Shortside Trade in IWM

Reversion to the mean trades mean that investors can often make quick profits.

   

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Video Transcript

Let’s look at a trade idea on the iShares Russell 2,000 ETF (NYSEARCA:IWM). With Wednesday’s market reversal and first real broad down day across the tape – if we take the Jan. 30 trading session into account, it’s the second down day – but really it’s the first one that I think really had a lot of volume behind. We certainly now have a good level to lean again in a lot of markets.

[The iShares Russell 2,000 ETF (NYSEARCA:IWM) counts Ocwen Financial (NYSE:OCN), Axiall Corp. (NASDAQ:AXLL), Pharmacyclics (NASDAQ:PCYC), Two Harbors Investment (NYSE:TWO), Genesee & Wyoming (NYSE:GWR), CommVault Systems (NASDAQ:CVLT), Starwood Property Trust (NASDAQ:STWD), Dril-Quip (NYSE:DRQ), Alaska Air Group (NYSE:ALK) and Brunswick (NSYE:BC) among its core holdings.]

Let’s look at a trade idea on the iShares Russell 2,000 ETF (NYSEARCA:IWM). With Wednesday’s market reversal and first real broad down day across the tape – if we take the Jan. 30 trading session into account, it’s the second down day – but really it’s the first one that I think really had a lot of volume behind. We certainly now have a good level to lean again in a lot of markets.

I would caution against using technical analysis as the only indicator, but if we also understand the structure of the market where the invisible hands and a lot of the central banks still rule the land, we shouldn’t be surprised at any moves that go entirely against what technical analysis is giving us. On average, however – and I think this is the important thing to note – technical analysis will also work now.

So, what I am seeing here is an interesting spot to lean against the highs of Wednesday on the IWM around $92.65-ish, give or take a few cents. That’s the level to lean against, and I think it’s important to distinguish because just opening a blind short and having a very defined level to lean against.

In this case, because of the big outside day that we had across the markets in the U.S. in different asset classes, as well, we see how it fully engulfed about the four previous trading days. So, it took one day to wipe out four days of gains. That’s very powerful.

We also had good volume. The momentum oscillators are coming off, so that’s a very good level to go against.

In terms of looking how extending the index got, we just to have flip back a little bit. On the chart in the video, I show you the 200-day simple moving average as noted by a red line. We can see how far the index had gotten extended past it. There have certainly been times in the past where it has also extended far past it, for example, the lows in early 2009, but those were extreme circumstances, and again in the fall of 2011, where we had crazy volatility.

But, on average, the IWM did get very far extended past the 200-day moving average and some sort of mean reversion trade here should be in order.

So, we have a clearly defined stop-loss level for a short trade in IWM, which is about 2% from Wednesday’s close at $90.83. If one were to go short or buy puts on IWM or even selling (writing) out-of-the-money call spreads, these are all interesting strategies to make money on IWM’s downside.

My point, however, is from a pure price point of view on the underlying, which now sets up for something I would consider good risk/reward and a high probability trade, not so much because you’re going to make 20% off it but because you have very defined risk right off the bat on one day off of a very important cycle and the extent of the extension it had past moving averages.

In terms of the first downside price target, I wouldn’t get too greedy. I would give this about 2.5% to 3% of a downside move somewhere into the mid- to high $80s is probably the first target, so somewhere around $87 or $88. Then, we’ll have to re-evaluate.

But the point is, we have a good risk/reward shortside trade in IWM with very defined risk.

Serge Berger is the head trader and investment strategist for The Steady Trader. Sign up for hisfree weekly newsletter.


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