From the July 01, 2008 issue of Futures Magazine • Subscribe!

Trading ETFs with round numbers

Trading tools do not have to be complicated. Indeed, anecdotal evidence suggests that if you can count by whole- and half-dollar increments, you have a solid basis for tracking intraday movements in several markets. These levels often identify market price turning points in certain exchange-traded funds (ETFs). Using this knowledge is one more way to anticipate support and resistance and improve your trading.

One reason for this phenomenon could be that small and large traders alike find that placing orders at a 50¢ or $1 level is easier on the brain. Perhaps it’s a form of groupthink, wherein what’s convenient manifests itself as a dynamic of the markets as a whole.

Of course, the groupthink argument might logically follow from the adage that stop orders are predominately placed at round numbers. That this tendency is stronger for retail-oriented investment vehicles, such as ETFs, makes sense.

That said, although it’s consistent enough to provide trading insight, the whole- and half-dollar resistance levels are not immediately apparent, nor are they magical price levels that work in all situations. As all indicators so far discovered by the trading community, the concept works only some of the time. However, once you start paying attention, you’ll quickly discover that this tendency is reliable enough to serve as a serious building block to any ETF trading program.

HALF-FULL DOLLAR

Half-dollar and dollar levels are porous indicators. Price can run through a 50¢ or $1 level before being stopped by the next 50¢ or $1 level — or the next. Granted, it’s a slight tendency. If you are a glass-half-full trader, you might think, “OK, this indicator could be interesting.” If you are a glass-half-empty trader, you might think, “time to move on.”

Starting on April 21, a five-day log of the following ETFs was started: QQQQ (Nasdaq 100), SPY (S&P 500), SMH (semiconductor), RKH (regional bank), RTH (retail), IYM (basic materials), OIH (oil services), TLT (long-term U.S. interest rates), FXE (euro currency), GLD (gold) and USO (crude oil).

“Top down” indicates how often price found resistance at a half- or whole-dollar level for each ETF during the test period. “Bottom up” (below) shows how often price found support at a half- or whole-dollar level. A “W” in each table indicates that the day’s high or low for the indicated ETF was within 10¢ of a whole-dollar level. “H” indicates that the day’s high or low for the indicated ETF was within 10¢ of a half-dollar level. These results do not take into account how often a market hit a half- or whole-dollar level, then reversed or churned until the close.

It’s also helpful to see a graphic representation of this tendency. “Five days in April” shows a series of one-day charts for the QQQQ for each day of the test period. The charts allow us to visualize how often QQQQ, in this case, found resistance or support at a half- or whole-dollar level. The time period for each chart is the regular trading period for the New York Stock Exchange, 9:30 a.m. to 4 p.m. (Eastern).

The week of April 21 starts off with the QQQQ ETF finding support at $46.50 and resistance at $47. On Tuesday, support manifests at $46, while we hit resistance the following day at $47. As the week wraps up, $46.50 appears to be a significant price point, as both Thursday and Friday see support at this level.

Also note that these charts depict linear regression channels, which are extremely helpful at providing a sense of order to even volatile trading days. (For more information on linear regression channels, see “Market relationships key to price moves,” Futures, December 2007. Subscription required.) A moving average also is included to smooth out some of the short-term price fluctuations found on intraday price data.

DIGGING DEEPER

Taking this concept further, there are a number of ways you can apply the whole- and half-dollar bias to different trading approaches and styles.

For futures traders, they should consider keeping an eye on the equivalent ETF. For example, if you trade E-mini Nasdaq 100 futures, keep a chart of the QQQQ up alongside the NQ. If you trade crude oil, then try watching CL or YC alongside USO. Watching the equivalent ETF, and taking note when it approaches a whole- or half-dollar level, particularly one that has been significant in the past, can give you a heads up when and where your futures may hit resistance or support.

If you trade futures, stocks and ETFs, you can use an upside leader or a downside leader to give you advance warning when a broad rally or a broad break may be running into resistance or support. If a leading ETF, for example, looks like it may reverse on a half- or whole-dollar level, get ready to see the followers reverse, no matter where they are at the moment.

A leading stock or ETF can increase the success rate of the half-dollar/whole-dollar indicator. If a leading ETF, for example, reverses on or churns along a half- or whole-dollar level and impacts several stocks and ETFs, it is arguable that all the stocks and ETFs effectively reversed on or churned along that half- or whole-dollar level. The indicator becomes, effectively, a higher order indicator.

Remember, if price runs through one half-dollar or whole-dollar level look to the next level, and so on. Take a handful of stocks or ETFs that you follow. Keep a five-day log. See for yourself how well the half-dollar whole-dollar indicator works.

Often the best core rules come from the simplest ideas. The trick is to have a clear understanding of the method you are using, taking the time to learn its intricacies and not diluting its effectiveness by layering on an over-abundance of conditions. The whole- and half-dollar concept is about as basic as they come, but for retail-oriented trading vehicles, such as ETFs, it could be an important and profitable concept. You probably can’t build a stand-alone strategy off of it, but it can help improve overall performance, which could be the difference between profits and losses.

Richard L. Muehlberg uses linear regression channels and intermarket analysis to day-trade his own account. He publishes a day-trading diary on his Web site www.DayTradingWithLinesInTheSky.com. E-mail him at richardmue@yahoo.com.

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