When planning a trade, the goal is to find situations where you risk a little for a larger reward. Having this asymmetry at the start of a trade allows you to be wrong often and still make money.
But what happens in an extended stock market? The expected returns get smaller which means you have to make adjustments to your risk. You can take your chance with areas and stocks that haven't gotten as extended. Or you can make adjustments to your position to manage risk. In this retail ETF trade, we did both.
Time To Look Elsewhere?
The strong move in technology presents some swing trading challenges. As technology stocks lead this extended stock market, it leaves slim pickings for new setups. The risk of a pullback is large relative to the potential return. It might be all OK in the long run, but in the shorter time frame of swing trading the risk is too great.
Eric Krull shares his "Everest" signal to determine when a stock's peak is near.
Alternatively, you can look for other areas that aren't extended but still strong. These can offer new areas to explore. That's where Direxion Retail 3X Bullish ETF came on our radar. We'll often look to leveraged ETFs to let us participate in a group move but make the risk-reward ratio more like an individual stock.
And retail has had strength. From the Nov. 1 follow-through day, RETL gained nearly 100% to its December peak (1). Granted that was with triple leverage. It's important to note there is a downside there as well. Just look at the 10% drop at the start of the year for an example of that (2).
While many of the technology stocks bounced back quickly after the early year shake-up, the retail ETF was a little slower to do so. To its credit, it did hold at its 50-day moving average line (3). After finding support, it seemed 8.50 was an area of resistance (4).
Adjusting The Trade In Extended Stock Market
When the Nasdaq composite started pulling back at the end of January, testing its 21-day line, the RETL tested its 50-day line again (5). Once it cleared 8.50, we put the leveraged retail ETF on SwingTrader (6).
Being outside of technology, we could look at the base pattern as a fresh breakout rather than buying at an extended move. That helped boost expected return.
But we had to consider that the extended stock market still increased the risk. A lot of times when leaders falter, they bring down a lot of stocks with them — even normally uncorrelated stocks.
We also had to adjust for the leverage. Even though the leverage made the risk closer to what we would expect from an individual stock, it was still higher than desired. So we went with a half position or roughly a 6% weight.
A couple days after our entry and the retail ETF was bumping its head against its former December high (7). We had over an 8% gain and so we took a third of the position off to lock in profit.
That action saved the trade. The next day Shopify reported earnings and not only did it take technology down sharply but also retail (8). We exited that day as we fell below our entry. But the earlier profit taking left us profitable on the trade.
The adjustments we made for the extended stock market gave us a successful swing trade that we might have otherwise skipped.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on X, formerly known as Twitter, at @IBD_JNielsen.
