Last Updated on June 11, 2021 by Oddmund Groette
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.
In this article, we discuss the consumer staple ETF XLP and why it’s such a great trading vehicle. It works very well on the short side, is much less volatile than “normal” stocks, and moves differently than many of the other stock ETFs, thus providing a hedge.
What is the 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. Per June 2021 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 trading tool:
XLP is great mainly because of three reasons:
XLP goes its own way
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 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:
We have additionally published over 60 trading strategies free of charge. 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
Disclosure: We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinions – they are not suggestions to buy or sell any securities.