This column was originally published on RealMoney on May 1 at 12:00 p.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.
Exchange-traded funds are multiplying faster than bunnies on a hot spring day. These specialized stocks have fundamentally altered the financial markets, with a sizable percentage of all volume now passing through them directly, or through their underlying components. This powerful trend is likely to continue in upcoming years.
The broad variety of ETFs ensures that market movement in both directions gets stretched beyond its natural limits. Consider how a downdraft in the
Nasdaq 100 Trust
exerts an immediate pull on its component stocks. Traders take note of this selling pressure and dump noncomponents, as well, to get out of the way of the falling market.
In turn, broad baskets of ETFs get tugged south, inducing a domino effect that can ripple through a wide variety of sectors and world markets. Finally, add in the infinite variety of program-trading algorithms that use ETFs, and this selloff synergy can grow to outsized levels, as we saw during the Feb. 27 drop.
Ironically, these issues also add considerable stability and liquidity to the markets. In fact, they're a primary reason the Market Volatility Index has fallen to historic levels in recent years. They're also a great way to manage risk because their daily movement is small relative to individual stocks, but they can trend reliably for months or years.
I scanned my databases to uncover the most interesting ETF patterns I could find. To this end, let's look at five funds that could move considerably higher in the weeks ahead.
iShares Malaysia Index Fund
got caught in the late February selloff, dropping 15% in one day. But that ugly session also marked the low for this strong performer. Price recovered through March and returned to the high about three weeks ago. It hovered there for a few bars and then broke out to a nine-year high.
That rally stalled at 11.86, with price dropping into a triangle pattern. It looks like this consolidation is almost over, and the stock will resume its uptrend soon. Readers can buy the breakout or build positions within the triangle as long as they place stop losses under the 50-day moving average. The strong uptrend should continue into the upper teens.
iShares Mexico Index Fund
has been in a powerful uptrend since 2003, rising from 11 to over 50. The last leg of its rally topped out at 56 in February, with the stock selling off with the world markets in the first quarter. Price recovered back to the high in early April. It nosed above it a week later and dropped into a rectangle pattern.
Watch the edges of this trading range to determine the stock's short-term direction. A rally above 57.70 will set the uptrend back into motion, while a selloff below 55 could trigger a test of support at the 50-day moving average, currently near 54.40. The stock needs to hold that level for the bullish pattern to stay intact.
The utilities sector has been an outstanding performer in recent weeks. This is confirmed by the
SPDR Select Sector Utilities ETF
, which is currently trading at an all-time high after breaking above February resistance at 40.30. The sharp move following the breakout didn't offer good entry points, so the current downturn is relatively good news.
Weakening relative-strength indicators predict this stock could pull back for a few weeks in order to consolidate its recent gains. An orderly decline to breakout support near 40 would be a good place, and price, to get on board for a renewed uptrend that presses above the recent high and heads into the mid 40s.
iShares Russell 2000 Growth Index Fund
is a subset of the broad Russell 2000 small-cap index, focusing on growth issues. The ETF rallied to an all-time high at 86.50 in 2000 and pulled back during the bear market. It rallied to within 2 points of that high last week and sold off on Monday.
The current pullback should tell the tale. Look for support to come in between the 50-day moving average and "round number" 80. A bounce there should set up a strong run that tests the multiyear high. In turn, that might yield a larger-scale breakout that lifts this ETF into the mid 90s.
Powershares Water Resource Portfolio ETF
is a surprisingly liquid fund that focuses on bottled water and water-treatment facilities. The stock rallied to an all-time high last May and dropped into a mild correction. It bounced in July and rallied through resistance on strong volume in February before selling off with the broad market.
Price nosed above the February high last week and pulled back during Monday's downturn. Look for this ETF to outperform in any market weakness because it's an obvious defensive play. If it can hold above 19 here, buyers should step in and start the next leg in a rally that reaches into the low 20s by early summer.
At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.
Alan Farley is a professional trader and author of
The Master Swing Trader
. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback;
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