ETF Pullback Choices: Still in Worry Mode

by: Marc Gerstein

Last week, my weekly ETF Pullback strategy was all-energy. This week, it’s still energy heavy, but not as pure. Here’s this week’s list:

  • Index IQ Canada Small Cap (NYSEARCA:CNDA)
  • Guggenheim Canadian Energy Income (NYSEARCA:ENY)
  • First Trust Tech AlphaDEX (NYSEARCA:FXL)
  • ETFS Physical Palladium (NYSEARCA:PALL)
  • PowerShares Dynamic Energy Explor. & Prod. (NYSEARCA:PXE)

This was last week’s list:

  • iShares Dow Jones U.S. Energy (NYSEARCA:IYE)
  • PowerShares Dynamic Energy Exploration (PXE)
  • Vanguard Energy ETF (NYSEARCA:VDE)
  • Energy Select Sector SPDR (NYSEARCA:XLE)
  • SPDR S&P Oil & Gas Explor. & Prod. (NYSEARCA:XOP)

This is a technical approach that identifies ETFs that had been in solid uptrends but which experienced very recent pullbacks with the idea that the pullback is a pause or correction, and not the start of a significant reversal. (See Appendix below for detailed explanation and performance data.)

The energy angle, here, is clear: The uptrend was sparked by Middle East events and the pullbacks relate to glimmers of hope that political crises will be solved. Not surprisingly, this investment angle is taking more than a week to play out. It has, however, now been diversified a bit with exposure to palladium, an industrial metal that has taken on precious metal status and a Canada fund, which is heavily, but not completely, exposed to energy and precious metals. FXL, the technology fund, seems like an add-on.

Aside from the near-term trends being picked up by the model, we still have the long-term issues, the potential for crises to persist in the Middle East, in one form or another in one place or another, and the upward pressure on oil likely to be exerted by global economic growth.

As seen in Figure 1, a screen shot from the account I use to trade, the energy play did not work well last week.

Figure 1

(Click to enlarge)

We’ll see how it goes in the next go-round.


To create this model, I started with a very broad-based ETF screen I created in

  • Eliminate ETFs for which volume averaged less than 10,000 shares over the past five trading days
  • Eliminate HOLDRs (I don't want to be bothered with the need to trade in multiples of 100 shares)
  • Eliminate leveraged and short ETFs (I think of these as hedging tools rather than standard ETF investments of even trading vehicles)

Then I sorted the results and select the top 5 ETFs based on the StockScreen123 ETF Rotation - Basic ranking system, which is based on the following factors:

  • 120-day share price percent change - higher is better (15%)
  • 1-Year Sharpe Ratio - higher is better (15%)
  • 5-day share price percent change - lower is better (70%)

The idea of using weakness as a bullish indicator is certainly not new. But often, it's an add-on to other factors that, on the whole, emphasize strength. Here, the weakness factor is dominant, with a 70 percent weighting.

This model is designed to be re-run every week with the list being refreshed accordingly. I trade through, where I pay a flat annual fee rather than a per-trade commission, so I don't care about the fact that turnover form week to week is often 80%-100%. If you want to follow an approach like this but do have to worry about commissions, the strategy tests reasonably well with three ETFs, or even with one. (Cutting the number of ETFs is far preferable to extending the holding period.)

Figure 2 shows the result of a StockScreen123 backtest of the strategy from 3/31/01 through 12/30/10.

Figure 2

(Click to enlarge)

Figure 3 covers the past five years, a very challenging market environment that witnessed the fizzling of many strategies that had succeeded for a long time.

Figure 3

(Click to enlarge)

Disclosure: I am long CNDA, ENY, FXL, PALL, PXE.