This column was originally published on RealMoney on Nov. 2 at 12:06 p.m. EST. It's being republished as a bonus for TheStreet.com readers.
Equities haven't had a major correction in over three months now. This makes it difficult to find good opportunities with favorable reward-to-risk ratios.
At times like this, I turn to exchange-traded funds, because many of these instruments trade independently of the popular indices.
The huge number of exchange-traded funds on the market these days boggles the mind.
From its humble beginnings with the
Standard & Poor's Depositary Receipts
, this market niche has grown to over 300 issues of all stripes and objectives.
While liquidity can be a problem at times, the majority of these stocks can now be traded with no slippage at all.
ETFs have a huge impact on the day-to-day trading environment because they're the cornerstones of vast program strategies that move the markets.
Want to know why thousands of stocks suddenly move in lockstep when a trend grips the tape?
Look no further than ETFs, which drag around each component like an obedient dog on a chain.
I've culled through charts to find which ETFs are offering the best opportunities for traders and investors right now.
In particular, I looked for patterns that don't look overextended, despite the broad equity rally.
Here are my top five picks.
iShares MSCI Japan
is a slow-moving ETF that rallied to a multiyear high at $15.55 in May and pulled back in a deep correction.
It found support above $12 and started to recover.
The stock has built an ascending triangle base, with resistance above $14.
A rally through this level should set up a test of the May high.
The best entry with this instrument should come on a pullback to the 200-day moving average near $13.45. That level would offer an attractive reward-to-risk profile, especially with larger positions hoping to benefit from a longer-term recovery. This could take some time, so be prepared to commit capital going into the first quarter of 2007.
iShares MSCI Mexico
rallied to a high at $44 in May and pulled back. It found support near $31 and returned to the high in early October. The stock broke out and hit $47.71 a few days ago before turning tail and starting a correction. It looks like this pullback should be buyable at support.
This ETF is attempting to bounce right now, so is the selling over? It's hard to tell, but there's no rush to take exposure here. Wait for a deeper pullback to $44 or a consolidation pattern near current levels that lasts a few more weeks. That basebuilding exercise would support the rally in the same manner as a test of breakout support.
iShares Russell 2000 Value Index Fund
is a targeted fund composed of 50% of the Russell 2000 index components. It's outperforming its big brother right now and has an interesting bull pattern. The stock rallied back to its May high at $77.22 two weeks ago, jumped above it and sold off Wednesday.
Note the rising channel off the summer low. The stock will reach channel support if and when it drops below $75. This level should provide a good entry for a recovery that carries it through the October high. But make sure to place a stop below support, because a breakdown could start a decline into the 200-day moving average at $72.
The streetTracks KBW Bank
ETF has the most interesting pattern I see in the financial sector. It set a new high of $57.19 in May and dropped back to the low $50s. It based at that level and returned to the high about four weeks ago. It has been pulling back since then in a bullish consolidation.
This sideways pattern should yield a breakout sooner or later. It looks like $57.50 will be key resistance within this smaller formation, so a rally through that level should be a reliable buy signal. The first reward target after the move gets under way is $62, which is equal to the size of the recovery off the June low.
UltraShort QQQ ProShares
trades inversely to the
Nasdaq 100 Trust
and with 200% of its daily movement. Ominously for the broad market, it nosed above a three-month downtrend during Wednesday's selloff. If confirmed, it would trigger a buy signal for a rally up to the 50-day moving average near $61.50.
This position would be a countertrend trade because the instrument is sitting below longer-term resistance levels. A subsequent buy signal will come if the ETF pushes above the 50-day moving average. That breakout would set up a move into the September peak at $68.25.
At the time of publication, Farley held none of the ETFs 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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