Why An S&P 500 Index ETF Trade Made Sense In This Market

While the stock market doesn’t produce guarantees for trading, we like to get as many things working in our favor as possible. Strong action in the stock market indexes, like the S&P 500, is just one part of the equation. You also want to see stocks setting up with low-risk swing trading entry points. It’s been tough getting those criteria to line up.

It’s a big reason why our exposure in SwingTrader has been low for most of the year. Here’s where we are focusing now.

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Was The Bearishness Excessive?

Though the S&P 500 has been stuck under its 200-day moving average line for most of the year, that doesn’t mean there haven’t been tradable rallies. March and July were two examples. Since then, rallies in August (1), the beginning of September (2) and beginning of October (3) all failed in under a week.

By the time the last Consumer Price Index (CPI) report came out hotter than expected (4), bearish sentiment was historically high. Oversold levels on the S&P 500 and other indexes seemed unsustainable. The quick bounce after the bad news on the CPI report might have been expected, but it was hard to know how long it would last.

Taking advantage of the bounce offered another problem: The strength of the bounce largely came from the most beaten-down stocks. Those are not exactly prime candidates for swing trading. That was why a market index seemed like a better place to start for exposure. But we also wanted to see a follow-through day to confirm the strength of the rally.

Why The S&P 500?

The fourth day of the rally attempt (5) nearly qualified but didn’t quite have the power necessary. Especially with the higher volatility, the day just didn’t stick out on the S&P 500 or Nasdaq composite as unequivocal buying. It still seemed hesitant.

But a few days later, we got strong price action and accompanying volume (6). There were a couple of individual stocks added to SwingTrader early in the session, like Cummins (CMI) from last week’s swing trading column. At the end of the trading day, we capped off our buying with a leveraged version of the S&P 500 for added exposure. The ProShares Ultra S&P 500 ETF (SSO) basically doubles the action of the S&P 500 on a daily basis.

Why not the Nasdaq composite or another stock market index? The S&P 500 offered two benefits. First, since we compare performance vs. the S&P 500, the leveraged ETF gives us a strategic benefit when our exposure is low. If the stock market falls, our low exposure is still going to keep us ahead of the S&P 500. If the stock market rises, the low exposure will cause underperformance but the leverage helps narrow the gap with our benchmark index.

While the Nasdaq might have offered a bigger bounce since it has punished more severely, the ugliness of many charts in the tech space still gave us pause. At least the S&P 500 offered more exposure to energy stocks that were outperforming.

We also had the problem of a lack of setups. Good stock picking gives you a greater edge over a stock market index but we didn’t have a large number of stocks to choose from with good swing trading setups. Some of the better looking setups got disqualified because they didn’t have volume behind their moves up or they had earnings coming too soon.

Taking Profits Quickly

Though the prospects of a strong bounce are there, the S&P 500 also faces many obstacles. Prior resistance from previous rallies, the 50-day moving average and eventually the 200-day moving average all could be brick walls on the path of the index.

That made the case for sticking with our strategy of taking profits quickly. Our first third came off with nearly a 5% profit (7). That also coincided with reaching a significant hurdle in the 50-day line.

The S&P 500 pulled back shortly after but seemed to get support at the 5-day moving average line before taking another jump above its 50-day line on Friday. That strength is letting us stay in the trade for now and ride it for a bigger gain.

More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on Twitter at @IBD_JNielsen.

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