What do you do when the market is so overbought that you can’t bring yourself to buy anything, but not so overbought that you feel comfortable running out and shorting everything?
What I do during periods like this is create a shopping list of items I’d like to own on a pull back. In my opinion the best way to play pullbacks are through sector ETFs. An ETF is like a sector mutual fund but it trades just like a stock. You can short them, buy them, and even trade options on them.
The advantage of an ETF is that you can get pinpoint exposure to any sector of the market you wish. This allows you to virtually eliminate individual company risk, which is a big deal for individual investors, who are sick and tired of the volatility of the “hot stock” being touted on TV.
When looking to buy in on a pullback you want to look at sectors that have been performing better than the overall market. While they may pullback further than the market, they will also bounce back further. We manage our risk by always using a stop loss.
Generally speaking, leadership sectors, that is, sectors that are outperforming the broad market, will go down less than other sectors on a pullback and will rise further on a subsequent rally.
There are two sectors I want to put on your radar that have been significantly outperforming the broad market as measured by the S&P 500. The first is the pharmaceutical sector.
PowerShares ETF Trust Dynamic Pharmaceuticals Portfolio (PJP)
This ETFs performance has almost doubled the performance of the S&P 500 over the last 6 months. Each share gives you exposure to some of the biggest names in Pharmaceuticals.
This ETF currently trades at $37.50 with a 1.48% yield. Look for a pullback to $34 before being a buyer and use a stop loss of $32 with a price target of $40-$42.
The second ETF is also in the medical space but on the Biotech side. Like PJP this ETF has almost doubled the return of the S&P 500 over the last 6 months.
iShares Nasdaq Biotechnology Index Fund IBB
This is an excellent ETF for gaining exposure to the notoriously tricky Biotech space. This is where ETFs really shine because we don’t have to become experts in Biotech in order to profit from moves in the space!
IBB will give you exposure to all the names that matter in the sector as you can see in the table below.
The ETF is currently trading at $145.50 and is not a buy yet. Use a move to $134 to put on a position along with a stop loss of $125 and look for a price target of $165. Remember, ETFs are your single biggest friend when it comes to making money in the stock market. They reduce risk by increasing diversification and are much cheaper and easier to trade than a similar sector mutual fund.