Stocks went on a tear from late December to early February with the S&P 500 SPDR (SPY) advancing some 11% from low to high. SPY then pulled back last week with a 2.5% decline from the 2-February high to the 10-February 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 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 5-day Normalized 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 are not exactly the same as shown on the chart above, but they are quite similar. This strategy includes a selection process to rank signals, an entry procedure for setups and the 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.