When markets are volatile, buy-and-hold investors can feel the pain…
As soon as they get into a trending position, the stock turns around and bites them hard.
However, by using our mean reversion strategy, we profit when a trend unravels and snaps back the other way.
What’s more, we can apply this strategy in either direction.
Today, I want to show how we used our strategy to profit from the SPDR Euro Stoxx 50 ETF (FEZ). It had been bid up way too far.
While long investors were losing money, we generated a blended 35% gain for members of my options advisory, The Opportunistic Trader…
Looking for Diverging Patterns
In the chart of FEZ below, you can see its huge rally that began in October last year.
The Relative Strength Index (RSI) kicked things off. It made a double ‘V’ (red circle) and rose from oversold territory (lower grey dashed line).
Then the 10-day Moving Average (MA, red line) crossed above the longer-term 50-day MA (blue line). And both started trending higher…
SPDR Euro Stoxx 50 ETF (FEZ)
As you can see, though, the rally wasn’t all one-way traffic…
FEZ made higher highs in November through December (upper orange line at ‘A’). But the RSI (lower orange line at ‘A’) showed that buying momentum had plateaued in overbought territory (upper grey dashed line).
When buying momentum stalls like this, the rally will eventually peter out too… FEZ then started to retrace as the RSI tracked lower.
Then in January/February this year, we saw this pattern repeat… FEZ and the RSI again diverged (orange lines at ‘B’).
FEZ peaked on February 2 and then gradually drifted lower as the RSI trended down.
FEZ had already rallied nearly 50% from its October low (to February high). And our signals looked bearish. So we entered a short position by buying a put option on FEZ on February 24. (Note that a put option should increase in value when a stock price falls.)
As the chart shows, however, our position initially went against us. FEZ briefly counter-rallied over the following days.
Take another look:
SPDR Euro Stoxx 50 ETF (FEZ)
But the RSI continued to track lower. And FEZ soon rolled over and started to head down too…
FEZ then gapped down as the Credit Suisse news broke. That sent a wave of fear through the markets.
Credit Suisse bonds were trading at distressed levels, and credit default swaps in the banking sector went through the roof. This meant the European market’s fall was three times that of the U.S. market’s reaction.
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However, we saw the prospect that the European Central Bank (ECB) would come in to bail out Credit Suisse – much like the Fed handled the Silicon Valley Bank fallout.
So we decided to lock in a part of our profits by selling half our position on March 15 for a 42.1% gain.
Although it was the Swiss National Bank (not the ECB) that handled the bailout, this proved to be the right call…
As you can see, FEZ rallied higher the following day.
The remaining half of our position was still in good profit, and we didn’t want to hand any more of our remaining profits back at that point.
So we closed out the remainder of our position on March 17 for a 27.7% gain.
Altogether, that averaged out to a handy 35% blended gain over three weeks.
To be clear, we generated this level of return using options. Had we just shorted FEZ shares instead, our profits would have been lower.
However, by choosing the right stock and strategy, traders can make money… no matter what direction the market takes.
Editor, Trading With Larry Benedict
P.S. This past Saturday, I held a demo of my “lightning trades” strategy…
These trades typically occur in 24 hours or less. Yet even in that short window, we’ve been able to generate multiple 100% wins.
In 2022, we did this 245 times. And so far in 2023, we’ve done it another 100 times. That’s why this is one of the best income trading strategies I know of… We can profit even during volatile markets and bank collapses.
I’m sharing a rerun of Saturday’s event until midnight tonight… So if you weren’t able to tune in, don’t wait. Simply go right here to watch the replay.
Where do you think the banking industry is headed from here?
Send in your thoughts to [email protected].