ETF Trading Ideas After an Early Drop

04/29/2010 12:01 am EST

Focus: STRATEGIES

David Penn

Editor-in-Chief, TradingMarkets

Tuesday's selloff—inspired by both growing anxieties over the Greek economy and the spectacle of Goldman Sachs (GS) executives being grilled by Congress—provided opportunities for high-probability traders to both take profits in leveraged exchange traded funds (inverse leveraged ETFs, that is) as well as begin scaling into increasingly oversold markets.

As Larry Connors noted this morning in the "Morning Market Intelligence" section of his Daily Battle Plan, the selloff we experienced was widely discussed as being "extreme." However, selloffs of this severity are actually quite common, and, as Larry pointed out, are to be expected when markets become extremely overbought and due for correction.

Today, we'll take a look at both some recent winners as well as some potential new opportunities for high-probability traders for the day ahead.

Stocks

As markets climbed higher into overbought territory in the days leading up to Tuesday's selloff, a number of previously oversold stocks were able to rally to levels at which high-probability traders were able to take profits. Examples of these previously oversold stocks include Kit Digital Inc (KITD) below, which rallied by approximately 4% after becoming oversold above the 200-day moving average.


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Other stocks that have made significant gains after pulling back into oversold territory include Exact Sciences (EXAS) and Gerdau SA Ads (GGB).

Going forward, there are a wide number of stocks that have plunged into oversold territory and may be good candidates for high-probability traders over the next few days. Examples of some of the more oversold stocks are Alcon Inc (ACL), which has closed lower for ten consecutive days, and Ebay Inc (EBAY).

New Trade Ideas in ETFs and Leveraged ETFs

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Exchange Traded Funds (ETFs)

Many of the gains in ETFs over the past few days came relatively quickly insofar as they were the result very brief pullbacks into oversold territory. Examples of this are the one-day pullbacks in stocks like the Industrial Select Sector SPDR Fund (XLI) and the Vanguard Small-Cap ETF (VB), which resulted in modest, one-day gains just above 1%.

Over the next few days, high-probability traders trading ETFs have a sizable number of potential opportunities among oversold funds. Some of the funds earning the largest number of signals from our high-probability ETF trading software presently are ETFs like the iShares MSCI Pacific ex-Japan Index Fund (EPP), the iShares MSCI Australia Index Fund (EWA), and the Consumer Staples Select Sector SPDR Fund (XLP) (see below).


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With Larry Connors' high-probability ETF trading software, short-term traders have access to the same kind of "buy the selling, sell the buying" trading strategies that professional traders have used successfully for decades.

Leveraged ETFs

Some of the most impressive short-term gains in recent days have come from the world of leveraged ETFs, particularly inverse leveraged ETFs that track the opposite of a given index or benchmark and do so in a leveraged fashion (2x or 3x).

Inverse leveraged ETFs offer high-probability ETF traders in particular a unique opportunity to participate in markets when traditional high-probability trading strategies with non-leveraged securities is difficult due to persistently overbought conditions.

By trading inverse leveraged ETFs, high-probability traders can take advantage of these overbought conditions in non-leveraged, regular markets by scaling into the extremely oversold conditions in leveraged, inverse markets.


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Examples of this over the past few days are plentiful. Consider the recent performance of inverse leveraged ETFs like the ProShares UltraShort Oil & Gas (DUG) (see above), as well as the ProShares UltraShort S&P 500 (SDS), and the Direxion Daily Small Cap Bear 3x Shares (TZA).

By David Penn, editor-in-chief, TradingMarkets.com

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