Forget SPY, Trade Market Reversals with These ETFs Instead

by on October 13, 2014

Long-term investors aren’t the only ones to have embraced ETFs in recent years for their simplicity and cost-efficiency; active traders have also taken advantage of the exchange-traded product structure thanks to the unparalleled liquidity, ease-of-use, and sheer variety of instruments offering exposure to virtually any asset class around the globe [see also 7 Rules ETF Day Traders Must Know]. 

When it comes to total assets under the management as well as average trading volumes, the SPDR S&P 500 ETF (SPY) is unequivocally at the top of the list in the ETF universe. SPY boasts an average daily trading volume of around 100 million shares, making it a favorite among active traders who are looking for an easy way to move in and out of the market. 

Is SPY Your Best Bet?

Liquidity and popularity aside, is SPY really the most ideal trading instrument for those looking to maximize returns? That is to say, if an active trader identifies a market reversal taking place, should they run and buy SPY, or are there other instruments worth considering? Let’s start by taking a look at the most recent market reversals since the start of 2014 [see also 17 ETFs for Day Traders].

The chart below identifies the start of the three biggest reversals that have taken place this year in SPY, which occurred on February 6th, April 15th, and August 8th: 

spyreversals

Next, let’s see how SPY performed in the two weeks, or 10 trading days, following each of the “mini-bottoms” (marked with green arrows). Furthermore, let’s compare SPY’s return in the 10 days following these reversals to that of three other ETFs that have caught the attention of more and more active traders in recent months:

  • PowerShares S&P 500 High Beta Portfolio (SPHB): This fund offers similar exposure to SPY, but with a twist; instead of holding the 500 largest companies, SPHB only holds the 100 most volatile ones from this universe as measured by their beta, or sensitivity to market movements, over the past 12 months [see also S&P 500 ETFs: Comparing the "Twisted" Funds]. 
  • VelocityShares Daily Inverse VIX Short-Term ETN (XIV): This is the definitive “risk on” instrument as it offers inverse exposure to the CBOE Volatility Index, known as the VIX or the “fear gauge”; in other words, this ETF is designed to rise as uncertainty evaporates and confidence returns to the market. 
  • First Trust IPOX-100 Index Fund (FPX): This IPO-ETF is a “risk on” instrument as well, given that its underlying benchmark is comprised of U.S. companies that have recently gone public – specifically, those that are within their first 1,000 trading days after making their debut. 

Consider the returns comparison below spanning from February 6th through the following 10 trading days, ending on February 20th. Please note that SPY is marked in red, SPHB in blue, XIV in green, and FPX in pink:

reversal1

Next, let’s take a look at the rebound that took place from April 15th through April 29th:

reversal2

Lastly, consider the most recent reversal that took place on August 8th through August 21st:

reversal3

Considering that we’re only looking at the reversals that took place in 2014, our sample size is fairly limited. Nonetheless, there are two key takeaways here. First and most obvious, XIV has proven to be a stellar trading instrument for those capable of harnessing its inherent volatility; during each of the three market reversals highlighted in the above charts, XIV returned approximately (if not more than) four times as much as SPY [see also How Well Do Defensive ETFs Actually Work?]. 

Second, SPHB and FPX both managed to beat SPY’s returns in each of the market reversals. Though their returns pale in comparison to those of XIV, both ETFs deserve the title of “risk on” instruments seeing as how they are capable of outperforming the broad market whenever the bulls flood the Street. 

The Bottom Line

With over 1,600 ETFs available on the market, investors and traders alike have a plethora of choices when it comes time to building out their portfolios and strategies. When it comes to market reversals, active traders who are used to flocking to SPY, given its unparalleled liquidity, may want to consider looking into some lesser-known ETFs capable of delivering outsized returns. As always, be sure you thoroughly understand the risks and nuances associated with a product before making an allocation. For active traders, remember to use limit orders and practice disciplined profit taking.  

Follow me on Twitter @Sbojinov

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Disclosure: No positions at time of writing.