Given that the stock market has been relentlessly marching steadily higher for more than a month, yesterday’s correction was not surprising, nor of major concern. Even the strongest of uptrends do not move in a straight line forever, and pullbacks along the way are both normal and healthy.
In hindsight, it’s easy to say that momentum traders should have been taking profits on long positions (before yesterday’s decline) because the market is “overbought.” But this is faulty reasoning because the same thing could have been said a full one or two weeks ago. Those who have been on the sidelines have been missing out on profitable trading opportunities, despite the market being “overbought.” This is why our mantra is to always trade what we see, not what we think!
Since our trading system is based on the performance of individual stocks and ETFs, rather than the main stock market indexes, our main focus is how well leading stocks hold up during pullbacks in the broad market. As long as they do, short-term corrections must be viewed as a buying opportunity. This bias (and our market timing model) changes only when leading stocks start falling apart, sector rotation dries up, and/or the broad market suffers five or more distribution days (higher volume selloffs) over the course of 3 to 4 weeks.
Now that the stock market is apparently entering short-term correction mode, we have begun scanning for potential pullback entry points in stocks and ETFs with the most relative strength to the broad market. Two such ETFs are Market Vectors Semiconductor ETF ($SMH) and Guggenheim Solar ETF ($TAN).
Since selling $SMH for a 9% gain last week, we have been stalking this ETF for an ideal re-entry point. Because it has been among the leading sector ETFs of the current rally, we were initially looking for possible re-entry above the high of its recent consolidation. However, now that $SMH is pulling back to near-term support of its 20-day exponential moving average, the reward to risk ratio for buy entry is even better:
Notice that $SMH is coming into support of its 20-day exponential moving average for the first time since it broke out four weeks ago. Typically, the first touch of this moving average after a strong breakout presents a low-risk pullback entry point. As such, we have added $SMH as a potential swing trade buy entry. Subscribing members of our nightly ETF and stock swing trading newsletter should note our predetermined and exact trigger, stop, and target prices for this swing trade setup in the “Watchlist” section of today’s report.
Another ETF we have been stalking for a pullback entry is $TAN, which blasted off and ripped approximately 30% over the past two weeks. We missed the initial breakout entry of this ETF, but it is now pulling back to the area of its 10-day moving average. Because this ETF has been showing so much relative strength since its breakout, there’s a good chance it will not retrace all the way down to its 20-day exponential moving average before the buyers return. As such, we believe it is a good risk to buy $TAN on a test of its 10-day moving average. Take a look:
In addition to $SMH being on today’s watchlist as a potential pullback buy entry, we have also added $TAN to as a possible pullback entry. Again, trade details for entry and exit are listed for subscribers on the watchlist.
Ideally, we would like to see an opening gap down in the broad market today (due to bearish follow-through from yesterday’s selling) that leads to a bullish reversal by the close. But even if that doesn’t happen, we feel pretty good about taking a shot at two of the strongest sector ETFs in the market on a pullback.