Will Overbought Emerging Markets Tempt Traders?

What, if anything, are active investors to make of the fact that the most overbought country funds heading into trading on Thursday are from Latin America?

It is a testament to the growth of the exchange-traded fund market that even such a statement is possible – let alone being a critical component of understanding how these markets are likely to move over the next few days. But as both growth in emerging markets and growth in the interest in trading and investing in emerging markets has exploded, so have vehicles like the iShares MSCI Chile Index Fund ETF (NYSE: ECH). The ECH, which tracks the equity markets of Chile, joins the iShares MSCI Brazil Index Fund ETF (NYSE: EWZ) as the two most liquid, single country funds for the South American continent.

How important is ECH? Even the iShares S&P Latin America 40 Index Fund ETF (NYSE: ILF), a regional fund, consists largely of stocks from Brazil – though the fund does include a handful of Mexican corporations among its top holdings. While there is no Bolivian ETF and no Peruvian ETF that is widely traded at this point, the rise of the ECH is a sign that their times soon may come.

Right now, these Latin American emerging markets have the complete attention of bulls, who have driven share prices into overbought territory once again. This means that traders and active investors currently on the sidelines who are looking to buy may only have to wait a few days for lower prices. And for those traders interested in selling short strength in bear market territory, the rallies in EWZ, ECH and ILF have taken the funds to levels where sellers in the past have been able to knock prices down.

Ahead of trading on Thursday, all three ETFs have closed higher for four days in a row, the last two days at extremely overbought levels beneath the 200-day moving average. EWZ, ECH and ILF all have “consider avoiding” ratings of 2 out of 10, and both EWZ and ILF have significant, short-term negative edges of more than 1%.

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David Penn is Editor in Chief of TradingMarkets.com.