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After forming a bullish reversal candle off support of a prior breakout level, iShares Msci Poland ($EPOL) has followed through nicely to the upside the past two days. The recent pullback in $EPOL is a good example of where to find a low risk entry point after a stock/ETF has already broken out using the high and low of the candle as an entry and stop. It can also serve as a low risk point to add to a position because of the tight stop beneath the reversal candle low. We did not add to our position in $EPOL because we are trading with reduced share size and did not want to increase risk.

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One industry sector ETF that has shown relative strength since the broad market began its decline off the September highs is S&P Homebuilders SPDR ($XHB). Trading near its five-year high, $XHB only briefly “undercut” horizontal price support in mid-November, right before the major indices formed a near to intermediate-term bottom. Since then, price action has been choppy and seemingly noncommittal. However, $XHB is starting to form a “pennant” formation that could soon lead to a breakout to another new five-year high…

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For the week, the Dow Jones gained 1.0% and the Nasdaq lost 1.1%, making for a rather sizeable weekly price divergence of more than 2% between the two popular stock market indexes. A significant part of the weakness in the Nasdaq could be blamed on the dismal performance of Apple ($AAPL), which plunged nearly 9% last week and closed back down near its mid-November low. Since $AAPL represents a 10% weighting in the Nasdaq, the stock has a tendency to lead the entire Nasdaq index. But as technical traders, the actual reason for the sudden “emergence of divergence” is largely irrelevant to us. Rather, it is more important to first be aware the divergence is simply taking place, then take that into consideration if entering any new positions in the coming days.

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In yesterday’s newsletter, we listed a handful of European ETFs that have been showing relative strength by breaking out in recent weeks. However, the strength has not been limited to Europe. Emerging Markets ETFs have also been outperforming by breaking out above resistance levels, even as the US broad market chops around in an indecisive range. The strength in Emerging Markets ETFs can be seen on the daily chart pattern of Direxion Emerging Markets Bull 3X ETF ($EDC), a leveraged ETF comprised of a basket of stocks from emerging regions.

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With the major averages stalling at resistance, our scans have produced a few quality short setups. We established a short position yesterday in the Russell 2000 by going long the Proshares Short Russell 2000 ($RWM). For those who missed yesterday’s entry, a slightly higher entry can be had on a move above Tuesday’s high (reduce share size to keep trade risk the same). We have one new setup on today’s watchlist in $IBB.

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When stocks are trading near their short-term highs while in a countertrend bounce off the lows, the presence of higher volume without accompanying price gains is considered negative because it hints at stealth selling into strength among banks, mutual funds, hedge funds, and other institutions. Nevertheless, one or two rounds of institutional profit taking after stocks have formed a “V” bottom off their lows is normal, and can easily be absorbed by a healthy market.

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In order to identify the best ETFs to buy now, it’s important to determine which ETFs showed the most relative strength to the broad market during the recent decline. ETFs that made lower lows and lower highs in recent months, alongside of the main stock market indexes, are probably not the best ETFs to trade right now because there is no bullish divergence. Rather, we have been screening for ETFs that held up near their highs, even while the Nasdaq was getting hammered.

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