Pullbacks within Uptrends Create Opportunities

Stocks went on a tear from late December to early February with the SPDR S&P 500 ETF (SPY) advancing some 11% from low to high. SPY then pulled back last week with a 2.5% decline from the February 2 high to the 10-February 10 low. A pullback within an uptrend creates a mean-reversion trading opportunity and several ETFs matched our setup for such a trade.

The chart below shows the iShares Russell 2000 Value ETF (IWN) with such a setup. The first indicator shows the 100-day slope above zero, which means the trend is up. The lower window shows the five-day normalized rate of change (ROC) dipping below -2 on Thursday to become oversold. A setup requires both criteria (uptrend and oversold). I ignore oversold setups when the trend is down.

The exit signal is important for the success of a mean-reversion strategy. Short-term oversold conditions pave the way for a bounce, but not necessarily an extended advance. Mean-reversion exits are often based on the first bounce and the idea is to sell into strength. This strategy requires us to think outside of the box (buy weakness and sell strength).

TrendInvestorPro introduced a mean-reversion strategy for trading ETFs this year. The indicators aren't exactly the same as shown in the chart above, but they're similar. This strategy includes a selection process to rank signals, an entry procedure for setups, and an all-important exit strategy. This strategy is fully quantified with rules and a backtest for understanding the process. We also publish signals on a daily basis and regularly track results. Click here for immediate access.

Normalized ROC, the Trend Composite, Momentum Composite, ATR Trailing Stop, and seven other indicators are part of the TrendInvestorPro Indicator Edge Plugin for StockCharts ACP. Click here to learn more and take your analysis process to the next level.