After holding a stock for a while with gains, the next swing trading question is where do you exit? Sometimes we sell into strength to get out while the going is good. Other times we might sell on weakness when it looks like a turn is happening. A downside reversal is a sell signal where you see both elements of strength and weakness in the same day, which we saw this week in the FAS financial ETF.
With all the focus on technology, it might be surprising how well financial stocks have done. Following the Silicon Valley Bank blowup, financial stocks weren't an obvious investing choice.
But looking at the Direxion Financial 3X Bull ETF it ran up 50% from the Nov. 1 follow-through day to a short-term top on Jan. 8.
After that kind of move, it was natural for a break and FAS stock pulled back to its 21-day line where it bounced strongly (1).
What Is A Downside Reversal?
After nine days up in a row, we saw a downside reversal on an outside day (2). What does that mean?
The stock rose higher than the previous day and also fell below the previous day's low to make an outside day. When it also hits highs but can't hold them and instead closes low in its trading range, that's your downside reversal. It's especially relevant when there is a lot of price discovery on the day, meaning a wide spread between the high and low. Why is it important?
Usually weakness follows that type of action. It suggests that more traders were interested in booking profits than building up positions. And for all the price discovery, the stock settling near the day's low suggests where investors are leaning. But keep in mind, that expectation is not a guarantee. Some stocks are so strong, they can shake off a downside reversal and quickly go higher.
In the case of FAS, it went sideways for a couple of weeks after its downside reversal. But it did get support at its 21-day line twice.
When it broke out of that short consolidation on Feb. 15, we added it to SwingTrader (3). We went with the 3x leveraged ETF to get more of the potential return that a stock provides rather than the typically watered down returns of an ETF. This was also discussed in our previous articles on the Direxion 3x Bull Retail ETF and the Direxion 3x Bull Healthcare ETF.
An Early Gain And Early Stumble For FAS
After a quick digestion of the strong entry day, FAS popped higher again (4). We took the opportunity to lock in a third of the position with profit. It helped.
Two days later we saw another downside reversal on an outside day (5). But notice that the spread was not as wide on this one. Just 3.8% vs. 5.6% from our earlier example. That suggested the momentum down wasn't as strong. Indeed, FAS quickly found support just below its 5-day moving average line and closed above it (6).
The financial ETF continued trending along its 5-day moving average line from there.
Another Downside Reversal Marks The Exit
We held through the prior downside reversal but ended up exiting on the next one (7). In this case, FAS had another downside reversal on an outside day. The spread was a bit larger at 4.9%. Plus we had extra distribution piling up on the indexes, breadth narrowing and more stocks looking extended. It was also our 20th day holding FAS and our gain was over 12% from our entry. Rather than getting greedy for further gains, we took the downside reversal as our signal to exit.
We could get support around 100 here but it's likely to need some time before it gets roaring again.
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.
