The stock market is having one of the worst starts to the year on record. On SwingTrader, we had a great start by mostly staying in cash. One of the standout areas of strength amid the destruction is in oil stocks. Swing trading a leveraged Energy Select SPDR ETF (XLE) position at the start of the year helped extend our gap of outperformance.
Know What You Are Getting Into With Leverage
Of the 11 sectors tracked by S&P 500, oil stocks stick out for their power so far this year. While the S&P 500 is down nearly 10%, XLE is up nearly 20%. That’s a barrel full of outperformance.
We took advantage of that with an early position in energy stocks to start the year. Rather than going for XLE, however, we went with a leveraged position. The Direxion Energy Bull 2X ETF (ERX) seeks to double the performance of XLE on a daily basis.
A few risks to keep in mind for these ETFs. First, any leveraged ETF is designed toward short-term moves. In the long term, you can stray far from the double depending on its trend.
Second, it’s important you recognize that leverage works both ways. It’s great when you are right on the direction as your gains come faster. Not so much fun when you are wrong. Your losses come quicker too.
Finally, it’s always a good idea to know the makeup of an ETF before you buy. XLE has very heavy weights in Exxon Mobil (XOM) and Chevron (CVX) — more than 20% weight in each. That means that moves in those stock will show up more in XLE and especially the leveraged version with ERX.
XLE Shrugs Off Correction
The Nasdaq composite topped back in November, but you wouldn’t know it looking at XLE. We took a position in ERX on the first day of trading for the year (1). It was breaking a downtrend, getting back above the 50-day line, the relative strength line moved to new highs and there was an uptick in trading volume.
As good as everything looked, we still had a weak market to contend with. That plus the leveraged position gave us incentive to take profits quickly into strength.
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We took our first third profit the next day, already achieving a 5% gain (2). Early in the session the following day, we had a 10% gain from our entry and took another third (3). The leveraged XLE position was paying off. By contrast, the Nasdaq composite fell nearly 5% over those two days.
It didn’t stop there. Oil stocks continued to buck the trend and the leveraged XLE was supercharged. With a good portion of profit locked in, we gave it room to run and on Jan. 11 saw nearly a 7% gain in a day (4) followed up by almost a 5% gain a few days later. In just over two weeks’ time, we had more than a 30% gain from our entry (5). All with very little ground given up as the leveraged XLE position held its 5-day moving average line the entire way.
Making Our Exit
That still didn’t mean we wanted to hold our XLE exposure forever. With that much profit, we didn’t want to give it all away. We put a line in the sand at a 20% gain from our entry and when that was breached, we exited (6). That also ended up being the first close below the 10-day line since our entry.
If we tried to hold and wait for a bounce, the drop of over 7% the next day didn’t offer any solace (7). A day like that could easily shake you out of a position. The early sells helped avoid a late sell.
Sure, you can look at the bounce (8) in ERX and say the sell was unwise. But the risk of overstaying our welcome was greater than the expected reward after such a big move in XLE. The light exposure overall, and being right on the counter-cyclical trend, still gave us a large cushion over the market. No need to get greedy.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on Twitter at @IBD_JNielsen.
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