantage of shifts in optimism/greed and pessimism/fear as they alternately make stocks overbought and oversold, respectively. This approach has resulted in a trading strategy with a high number of profitable trades (upwards of 70% on the long side in our historical testing).
It also means that there will be times — such as the present — when we find no edges in the short term. In fact, it is often at times when momentum and trend traders are at their most ecstatic that we prefer to stand pat and wait for imbalances and mispricings to occur — as they always have and, we suspect, always will.
Right now, all 25 of the stocks in our Top 25 PowerRatings stocks have Short Term PowerRatings of 8. Unfortunately, all but one of these 8-rated stocks are also trading below the 200-day moving average. As I have pointed out in the past, we do not buy stocks that are trading below the 200-day moving average. Our testing simply tells us that, over time, this is not a winning approach. So when we are confronted with this kind of data, our task is fairly clear cut: we stay in cash. And we wait.
Yesterday I noted a few exchange-traded funds — all with Short Term PowerRatings of 8 — that were oversold and due for a bounce. Those of you who took advantage of those oversold ETFs are likely glad you did so. All three of those suggested yesterday were up tremendously on Wednesday. SDS, the ProShares UltraShort S&P 500 ETF, gained more than 18%. FXP, the ProShares UltraShort China ETF, climbed by more than 27%. And the third ETF, the ProShares UltraShort MSCI Japan fund, EWV, was up more than 20%.
Those were outsized moves, and traders who enjoyed those gains should be wary of overstaying their welcome. And there is no guarantee that we will have opportunities like those again in the near future.
But these ETF opportunities are the same sort of mean reversion, buy weakness/sell strength trades that we look for every day in stocks. And whether those opportunities reappear in equities or remain most attractive in the world of ETFs, we will be watching, writing and trading them.
Does your stock trading need a tune-up? 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! |
Whether you have a trading strategy of your own that could use a boost or are looking for a way to tell the stocks that will move higher in the short term from the stocks that are more likely to disappoint, our Short Term PowerRatings are based on more than a decade of quantified, backtested simulated stock trades involving millions of stocks between 1995 and 2007. Click the link above or call us at 888-484-8220, extension 1, and start your free trial today.