Last Updated on June 19, 2022 by Quantified Trading
XLP is good for trading because it has few “sudden moves”, is very mean revertive, it has potentially many profitable short strategies, and it offers diversification because it moves differently than many of the other stock ETFs, thus providing a hedge.
The headline of this article, is XLP good for trading, deserves a big “yes”. This article argues that XLP (consumer staples) is an underappreciated trading vehicle, yet very few traders trade it. We believe this is mostly due to a lack of volatility and that XLP is one of the least sexy instruments out there. But in trading, boring is normally good. We have presented many XLP trading strategies over the years, and this is for a reason.
Many traders gravitate towards high volatility stocks. Traders need volatility, but you also need to make sure you don’t risk ruin. The ETF with the ticker code XLP is not a widely used trading vehicle, to our knowledge, but still offers good opportunities for profits while avoiding huge swings in your equity. This article argues why XLP is good for trading.
What is the ETF with ticker code XLP?
XLP is the ticker code for Consumer Staples Select Sector SPDR Fund and tracks the biggest consumer staples in the S&P 500. All the holdings can be labeled as large-caps and low volatility. The prospectus says the aim is to provide exposure to retailing, beverage, food, tobacco, and personal products.
Balancing is done quarterly. Currently, the ten biggest components include Procter&Gamble (PG), Coca-Cola (KO), Pepsi (PEP), Wal-Mart (WMT), Costco (COST), Mondelez (MDLZ), Philip Morris (PM), Altria (MO), Colgate (CL), and Estee-Lauder (EL).
Why would anyone trade something as boring as these names? The names are not exactly the most debated stocks and they are certainly among the least volatile in the market. We can safely say these stocks are among the most boring in the S&P 500.
But that is precisely why you should have a look at XLP:
Why XLP is a great tool to make trading strategies:
XLP is great mainly because of three reasons:
XLP goes its own way and is very good for trading
QQQ and SPY are highly correlated, but XLP correlates less. The reason is most likely twofold: XLP is often a “safe haven”, and due to changes in interest levels it might go opposite directions than for example growth stocks on Nasdaq.
Short trading strategies work well on XLP
We trade three different strategies on the short side in XLP. The value of having short strategies is invaluable due to diversification.
The backtest of our three short strategies looks like this (100 000 compounded – log scale):
The backtest shows 418 trades with an average gain before slippage and commissions of about 0.4%. The win ratio is 75%, but the average winner is smaller than the average loser. The profit factor is 2.35.
The annual and monthly returns look like this:
The best of the three short strategies has this equity curve:
Low volatility means a low chance of ruin (probably)
The short strategies are mean-reversion and mean reversion typically have a negatively skewed profit distribution, ie. many small winners and a few big losers that might wipe out any previous gains.
However, because the XLP consists of low volatile cashflow generative companies, the strategy has not produced (yet, at least) very big losers.
Yes, the average loser is bigger than the average winner, but only by 0.75% vs 0.88%.
The profit distribution looks like this:
Read more about mean reversion strategies in these two articles:
All of the three short strategies will later be published as a monthly edge in our subscription service:
We have already published two Trading Edges in XLP on the long side (per June 2021).
Free XLP trading strategies: Is XLP good for trading?
We have additionally published over 60 free trading strategies Three of those 60+ are in XLP and published between 2013-2017:
- Internal bar strength in consumer staples
- Trade the boring consumer stocks when they open down and yesterday was a down day
- When XLP diverges from recent high and low
XLP and the consumer staples might be boring as hell, but they are excellent trading vehicles. XLP trading strategies are the low-hanging fruit. Is XLP good for trading? Definitely yes!