Thursday, January 3, 2013

These Could Be the Best Long and Short Trades in the World for 2013

One of the keys to successful trading is to find value stocks. Another key is to understand which markets offer better short trading opportunities. This week we look at which countries are the most promising buys and shorts in 2013. Next week, we'll turn our attention to which sectors are the most attractive trade candidates.

The end of the year always brings a wealth of research reports about which stocks performed the best and worst during the past 12 months. Other reports are published offering opinions about what the year ahead will look like. We prefer to avoid speculating about the future and favor using data to identify high-probability trading opportunities. To us, looking ahead starts with a look at the past to find the strongest stocks or ETFs with good fundamentals.

This is measured with relative strength (RS). We compare the performance of all stocks and ETFs over the past six months and rank each one from 0 to 100 with higher numbers showing the biggest winners from the past. A number of studies show that trends tend to continue and strong stocks often beat the market over the next six months.

One of the ways we look at fundamentals is with the PEG ratio, which is found by dividing the price-to-earnings (P/E) ratio by the earnings growth rate. Value stocks generally have PEG ratios under 1 and stocks with high PEG ratios often make great short trades.

The table below summarizes the strongest and weakest stock markets around the world. PEG ratios are calculated based on data published by Citigroup. A representative ETF for that country is also shown, but the PEG ratio is not based on the holdings of that ETF.

Country ETFs
Based on RS and value, country ETFs Global X FTSE Greece 20 ETF (NYSE: GREK) and iShares MSCI Poland (NYSE: EPOL) are "buys."

Using only these values, iShares MSCI Ireland (NYSE: EIRL) and iShares MSCI Spain (NYSE: EWP) should be watched as potential short trades. Traders should usually enter a short position only after an ETF starts to break down with RS falling below 80. EIRL is thinly traded and a short trade in this ETF would be highly risky unless volume increases.

GREK began trading in May 2012, and the short trading history makes any trade in this ETF risky. However, by any measure, Greece is in a bear market and could be a turnaround trade. The Athens Stock Index is about 84% below its 2007 high. The economy has contracted in each of the past five years and is expected to continue contracting in 2013.

Traders often say the time to buy is when the news is at its worst. While Greece has been the source of ever-worsening news for years, that trend will reverse one day. Until it does, the 10-day moving average could offer a useful guide for traders.
GREK Chart
We can analyze EPOL more effectively. RS is high, prices are in an uptrend and the stochastics indicator is bullish. This ETF has recently broken out of a year-long trading range. Buying on a new short-term high at $29.70 could provide a gain of 22% if EPOL reaches the price target of $36.20, which is based on the depth of that trading range.
EPOL Chart
A trend reversal would be signaled if EPOL breaks below the trendline, which would happen on a move below $26.67. The stop-loss level will rise over time as the trendline is extended.

Turning to the best short trade among country ETFs right now, iShares MSCI Taiwan (NYSE: EWT) appears to be the most profitable opportunity. Taiwan is the fourth most overvalued country using the PEG ratio to define value, but it is the only one of the most overvalued countries with a bearish chart.
EWT Chart
EWT was stopped by resistance at the upper limit of a year-long trading range. A decline to support at $11.50 would offer traders a potential gain of about 14%. Options are available on EWT, which makes this a low-risk trade based on the dollar amount required to benefit from a possible decline.

Put options with an exercise price of $13 expiring in June are trading near $0.67 a share. They would be worth at least $1.50 if EWT reaches the price target of $11.50 for a potential 124% gain from current prices.

Entering 2013, traders looking for global market exposure should consider buying EPOL and buying puts on EWT. This strategy is likely to benefit in a bull or bear market over the next six months.

Recommended Trade Setups:
-- Buy EPOL with a buy-stop order at $29.70
-- Set stop-loss at $26.67
-- Set initial price target at $36.20 for a potential 21% gain in 6-12 months
-- Buy EWT June 13 Puts at $0.90 or less
-- Do not use a stop-loss
-- Set initial price target at $1.50 for a potential 67% gain in 6 months

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