ETFs

Inverse leveraged ETFs can be effective tools for traders looking to capitalize on short-term market weakness, writes Deron Wagner, reviewing a recent winning trade targeting the semiconductor sector.

As a technical swing trader whose trading strategy is based on following the dominant trend of the market, I am not bothered when the stock market shifts direction to the downside because my proven market timing model continually keeps me trading on the right side of the market (or out of the market altogether, at times).

Last week, as the main stock market indexes fell sharply, I profited from several short and inverse ETF trades. In this article, I will walk you through the technical anatomy of one of last week’s successful swing trades.

Just as my trading strategy for the long side of the market is focusing only on strong stocks and ETFs in an uptrend, my strategy for the short side of the market is to target weak stocks and ETFs already in a downtrend.

One ETF that was already meeting that condition at the beginning of last week was the Market Vectors Semiconductor ETF (SMH). The annotated daily chart of SMH is shown below:

chart
Click to Enlarge

Since forming a peak in March of this year, SMH has been in an intermediate-term downtrend, as indicated by the series of “lower highs” and “lower lows.” The 20-day exponential moving average also crossed below the 50-day moving average about a month ago, thereby confirming the intermediate-term trend reversal.

Additionally, the 50-day moving average is already sloping lower, which helps to confirm the trend reversal. After several successful tests of support at the $33 area, SMH finally broke below this level on May 8. This caused the prior support level around $33 to become the new resistance level.

Because it was such an obvious break of support at the $33 area (the dashed horizontal line), it became a false trigger for a short sale. Traders who sold short the initial breakdown on May 8 were likely shaken out of their position three days later when SMH rallied into and probed above resistance at $33. However, the bearish reversal bar of May 11—right at key resistance—provided a low-risk entry on the short side if SMH traded below that day’s low.

NEXT: See the Inverse ETF Trade I Took to Capitalize

Tickers Mentioned: Tickers: SMH, SOXS, EUO, DZZ