The market continued moving higher as better-than-estimated earnings and economic data signaled the global recovery is gaining momentum, despite budget woes in Greece and China tamping down their economy. Deere & Co. and Whole Foods beat earnings estimates and raised forecasts for next year. The Dow Industrials added 40 points to close at 10,309.24. The S&P 500 Index gained .42% and the Nasdaq Composite was the leader of the Big Three today, tacking on .55%.
Despite the advance almost all of the ETFs that turned in 2% or better gains today were those very thinly traded. For example, BHH, the B2B Internet HLDRS, was up 2.27% on a whopping 22,000 shares today. PBTQ, a global biotech ETF, gained 3.24% on…(wait for it)….1,000 shares. Even 3X leveraged ETFs like MWJ, the Midcap Bull, were up only 1.80% – but at least it did it on solid volume. Please click on the symbols for details.
The past few days I’ve been pointing out how volume has been declining as the market has been rising. The price rise on the Dow Industrials both yesterday and today came on lower than average volume. Same thing for the Nasdaq Composite. Yesterday I wrote about making trading decisions based on what you know, not on what you don’t know. I’d like to continue that theme today.
Markets that rise for multiple days are ripe for the pickin’, especially when they rise on steadily decreasing volume. Case in point is FXI, the Ftse/Xinhua China 25 Index ETF. It has moved higher on steadily decreasing volume since February 9. When I see a market making multiple day lows or highs on decreasing volume, I look for setups where I can utilize the RSI 10/6 and the RSI 90/94 strategies.
In Larry Connors and Cesar Alvarez’s book, “High Probability ETF Trading,” they describe in detail these strategies. It looks for extreme pullbacks on an ETF, buys or shorts them, then sells or covers on a snapback.
The trading rules are as follows. For buys:
1. Today the ETF is above its 200-day SMA.
2. Buy when the 2-period RSI of the ETF looks to close under 10. This tells us the ETF pulled back in an uptrend.
3. Buy a second unit if the RSI looks to close under 6.
4. Exit all positions on the close when the ETF closes above its 5-day SMA.
1. Today the ETF is below its 200-day SMA.
2. Short when the 2-period RSI of the ETF looks to close above 90. This tells us the ETF moved higher in an uptrend.
3. Short a second unit if the RSI looks to close above 94.
4. Exit all positions on the close when the ETF below its 5-day SMA.
While inverse ETFs can be bought (rather than shorting the regular ETF) when their market is trending lower, I’ll show you an example that shorts FXI. Please review the chart below, which you can make full-screen by clicking on it:
The chart is in thirds: price with moving averages (upper-third); RSI with an oversold limit of 10 and an overbought limit of 90 (middle-third); and volume showing each day’s volume and the average daily volume (lower-third).
You can see a successful short trade that was executed at the beginning of the month. The “-100 InitShort” means the strategy placed an initial short of 100 shares on that date. Although not shown on the chart, “2ndShort” means a second 100 shares was shorted. “C<MA5″ is the close below the 50-day SMA.
On February 2, FXI was trading below its 200-day SMA while its 2-day RSI closed just above 90, at 90.06. A short would have been entered at or near the close, at 39.84. Two days later FXI closed below its 50-day SMA at 38.02. If you covered there you made a 4.56% profit before trading costs in just two days. Another short trade was entered into last week on February 11. Note how FXI has been moving higher on steadily decreasing volume for a week. Look at the same volume pattern going into the February 2 short.
The February 2 trade is a bit misleading because with the RSI-2 closing only fractionally above 90, odds are you would not have placed the trade since you had no way of knowing with certainty the RSI would close above 90. I went and backtested this strategy using 10 years of data for FXI. There were 22 trades, of which 18 were profitable; 3 were not; and the 1 open trade. The wining percentage was 85.71%. The average gain was 2.33%.
Of course, past performance is no guarantee of future results. When Connors and Alvarez tested the strategy (both long and short) on a basket of 20 ETFs from their inception through 12/31/08, there were 1,075 long trades with a percentage winners of 81% and an average gain of .93%. There were 566 short trades with a percentage winners of 76% and an average gain of 1.56%.
The market climbing on decreasing volume is trying to tell us something. Are you listening? If not, it will be sure to tell you in the fullness of time.