Last Updated on April 19, 2022 by Quantified Trading
Why trade the XLU and utility stocks? Even though utility stocks are probably one of the most boring stocks, they offer diversification.
In this article, we discuss the consumer staple ETF XLU, why it’s a great trading vehicle, and why it might complement your other trading strategies very well. XLU is much less volatile than the other ETFs and it moves differently, thus it might provide a hedge.
Most traders like volatility, but sometimes a slow-moving trading vehicle might be preferred. Sometimes the best trading stocks are the most boring stocks. The ETFs XLP and XLU are both the most boring ETFs you can find. A few months back we discussed the pros and cons of using XLP trading strategies, and today we look at reasons why you should trade XLU.
XLU might not be the sexiest instrument, but that is exactly what makes it good. You want something that doesn’t have erratic moves, and both XLU and XLP offer something different than the other ETFs.
What is the ETF with ticker code XLU?
XLU was incepted in 1998 and is one of the oldest ETFs around. It tracks the utility stocks in the S&P 500. Utility stocks include water utilities, electric utilities, power utilities, gas utilities, and renewable utilities. However, electric utilities have by far the biggest weighting in the index.
All the holdings can thus be labeled large-caps and in a sector that is highly regulated. The latter means that most of the listed companies in the sector have a regulatory moat and very predictable businesses. Because of this, the volatility of the sector is pretty low both in terms of earnings and share price.
Balancing is done quarterly. The ten biggest components include NextEra Energy, Duke Energy, Southern Company, Dominion energy, Exelon Energy, American Electric Power Company, Sempra Energy, Xcel Energy, Public Service Energy group, and American Water Works Company.
We are pretty confident very few traders trade these companies, although many more might trade XLU. These names are probably among the most boring companies on the exchange!
But that is perhaps the exact reason why you should have a look at them?
Why XLU is a great tool to make trading strategies:
XLU moves differently than most stocks in the market. The components of XLU are no growth names and offer diversification.
XLU goes its own way
XLU correlates less with the S&P 500 than most other ETFs. The main reason for this is the regulatory moat that the utilities have. They are no growth stocks, but are, of course, dependent on the interest levels. Furthermore, they are sometimes a “safe haven”.
Short trading strategies might work on XLU
In the stock market, very few short strategies work well on the short side. XLP and XLU are two of the few instruments that work on the short side.
Low volatility reduces the chances of ruin
Because XLU has less volatility, you are less likely to have sudden adverse movements. Typically, the average winner is bigger than the average loser and the win ratio is more than 50%.
However, because the XLP consists of low volatile cashflow generative companies, the strategy has not produced (yet, at least) very big losers.
An example of XLU strategy
A current trading strategy we are trading in XLU can serve as an example of the potential in XLU. This is the equity curve:
There are 164 trades, the average gain per trade is 0.78%, the time spent in the market is 15%, the win ratio is 63%, and the profit factor is 2.4. The strategy is a seasonal trading strategy plus an additional variable.
The good thing with XLU is that it is correlated less with the overall market. If we employ the same variables to the S&P 500 we get a pretty erratic equity curve and a profit factor of only 1.7.
The above strategy is our monthly Trading Edge for January 2022.
XLU and the utility stocks might be boring as hell, but they are excellent trading vehicles. We consider both XLP and XLU as low-hanging fruit. There are many reasons for why trade XLU and utility stocks.