With more than 2,300 exchange traded funds and a combined market value of about $4.7 trillion, there’s a huge market for trading ETFs. But how exactly do you trade these index investments?
ETFs should not be treated exactly like individual stocks. Yet, they share enough similarities that they can be bought at breakouts and secondary buy areas, and can be sold using the same sell signals used for regular stocks.
Trading ETFs vs. Stocks
Find the cup with handle, double bottom, flat base and cup without handle bases in ETFs to buy at proper entries. Rebounds from pullbacks to the 50-day moving average (or the 10-week line on a weekly chart) also can be used to buy ETFs. IBD’s MarketSmith offers pattern-recognition tools to help you identify proper entries in ETFs. In fact, pullbacks often are the better option for ETF investing.
The same sell rules for stocks apply to ETFs. Among the most common: A sharp break of the 50-day moving average; a loss of 7% or 8% from the buy point; or a break below an upward trend line spanning several months.
Strategies For Trading ETFs
ETFs can be especially attractive investments in cases when an industry group starts rallying, but lacks a leading stock to spearhead the advance.
In early 2019, for example, homebuilders surged to a top-10 industry ranking, but none of the 22 stocks in the group formed a good base or had great fundamentals. Price corrections in the group were deep, and the few breakout attempts came in low volume or still far from 52-week highs.
To invest in the group’s fast climb, it made sense to buy one of several homebuilding ETFs. SPDR S&P Homebuilders (XHB) formed a cup-with-handle base in December and January within a much larger consolidation. The ETF broke out Jan. 30, 2019, and climbed as much as 15.7% from the 35.77 buy point.
Sure, this and other homebuilding ETFs were far off prior highs. But that’s one difference with buying the top stocks: When trading ETFs, you don’t necessarily restrict your buying to shares near new highs. With stocks, the best entries are within 15% of a high.
Sometimes, it takes a while for a leading stock to set up properly while its industry group starts to rally. Finding an ETF that tracks the industry helps investors get in early.
So, if there’s an industry group climbing fast in the IBD 197 industry group rankings, look for an ETF that tracks the industry. It can give you an early way of investing in the move.
Trading ETFs Daily
IBD’s ETF Market Strategy is a way for investors to own the major indexes when the general market is rising. You can use SPDR S&P 500 ETF (SPY), Invesco QQQ Trust (QQQ) and other index funds. When IBD’s market outlook is “market under pressure” or “correction,” you cut exposure in half or entirely.
Even in sectors with leading stocks, trading ETFs can make sense, and it reduces the risk if something goes wrong with an individual stock you’ve bought. For example, leading chip stock Xilinx (XLNX) plummeted 17% on April 25, 2019, on disappointing earnings, but VanEck Vectors Semiconductor (SMH) fell only 2% the same day, despite having Xilinx among its holdings.
Indeed, the chip ETF was a great way to ride the software sector’s market-leading performance in the first four months of 2019.
But trading ETFs also means you could forfeit much larger gains if you owned the sector’s top leader. Before its plunge, Xilinx, a former standout winner on Leaderboard, shot up nearly 50% from its Jan. 24 breakout. The VanEck chip ETF, by comparison, rose 21.6% from a 99.23 buy point.
This article was originally published May 3, 2019. Juan Carlos Arancibia is the Markets Editor of IBD and oversees our market coverage. Follow him at @IBD_JArancibia
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