Trading Range Opportunities

11/17/2008 12:18 pm EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Since the November 4th election, most sectors have dropped 10-15%. In only two weeks of trading we have gone from a potential break from the trading range off the October 10th lows to retesting those lows again. This sets up the potential for a break below the October lows or a bounce back towards the top of the current trading range. Below is a table with the major indices and the ten major sectors of the S&P 500 index. I have included where the break points are on the downside and the top of each trading range.

Reviewing the table gives you data points. The key is developing a strategy for playing any or all of them. My mission is to educate, not tell you what to do. So, in that vein let’s take an example from the table and put a simple strategy around it for educational purposes.

S&P Select Energy SPDR ETF (ARCA: XLE) shows a consolidation wedge over the last six weeks. This is defined by a downtrend on the lower highs and an uptrend on the higher lows. This is considered a bearish pattern. Thus, we would look for break lower out of this pattern for the strongest signal. $43.30 would be the break point on the downside creating an opportunity to be short XLE. ProShares UltraShort Oil and Gas ETF (ARCA: DUG) will allow you to buy the fund and be short the index as an alternative. Thus, the strategy for this ETF is based on a technical pattern. This means while scanning the market I came up with a potential play based on a predefined strategy. I mention this because we have to define the strategy before we proceed to trading. Now I put the ETF on my watch list and wait for the entry point defined by the strategy. In this example the entry would be a break below $43.30. I would also like to see above average volume on the break and a confirmation on the close. This defines the entry. Next we need to address the exit/stop. A stop or exit point is first determined by a violation of the strategy by which we entered the position. In this case a move back above the break lower or $44 would be the stop. This defines the risk as $0.70 for the trade. The target is the last piece we define and based on the strategy it is the height of the base of the wedge. That states $25.20. While the target is aggressive it is based on the strategy. Remember to use trailing stops to protect the gains in any position.

This is a simple approach to what the scans turned up. Use the table as a tool and build strategies that fit your style of trading. This will assist you in building discipline in your trading process. Start by scanning a defined basket of holdings. In this example I used ETFs. Using technical analysis I turn up interesting patterns for trends. I can then build a watch list based on the strategy I choose. From the watch list we have predefined the entry, exit, and target. This allows me to put them into play with discipline. Thus, I can scan the market, watch a predefined list from the scan, and then play it according to my discipline. This strategy is simple and implementable for any list. We remain in a very volatile market so discipline is imperative to protecting your principle. Have a disciplined strategy before you trade. You can follow along each day with my Chart-of-the-Day on SectorExchange.com.

Jim Farrish, founder and editor of Melbourne, Florida-based SectorExchange.com, writes regularly about sectors and speaks widely about investing and money management.

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