Find the Winners in the Sea of ETFs

Short and ultrashort exchange-traded funds are dominating the list of top performers in that huge market segment. But which ETFs catering to buyers have withstood October's perfect storm of selling pressure? These resilient issues could lead the way during a recovery rally, or whatever upside the market might offer in coming weeks.

ETFs of all stripes have become tough plays for at-home traders and investors in recent months. Electronic algorithms dominate these highly liquid instruments, making them jump around like pogo sticks, even in relatively quiet sessions. Add in historic volatility, and few warm-blooded players have the brainpower needed to pick out low-risk entries.

Two simple techniques will lower risk when trading these crazy instruments. First, reduce position size and hit for extra bases, rather than quick scalps. Second, use limit orders for all entries, scaling in when the fund moves against your intended direction. Then follow your last entry with a tight stop loss that will take you out of everything, all at once.

Index ETFs may be a better choice than sector or country funds in this wicked bear market. These funds move a tad slower than their cousins in the futures markets, despite broad daily ranges. In addition, they're technically oriented markets that respond well to classic trading techniques, like buying pullbacks and selling filled gaps.

Finally, trade baskets that cover a wide range of disparate market themes. This approach, when proper applied, will reduce risk and let you take advantage of volatile moves without losing too much sleep. Just choose wisely, because algorithms flow through hundreds of ETFs simultaneously, and too many eggs in the wrong basket can incur fast pain.

PowerShares U.S. Dollar Bullish (UUP)
Click here for larger image.
Source: eSignal

The PowerShares U.S. Dollar Bullish ( UUP) ETF tracks the greenback across a wide range of currencies. It bottomed out near $22 between March and July and then ticked higher in a relentless recovery. The instrument broke out of its basing pattern in August and is now testing the 52-week high near $26.

It's hard to find actionable levels because the fund has been trading for less than two years, so I recommend using the much older U.S. Dollar Index for decision-making. That index shows that price has now rallied into the 62% retracement of the 2005-to-2008 downtrend. This predicts a consolidation or pullback that starts at or near current levels.


CurrencyShares Japanese Yen Trust (FXY)
Click here for larger image.
Source: eSignal

Continuing with the forex theme, the CurrencyShares Japanese Yen Trust ( FXY) ETF rallied to a high at $103.46 in March and pulled back. It bottomed out in August near $90 and began a steady recovery. The fund has been moving higher since then in a series of stair-step rallies.

The early-October gap between $93 and $96 is quite bullish because it looks like a continuation gap that will mark the halfway point of the current uptrend. My quick math yields an upside target right at the 2008 high. Notably, this type of bullish gap rarely fills until the rally hits the last tick of the uptrend, so an entry near $97 could be rewarding.


SPDR S&P Dividend (SDY)
Click here for larger image.
Source: eSignal

The SPDR S&P Dividend ( SDY) ETF tracks a basket of the stocks with the highest-yielding dividends in the S&P 1500 Composite Index. Despite the recent plunge, it's leading other long-side equity funds in relative performance since Sept. 1. The instrument is also setting up a possible "2B" buy signal near the three-month low broken by the October selloff.

Price plunged to $36.16 on Oct. 10 and then surged back above the July low at $40.71. It's been moving sideways in a volatile pattern just above this remounted support level for the last six sessions. A basing pattern here will support a follow-through recovery that lifts price up to resistance in the mid-$50s.


iShares 1-3 Year Bond (SHY)
Click here for larger image.
Source: eSignal

The iShares 1-3 Year Bond ( SHY) rallied to a multiyear high just below $85 in January and pulled back. It tested that level in March and entered a decline that ended in June near $82. It then began a persistent recovery, returning in September to the high, where it's been oscillating in a broad holding pattern for the last month.

This is a slow-moving instrument that tends to trade against the equity indices. It still hasn't broken out even though the stock market is sitting at multiyear lows. This divergence reflects instability across the full range of debt instruments. However, once things calm down and the recession takes hold, this fund could move well above $90.


Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.

At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.

Farley is also the author of The Daily Swing Trade, a premium product that outlines his charts and analysis. Farley has also been featured in Barron's, SmartMoney, Tech Week, Active Trader, MoneyCentral, Technical Investor, Bridge Trader and Online Investor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

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