Mega- and large-cap tech stocks had a great start to the new year and indeed to the new decade. In the first three trading weeks, the PowerShares QQQ ETF (NASDAQ:QQQ) has risen about 5%, and that on top of a viciously sharp rally in Q4 2019.
As a result, this index and many of its largest constituent stocks are morbidly overbought in the short-term and in dangerous territory. Active investors and traders may find better reward-to-risk opportunities on the short side.
To be clear, I am not in the business of top or bottom calling as trends can remain intact and markets can remain ‘irrational’ in the short-term for longer than most market participants imagine.
Having said that, one of the most powerful phenomena in the markets it that of ‘mean-reversion.’ Mean-reversion is simply the reaction of market participants in the opposite direction when a market moves too sharply in another direction. Whether it’s buyer exhaustion when a market is overbought, or seller exhaustion when markets are short-term oversold, it is all the same thing. Mean-reversion in my eye is not only one of the most powerful setups in markets, but also one that I see too few market participants take advantage of.
When markets go vertical or ‘parabolic’ in technical analysis speak, and take the stairs higher for weeks at a time (with little-to-no volatility), then the mean-reversion moves to the downside rarely take place in an orderly fashion. In those instances mean-reversion is sharp as investors take the proverbial elevator down.
QQQ ETF Stock Charts
Even just a brief look at the multi-year weekly chart of the QQQ ETF should make it blindingly obvious that from the move since Q4 2019, this index (which is largely concentrated in just a handful of mega-cap stocks) is beyond steep and the result of indiscriminate chart chasing. This rally is now so steep that even the decade-long channel is being overcome as QQQ blew out above it in recent weeks.
Through the lens of just about any metric I can come up with (technical, structural or fundamental), this group of stocks is in very dangerous territory and in need of a mean-reversion lower.
On the daily chart the picture is no more sane than that of the longer-term chart. Here we see that the QQQ ETF is currently trading about 6% above its yellow 50-day simple moving average. Pretty much any momentum oscillators such as the daily MACD at the bottom of the chart are in historical overbought readings.
Trading QQQ
Active traders and investors could look to short QQQ in the $223 – $225 area. A first downside target is the $218 and a second target would be a revisit of the yellow 50-day moving average, which currently trades around the $210 area.
Options traders could take advantage of the still very low implied volatility and buy at the money bear put spreads, utilizing March expiration options.
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