3 Top-Heavy ETFs That Are Ready to Tumble

by Johnson Research Group | May 16, 2013 9:01 am

The market appears to be trading in the land of unicorns and dragons lately as stock seem to have decoupled from reality on their nosebleed drive higher.

With large quantities of cash still sitting idle on the sidelines, it’s hard to not think that there is more upside to be had … but even harder to remember that a healthy pullback is more likely to happen soon.

With the latter in mind, it’s a good time to look at some of the ETFs that are trading in what could be called overbought situations. There are a number of ways to measure overbought conditions, one of which is monitoring the percentage of companies within an ETF that are trading above their 50-day moving averages.

The table below details the current percentage of constituent companies in SPDR funds trading above their respective 50-day moving averages, along with the same measurement from 5-, and 10-days ago.

Of particular concern is the breakneck change in the percentages of companies trading above their 50-day moving averages at the top of the list.

ETFs like the Financial SPDR (NYSE:XLF[1]), Retail SPDR (NYSE:XRT[2]) and the SPDR Dow Jones Industrial Average ETF (NYSE:DIA[3]) have seen significant spikes over the last week, suggesting that these key sectors may be encroaching on overbought territory, increasing the odds of a sudden move lower.

What does this mean for the average investor? Well, that it may be time to cash out on some of the more rich profits in your portfolio, especially if they are in the ETFs named above.

For the traders out there, the potential over-reach of these ETFs may be providing an opportunity to play a long-awaited pullback. Let’s take a look at a few of these potential opportunities.

Financial SPDR

Click to Enlarge The financial stocks have been ablaze lately as names like Moody’s (NYSE:MCO[4]), E*TRADE Financial (NASDAQ:ETFC[5]) and other components of the XLF have shot higher on renewed interest in the market. Unfortunately, the lurch higher is likely to cause some profit-taking among the ETF.

Taking a look at the XLF chart, the shares just breached a technically overbought condition with its RSI cresting above the 70 level. The last time the ETF saw a similar situation was in February before the XLF retraced about 5%.

Traders looking to play the downside potential of the XLF should find the Proshares UltraShort Financials ETF (NYSE:SKF[6]) as an attractive play. This ETF provides leveraged 2:1 inverse performance of the XLF shares, meaning the SKF goes up 2% for every 1% decline in the XLF. With a potential target of $19 or $18.50 for the XLF, a trade in the SKF would appreciate by roughly 8% to 13%.

Retail SPDR

Click to Enlarge Retailers are hot as the market anticipates further improvements in the discretionary activity of consumers. The rally in retail has been widespread, though notably absent are names like Target (NYSE:TGT[7]), Walmart (NYSE:WMT[8]) and Dollar Tree (NASDAQ:DLTR[9]), all of which are underperforming against the XRT.

Like the XLF, XRT shares are ringing the overbought bell as its RSI moves above the 70 level. Historically, readings above 70 come as the shares get tired and retreat to lower levels. For now, the charts suggest that the $74 level would be the first round of support for the XRT, providing a good point to buy the shares back. A break below $74 would see the shares move to support at $72 — about 7.5% lower than today’s close.

Our approach would be to use short-term puts on the XRT or the more overbought companies within the ETF like Cabela’s (NYSE:CAB[10]), Netflix (NASDAQ:NFLX[11]) or Supervalu (NYSE:SVU[12]).

SPDR Dow Jones Industrial Average ETF

Click to Enlarge Finally, the Dow Jones Industrial Average has hit its own overbought conditions. A whopping 93% of the companies within the Dow 30 are trading above their respective 50-day moving averages, while the RSI trades at 71.

As a result of the overbought conditions, the charts target a move to $148 for the Diamonds as the Dow looks ready to rest.

Like the financials, this fund can be shorted easily with the Proshares Short Dow30 (NYSE:DOG[13]) or the more aggressive 2:1 inverse shares, the UltraPro Short Dow30 (NYSE:SDOW[14]).

As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2013/05/3-top-heavy-etfs-that-are-ready-to-tumble/

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