Not every moment is a worthwhile time to trade. Depending on the strategy employed, the current price falls on a spectrum between between great entry point and horrible entry point. When the price is trading near a great entry point, that is obviously best, while a good entry is also acceptable if the potential reward still outweighs the risk. This is why watching price action is important, as it highlights those potentially good or great entry points.
Let’s start with the VanEck Vectors Russia ETF (RSX). After pulling back for most of 2017 from a prior uptrend, late August has seen the price surge, ending the pullback phase. From a longer-term perspective, the price could be commencing another major wave to the upside, which could unfold over the next several months to a year. The price was recently moving in a channel, which it has broken out of, providing an upside target of $23.50 or above. For an entry, catching a small pullback into the $20 region would be good, while an entry up near $21 (further away from the breakout) is not as good. This is because a stop-loss order can be placed below $19.50, so the difference in entry points dramatically affects the risk/reward of the trade. (See also: An Active Trader’s View on BRIC.)
The Technology Select Sector SPDR Fund (XLK) has been consolidating for most of July and August. On Aug. 30, the price jumped 0.72% to close at $58.48. That is equal to the Aug. 16 intraday high. A closing price above $58.48, especially on a strong upside day, would signal a breakout from the consolidation and at least a short-term rally. The target is the top of the rising channel, near $62. The closer the entry point to the breakout, once it occurs, the better. Buying near $60 leaves little room before hitting the profit target, while purchasing near $58.50 leaves more room. With a stop-loss placed below $56.50, the lower entry provides a superior risk/reward ratio. However, it is worth noting that the risk/reward still is not ideal. The profit potential is just slightly larger than the risk. A good entry does not always mean the trade is worth taking if the risk/reward is not good. The pattern can also be used by those already in trades, as it provides an idea of where to look for an exit and potentially the level at which to trail the stop-loss. (For more, see: Two Sector ETFs to Buy in an Accelerating Economy.)
The VanEck Vectors Semiconductor ETF (SMH) has also been consolidating for the past month and a half, just slightly below the June high of $89.72. Drawing a trendline along the swing highs of the consolidation reveals that the price broke out on Aug. 30. The breakout point was $87. Following prior breakouts in this long-term uptrend, the price has typically run between 8% and 14% higher. Using the 8% figure, the upside target is just below $94. Ideally, a stop-loss is placed below $84, but it could be placed near $85 to improve the risk/reward (although this would increase the chance of being prematurely stopped out). Once again, slight alterations to the entry and stop-loss can significantly affect the risk/reward. (For more, see: Top 5 Semiconductor ETFs.)
The Bottom Line
RSX broke out of a large pattern recently, and depending on the entry point, the ETF may present a high reward-to-risk opportunity. XLK and SMH offer upside potential, but whether or not the trade is worth taking depends on the entry and stop-loss levels. If the reward does not justify the risk, the trade should be skipped. Risk/reward ratios utilize a profit target, which is a way of assessing trades as part of a strategy and is not meant to be a predication of exactly where the price will go. Losing trades happen, so it is important to risk only a small portion of account capital on any given trade. (For additional reading, check out: Strategies to Trade the Risk-Reward Equation.)
Charts courtesy of StockCharts.com. Disclosure: The author does not have positions in the ETFs mentioned.