Exchange-traded funds, or ETFs, are securities that comprise multiple equity shares or other commodities. The most common way to trade ETFs is by using fundamental analysis. However, contrary to popular belief, other analysis methods work excellently on ETFs too. But, does technical analysis work on ETFs?
Technical analysis does work on ETFs. Through technical analysis, investors can get a real-time perspective of how well an ETF is doing. Using technical analysis is a valuable tool to determine when to purchase or sell an ETF. Stick to 50-day and 200-day Lines for the best results.
This article will explain why technical analysis can work on ETFs. Also, we’ll describe the most popular technical indicators that expert investors use when trading ETFs.
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Table of Contents
Why Does Technical Analysis Work on ETFs?
An ETF is an asset that consists of multiple securities, including stocks. Given that technical analysis can apply to various securities, it can accurately predict the price patterns of an ETF.
Besides pinpointing buying and selling opportunities, many traders use technical indicators to investigate the current status of an ETF. Price movements reflect current sentiments towards the index. While this method is not always completely accurate, the information gathered is usually substantial for investors to make more precise judgments.
Many agree that investors shouldn’t rely solely on technical analysis. Instead, investors should combine technical analysis with some fundamental analysis to reduce their risk even further.
But this isn’t admitting that technical analysis can’t be profitable on its own because it can make investors a lot of money when done correctly.
Are you more comfortable using technical analysis for trading? Then, consider using indicators proven to work well with ETFs to guarantee the best results.
What Are the Best Technical Indicators To Use on ETFs?
Technical indicators are the result of mathematical formulas which provide insight into the status of the market. In some cases, these formulas are complex and are best used by expert traders when dealing with ETFs. On the other hand, there are simple indicators that most traders prefer.
The following indicators are some of the best technical indicators to use when trading ETFs:
Moving Averages
Moving averages are the most basic indicators investors can use with an ETF. It provides the support levels of an ETF during a pullback to pinpoint buying opportunities.
In short, the moving average is the mean price of the ETF over a set period. Traders can calculate this number using any time they prefer. By calculating the moving average of an ETF, the impact of short-term price changes is decreased.
To determine the moving average, add a stock’s prices over a certain period. After that, divide the sum by the total number of periods. For example, if you tracked an ETF’s minimum price for five days, the sum of all five days should be divided by five.
For ETFs, investors often use 50-day, 100-day, or 200-day charts to understand the moving average of the price that it is trading at. Any crossovers among these moving average lines indicate bullish movement and potential buying opportunities, or a bearish movement and potential sell opportunities.
While you may choose to use your preferred moving average, studies indicate that investors find the most success when using the 50-day and 200-day moving average to formulate their technical analysis strategy for ETFs.
How To Use 50-Day and 200-Day Moving Average Lines?
The 50-day and 200-day moving average lines are the most widely watched moving average lines by technical analysts.
To draw a 50-day or 200-day line, you must select the option in your trading program. Usually, you can choose the “indicators” or “strategies” menu inside your trading app and search for moving averages. Once selected, the program will automatically display the line for you. Afterward, you can then change the time length to 50 or 200 days.
Alternatively, you can manually draw the line using your calculations.
It’s easier to determine when an ETF is in an uptrend based on how it trades using both lines.
Now, say an ETF is traded above the price of the 50-day and 200-day lines. When that happens, there’s a strong uptrend that investors can use to their advantage. In contrast, when the price drops below these lines, the ETF is on a downtrend.
Relative Strength Index
The relative strength index, or RSI, measures the momentum of the ETF’s price. Generally, this rating is calculated over a 14-day or 52-week period and given a number between 0 and 100. Readings below thirty are considered oversold. In contrast, a rating above 70 is deemed to be overbought.
Investor’s Business Daily suggests focusing on ETFs with an RSI of 70 or above to increase your chances of making a profit.
Calculating the RSI is a two-step process when you’re doing it yourself. But most trading platforms have this indicator available under the strategies section for your convenience.
Chart Patterns
Using chart patterns to trade ETFs relies heavily on accurately placing your trend lines. Usually, these are lines that consecutively connect the highs or lows of a price chart.
Once they can establish a trend line, the investor can trade ETFs using these lines to their advantage. Often, the lines will reveal:
- Resistance levels
- Support levels
- Pullbacks
- Trend shifts
Every investor draws their trend line differently, but there are guidelines that new ETF traders can follow when developing their trend line strategy.
Trading Volume Indicator
The trading volume indicator is a measure of how much an ETF has traded in a given period. Some investors note that the trading volume is not essential to ETFs, but it’s worth investigating.
You can find the trading volume on your trading platform or your broker’s website.
An ETF with a low trading volume is likely to have a wider bid-ask spread. This spread is the difference between the best price offered and the price that the company is willing to accept.
Wide bid-ask spreads usually reduce your profits, so you should approach low-volume ETFs with extreme caution.
Accumulation-Distribution Indicator
The accumulation-distribution indicator shows whether institutional investors are trading ETFs. It uses a scale ranging from A to E. An A ranking indicates that big investors are buying the ETF. On the other hand, an E rating means that the large investors are selling the ETF instead.
You can’t calculate this rank. Luckily, investors can receive this rating from their broker or on their trading platform.
Notably, a high rating doesn’t necessarily mean that the price is rising. Also, a low ranking doesn’t mean that the price is falling. Therefore, it’s best to use this indicator in combination with another.
Also, the accumulation-distribution signals can only apply to liquid ETFs. It’s not a good idea to use these on non-liquid securities.
What Are Strategies for Trading ETFs With Technical Analysis?
The Exchange Traded Funds Database suggests that investors experiment with multiple time frames when interacting with ETFs. Use the different time frames to develop your trend lines and place any other indicators.
Following this placement, look for trendline breakouts. This beginner-friendly method helps new traders because a trendline takes minimal effort and is easy to understand.
Many traders prefer using complex chart analysis like:
- Wave principle
- Dow Jones principle
- Head and shoulders
- Triangles
- Double tops
If you are looking for a more detailed strategy, then the previously mentioned techniques may suit you better.
What To Avoid When Using Technical Analysis on ETFs?
You’ll want to be mindful of several things in your technical analysis to avoid losing money. The most significant thing to do when trading ETFs is checking for the black cross.
The black cross is a term that describes when the 50-day moving average falls below the 200-day line. When an ETF’s price drops below this line, the ETF is likely failing on the market, too. Look for this line before moving into other areas.
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Conclusion
Trading ETFs using technical analysis is very common, and some traders prefer this method to any other investigation tactic. However, there is no way to guarantee a profit on the stock market. Still, technical analysis can improve your chances of finding great buying opportunities for ETFs.
Are you new to ETF trading and want to know more about how technical analysis can help you? If so, Joseph Hogue has a video on ETF trading strategies using technical indicators:
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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