Broad Market Analysis - Great charts for sector trading ETFs
Last weekend, we conducted the last in our series of live trading seminars in Los Angeles, each of which focused on a simple method for sector trading through the use of ETFs. We received a lot of positive feedback from these educational trading seminars, and it was a pleasure meeting many of our subscribers around the USA. If you were not able to attend, we thought you may enjoy a brief lesson and discussion on the benefits of sector trading in this week's Wagner Weekly commentary.
At one time or another, most traders have taken a position in the common broad-based ETFs such as SPY, QQQQ, or DIA. But only a small percentage of traders pay attention to the plethora of ETFs that track specific industry sectors such as Retail, Pharmaceuticals, or Semiconductors. Through years of experience in trading all different types of ETFs, we have become convinced that the sector ETFs are consistently a better bet than the broad-based ones. While we occasionally take positions in the broad-based ETFs, regular subscribers to The Wagner Daily know that we trade the sector ETFs much more frequently, and with good reason.
The problem with the broad-based ETFs is that they often tend to be choppy, making it difficult to participate in long-term trends. If, for example, you invested in QQQQ on January 1 of this year, you would be showing a gain of exactly 0.6% (24 cents) as of the end of September. Conversely, there were 15 ETFs showing a year-to-date gain of more than 20% as of the end of last month. Did you know that the Telecom HOLDR (TTH), for example, is up 25% for the year? On the downside, the Internet HOLDR (HHH) is showing a year-to-date loss of 26%, a handsome profit if you were short. These ETFs may not be as exciting as trading QQQQ, but remember that we are in this business for profits, not thrills. You might be thinking, "That's great, Deron, but this is all in hindsight. How can I determine which sector ETFs are going to make big moves before they happen?" While this was discussed in detail during our seminar, it is obviously impossible to answer the question in great detail within the confines of a few paragraphs. Nevertheless, I will give you one big tip to get you started. It's called the "percentage change" overlay chart.
A standard stock chart shows only the price, along with optional technical indicators, of a stock or ETF. A "percentage change" chart, however, shows only the percentage that an equity has gained or lost during a specified period of time and ignores the actual price. When overlaying more than one ticker symbol on this type of chart, it becomes an excellent way to quickly determine the relative strength or weakness of one equity compared to another. Specifically, we use a broad market index such as the S&P 500 or Nasdaq Composite and overlay it with the ticker symbol of a sector ETF. If you create a separate chart of this type with all the major sectors, you will instantly be able to see which sectors are seeing positive or negative money flow for any given period. Then, it's as simple as buying the sectors with relative strength and selling short those with relative weakness. When using our "percentage change" overlay chart to compare the performance of the Biotech HOLDR (BBH) with the S&P 500 SPDR (SPY) over the past two days, here is what you get:
As you can see, this type of chart enables you to easily spot divergent trends, and those are the stocks or ETFs you should be positioned in. Regardless of market conditions at any given time, it is always possible to profit from positions on both sides of the market because institutional money is constantly flowing out of one sector and into another. A good example of this is how the S&P 500 was unchanged over the past two days, but our long position in the Biotech HOLDR (BBH) gained 1.1% during the same period. Furthermore, both of our open short positions moved lower as well. While the S&P has been flat since this Wednesday's close, the Semiconductor HOLDR (SMH) fell 1.4% and the Utilities HOLDR (UTH) lost 0.9%. The divergence between our current long and short positions, compared to the S&P 500 SPDR (SPY), is illustrated on the chart below. Taking the "percentage change" chart a step further, notice how you can overlay more than two symbols with one another for an even better way to spot divergence:
Regardless of the time horizon for your trades, you can use "percentage change" overlay charts to find quickly spot relatively strong or weak sector ETFs before the general public does. If a day trader, you might use a 5-minute intraday chart interval and see which sectors are strong or weak thirty minutes after the open. If a swing trader, you may use 60-minute intraday charts that go back a few days. If you hold positions for several weeks or more, consider using the daily price interval and looking for divergent trends over the past several weeks. With our hedge fund, we scan the percentage change charts of all the major sectors on a weekly basis, looking at how each sector performed relative to the broad market over the past five sessions. We use line charts instead of candlestick charts because it is easier to read the line charts when overlayed with two or more symbols.
This, of course, is only one part of the equation to profitably sector trading ETFs, but it will get you started nicely. If you learn to spot which sectors are seeing positive and negative institutional money flow, you can simply ride on the coattails of the "smart money" through simultaneously buying the ETFs with the most relative strength and selling short those with the most weakness. After a while, you won't really care which way the broad market is trending because you will always find opportunities on both sides of the market. The financial media has been speculating as to whether or not the fresh all-time high in the Dow is for real, but we don't really care either way. Regardless of how long the Dow holds at a new high, there will continue to be sector ETFs with relative strength or weakness to the broad market. Using "percentage change" overlay charts is an efficient way to spot the institutional money flow early in the trends. Most charting packages will allow you to do this type of chart, but we personally like TradeStation because of all the additional features it offers. Also, if you have not already done so, we suggest you download our free ETF Roundup guide, as it is a handy reference tool for all the ETFs, conveniently grouped together by sector and sub-sector.
On a different note, consider the iShares family of fixed-income funds if you're looking for a new long setup that may not be so "obvious" to the crowd, as most of them are approaching low-risk entry points on the buy side. Each of these bond ETFs have been in steady uptrends since the beginning of July 2006, which we pointed out several times along the way, but they are finally in the process of correcting down to support of their primary trendlines. Below is a daily chart of the iShares 20+ year Treasury Bond Fund (TLT). The ascending blue line illustrates support of the multi-month uptrend, a retracement to which would present an ideal buying point. A protective stop on such an entry should not be much below the 50-day moving average (the teal line):
Most of the ETFs in the fixed-income family have similar chart patterns. This is important because we always like to have confirmation of similar chart patterns within the same sector. If, for example, TLT was the only bond ETF that was in an uptrend, we would pass it by because stocks and ETFs without sector confirmation usually have a difficult time sustaining a trend. Notice how the iShares Corporate Bond Fund (LQD) has been moving nearly in lockstep with TLT:
Of the six different iShares bond ETFs, the only one we would avoid is the TIPS Bond Fund (TIP). It has been showing a lot of relative weakness while the others have been moving higher, and is the only ETF in the family that is still below its 200-day moving average. Like all ETFs, remember that the fixed-income ETFs pay dividends whenever the underlying issues do so. In the case of the iShares bond ETFs, each of them pay dividends on a monthly basis, a nice bonus in addition to any capital gains you may realize.
Last week, we pointed out the potential breakout that was setting up in the iShares Xinhua China 25 (FXI). As you may recall, we were anticipating a breakout above the high of a tight consolidation at its 52-week high. On October 4, the breakout came, but FXI fell back down to its breakout level two days later. As such, it is now at a "make it or break it" level:
Being that it only closed last week a few cents below the high of the prior consolidation, it could still easily hold and take off from here. It therefore provides a great risk/reward level for entry on the long side, just as long as you keep a tight stop below the October 4 low, which nearly converges with the 20-day moving average as well. Conversely, we also know that failed breakouts to new 52-week highs make very nice short selling opportunities as well. We'll be monitoring the price action in FXI closely over the next several days and may take a position. As always, regular subscribers will be notified via e-mail alert of any intraday entries.
Now that the third calendar quarter has concluded, we are in the process of computing our quarterly performance statistics for both The Wagner Daily and the MTG Stalk Sheet. The results will be presented at the end of this week, in our next weekly newsletter and will also be updated on the Morpheus web site.
If you wish to learn about Morpheus Trading Group's ETF trade entries on the same day they occur, sign up for a free trial to The Wagner Daily or other MTG services by clicking here (limit one per household). Also, remember that all previously published issues of both The Wagner Daily and The Wagner Weekly are available in the MTG archives. If you are new to our services or wish to broaden your knowledge of ETF trading or our general trading style, we recommend you browse the archives because it is educational and free! Click here to visit the Wagner Daily archives or here to visit the Wagner Weekly archives.
In this column, MTG presents you with a FREE, actual trade setup that we are stalking for entry at some point during the week. Note that, unlike the daily guidance that regular Stalk Sheet subscribers receive, this free Stalk of the Week does not take into account overall broad market conditions that can easily affect the trade over the next several days. This week's setup is:
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Below is the weekly commentary that accompanied this week's updated ETF Trend Tracker that was e-mailed to subscribers. The Morpheus ETF Trend Tracker, a perfect supplement to the ETF Roundup guide, is a comprehensive table of Exchange Traded Funds (ETFs) designed for informed investors and longer-term traders who prefer to hold their ETF positions for a few weeks to several months at a time. Based exclusively on a weekly analysis of trendlines on the daily and weekly charts, the ETF Trend Tracker provides subscribers with a thorough snapshot of the primary trend direction of ETFs in every category from broad-based to industry sector to international. This information is e-mailed to subscribers weekly, in a user-friendly format that groups ETFs based on the direction of their primary trends.
Commentary:There were no trend reversals last week, but we were busy updating several stops to lock in profits on the ETFs that have been moving steadily higher. ETFs in the "ascending trend" list are doing very well, with only the Internets (HHH) sitting below the original "Trigger Price."
Several ETFs hit new highs intra-week, but fell to close the week's session lower. Nice moves higher were found in Real Estate (IYR), Biotech (BBH), Aerospace (PPA), Software (SWH), Wireless (WMH), Financial (XLF), Technology (XLK), Consumer Discretionary (XLY), and Healthcare (XLV). XLY is really pulling away strong and is accelerating higher. We note acceleration by the rate of change, relative to the slope of our trend channel.
Singapore (EWS) also caught our eye, as it is showing solid acceleration and relative strength. It is also probing for new highs. Usually, professionals sell into these levels, near previous major highs, which in turn creates a near-term double top. However, if the stock market is truly strong, there should be no problem for an ETF to eventually sprint higher. Re-entry above the May 2006 high of $9.75 would be a valid re-entry or new entry point. If new entries are made, follow the MTG Stop (S1) to set your initial stop. The S1 stops are set closer to the current price they focus on hunting down gains for you.
No alerts of pending trend reversals this week.
A bit unusually, we noticed a few ETFs printed individual rogue trades, most of which occurred at the open. Bear in mind, however, that ETFs are synthetic products and the spreads should therefore be fairly tight all the time. One reason we use the MTG Opening Gap Rules is to help avoid getting stopped out by these erratic opening trades that are usually indicative of nothing.
Click to receive your free 1-month trial to the ETF Trend Tracker (limit one free trial per household), which will be e-mailed to you every week, along with intra-week updates on an as-needed basis.