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April 2, 2012, 12:01 a.m. EDT
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David Penn is Editor in Chief of TradingMarkets.
By David Penn
With the impressive performance of the stock market in the first quarter of 2012, how wary of a significant correction should traders and active investors be as we move into Q2?
It's worth remembering a few things. First, the stock market corrected fairly sharply not too long ago in the fall of 2011 "” 19% from April peak to October trough "” and traders need to be careful of not fighting the last war when it comes to anticipating this year's potential for a spring setback.
Second, and related to the first, is the idea that markets only do one of three things: go up, go down, or go sideways. If you have strategies in place to take advantage of as many of these conditions as possible, then you have the potential to successfully manage your money through the majority of what any market will ever bring.
This is why short-term, mean-reversion trading is such a popular active investing strategy for a growing number of independent traders. The quantified approach of buying short-term weakness in overall uptrending markets has performed well in both rising and sideways markets. And by adjusting the rules, more advanced traders can even take advantage of falling prices by selling short short-term strength in overall downtrends.
(Learn more about short-term mean reversion trading in the new, updated, 2nd edition of How Markets Really Work: A Quantitative Guide to Stock Market Behavior .)
What's clear is that there is a demand for US stocks that continues despite concerns over Europe and Asia. And as these concerns about growth in emerging markets and financial reform in Europe become more and more priced into the market, the less likely they are to provide surprising negative shocks in the context of an increasingly US-led recovery.
More about global growth concerns and emerging markets below.
Shifting gears, a turn to the upside in energy stocks in recent days has not lifted all shares, as both Valero Energy /quotes/zigman/186158/quotes/nls/vlo VLO -3.30% and Tesoro Corporation /quotes/zigman/243084/quotes/nls/tso TSO -1.25% retreated to new, two-week lows in Friday's session. Down three in a row and four in a row, respectively, both stocks are short-term oversold. And while it was Tesoro that earned the upgrade to "consider buying" status midway through trading on Friday in terms of stock rating, the edge is actually higher in Valero, at 1.75% in the short-term.
Similarly, the lagging ETF in the oil and gas sector is the S&P Oil & Gas Exploration & Production SPDR ETF /quotes/zigman/477969/quotes/nls/xop XOP +0.51% , which is still technically oversold as of midday Friday after pulling back for three days in a row. The positive edge in XOP, with the fund up fractionally late on the final trading day of the week, is just above a third of a percent.
For truly oversold ETFs, traders may want to consider the emerging markets. Here, funds like the iShares MSCI Brazil Index Fund ETF /quotes/zigman/264176/quotes/nls/ewz EWZ -0.34% and the iShares MSCI Hong Kong Index Fund ETF /quotes/zigman/260342/quotes/nls/ewh EWH +0.37% have closed in oversold territory for two or more days in a row, earning positive edges of more than 1% and upgrades to "consider buying" status based on their ETF ratings.
Domestically, any continued selling in the home construction/homebuilding sector will put exchange-traded funds like the iShares Dow Jones US Home Construction Index Fund ETF /quotes/zigman/1496092/quotes/nls/itb ITB -1.47% near levels where buyers have historically come off the sidelines to take advantage of short-term excessive selling. ITB currently has a positive edge of more than three-quarters of a percent.
Going back to where we started, every trader has their own method for getting into a position. But one of the most confounding decisions for most traders and investors is choosing a sound strategy for consistently getting out.
Ultimately, your goal may be to have different strategies with different entries and exits in order to help diversify your portfolio. But for now, if you are buying stocks and exchange-traded funds after they have pulled back and are wondering when is a good time to sell them, here are a few quantified and time-tested strategies for locking in gains.
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