One of the basic principles of profitable trading is to do more of what is working and less of what is not. Bending this theory into action can at times be confusing, but one approach is to focus on which stocks have been strongest and position for the ride.
For the investments my weekly newsletter EPIC Insights, I often look for items that have traded strongly and then follow the trend higher. However, I hate rushing into items that have experienced sharp moves that are unsustainable. Instead, I would rather find an item that is exhibiting strength and slashing through technical barriers, yet has lagged its peer group. When we find such an item, we enjoy the benefits of both strong bullish trends and mean reversion. One of these is enough for a trade, but add them together and the idea becomes even better. This week I have found something that meets all of these criteria-the FTSE 100 index.
The FTSE is a capitalization-weighted index of stocks that trade on the London Stock Exchange. Like nearly every major stock index, the FTSE has had a wild ride over the past year. Since the United Kingdom (UK) faced many of the same troubles that plagued U.S. markets (poor lending standards, excessive leverage), it is not surprising to have seen the FTSE collapse from a high of 6,732 in June 2007 to a panic low of 3,512 in March (red line). Since then, the recovery started tepidly, but has since gained speed.
Focusing solely on a graph of the FTSE's price from the March panic lows, we see an interesting pattern that speaks to further gains. Great bull markets usually operate in a staircase fashion with sharp gains leading to a consolidation pattern which eventually leads to more gains. The FTSE has done just that as each rally (black line) consolidates into a tight trading range (green dotted lines) which then leads to another rally. With the FTSE in the midst of a prolonged rally that launched from a trading range in July, the trend is clearly higher.
Since the shorter time period encourages us to buy the index, I would like to see other factors that encourage this action as well. Returning to the longer-term chart, two items offer support. First, the FTSE has recently traded above its 50% retracement level (green arrow). Bear market rallies usually regain 50 to 63% of prior losses, and the fact that the FTSE closed above this resistance point now encourages me that the 61.8% retracement is the next price target. Also, the FTSE has lagged nearly all international indices this year and still remains below its 200-day moving average (MA). Just as nearly every other index has reclaimed its 200-day MA, the FTSE will quickly do so as well.
Believing the U.K. markets will continue higher, we should buy the shares. I will use an ETF that tracks that market-the iShares MSCI United Kingdom Index Fund (EWU). To profit from a move toward the 200-day MA, I recommend a position in EWU as this week's technical trade. Close the entire position if the FTSE trades below 4,750.
Note: At the time of this article, I am long EWU.