A quick way to find upward-trending stocks or exchange-traded funds (ETFs) that have experienced a recent pullback is to screen for ETFs that are above their 200-day moving average (MA) but that have dropped below 50 or 40 on the relative strength index (RSI) indicator. Traders can look through the results for ETFs that are trending higher (making overall higher swing highs and higher swing lows) but are in a corrective phase that may offer a timely buying opportunity. Here are two ETFs that currently offer this type of opportunity.
The Utilities Select Sector SPDR ETF (XLU) has been in an uptrend since late 2016, when it began making higher swing highs and lows. On Sept. 11, the ETF hit a high of $55.90, and it has been pulling back since then. The ETF is above the 200-day MA but is below 40 on the RSI. Traders can watch for the RSI to move back above 40 to trigger a long trade, placing a stop-loss below the most recent price low that formed just prior to entry. This method is subject to whipsaws, like the one seen on Sept. 25, when the RSI popped above 40 but then went back below on Sept. 27. (See also: Why Utility Stocks Are Looking So Attractive Right Now.)
An alternate entry method is to wait for the price to consolidate for at least three days with the RSI below 40 and then buy when the price moves above the high of the three-day (or longer) consolidation. In this case, traders can place a stop-loss below the consolidation. An example of this entry occurred in July, capturing the ensuing two-month rally. While an exact entry is yet to be determined on the current pullback, it is likely to form between $53 and $52. An upside target can be placed at $56.50, just above the prior high.
The iShares U.S. Real Estate ETF (IYR) has been in an uptrend since late 2016, with a slightly rising trend channel throughout 2017. Drops below 40 on the RSI have been followed by rallies to the top of the channel. Once again, this chart highlights the whipsaw problem with using only the RSI for an entry point. In May and July, the RSI moved above 40 from below, but then the price fell some more and then rallied. Combining the price action and the trendline has produced better signals. The rising trendline provides an approximate area to get interested in long positions. An upside consolidation breakout or a bullish engulfing candle are patterns that could be used to signal an entry after the price has been near the trendline.
The Sept. 27 close of $79.20 puts the price very close to the trendline. It is now time to watch for bullish price pattern to develop and signal the long trade. Once the pattern occurs, a stop-loss could be placed below the most recent swing low that formed just prior to entry. An upside target is placed at $82, near the top of the channel. Since this trend has been weaker (compared with XLU), moving more horizontally than up, the target is placed near the former high, but not above it. This improves the chances of being able to get out of the trade with a profit.
The Bottom Line
The utilities ETF is in a strong uptrend, but it has pulled back and is now presenting another opportunity to buy. The real estate ETF has been moving in a channel and is currently near the bottom of that channel, indicating a potential buying opportunity. If the price keeps dropping, traders should avoid the longs. A long trade is advisable only if a buy signal occurs, showing that the price is starting to rally again. It is important to control risk with a stop-loss in case the price drops after buying, and traders should risk only a small portion of account capital on any single trade.
Charts courtesy of StockCharts.com. Disclosure: The author did not own shares of the aforementioned ETFs at the time of publication.