Because my strategy is focused on trend trading the momentum of leading stocks, I generally avoid the short side of the market whenever my market timing model is on a buy signal (as it presently is).
However, this is not always the case with ETFs (exchange traded funds).
Since ETFs come in many flavors of asset classes, those with a low correlation to the direction of the US equity markets (commodity, currency, fixed income, etc.) sometimes present low-risk swing trade setups that are largely independent of broad market trend.
That’s the nice thing about ETFs — they often provide interesting trading opportunities outside of my standard trend trading model.
Emerging Markets Getting Submerged
One such ETF on my radar screen for potential short selling entry is iShares Emerging Markets ETF (EEM), an international ETF.
Last month, EEM convincingly broke down below support of a long-term uptrend line, and is now bouncing into new resistance of that prior support line (which is also converging with resistance of its declining 50-day moving average).
Yesterday (February 24), the price action stalled near the 39.70 area for the second time in two weeks.
In addition to key resistance of its 50-day moving average and prior uptrend line around that price level, there is also resistance from a prior swing low that formed in mid-January (around 40).
On the daily chart below, notice how perfectly the 50-day moving average (teal line) has been acting as resistance:
Since I prefer to sell short stocks and ETFs as they are bouncing into resistance, rather than on their initial break of support, the stalling action of EEM as it bounces into resistance of its 50-day moving average now presents me with an ideal, low-risk entry point on the short side.
Buy It Instead
If you have an IRA or other non-marginable account that disallows short selling, you may instead consider buying Direxion Emerging Market Bear 3x (EDZ), an inversely correlated “short ETF” that is leveraged 3x to its underlying index.
As the price of EEM moves lower, EDZ is designed to move higher (with greater volatility). Notice how the chart of EDZ kind of looks like an upside down chart of EEM:
Going into today, I am stalking EDZ for potential swing trade entry. One quick note about “short ETFs” in general is that most of them have a tendency to underperform their underlying indexes as the holding period increases. Therefore, inversely correlated ETFs are best designed as short-term, momentum-based trading instruments, rather than ETFs to consider buying and holding.