Along with many of my colleagues at Investing Daily, I have a contrarian streak when it comes to trading stocks and exchange-traded funds (ETFs). And recently I spotted a sector where going against the grain paid off in a big way, at least in the short term.

With this in mind, one of my favorite activities when looking for areas in which to put my money is to find mismatches between stock price action and affiliated indicators that help quantify money flows into stocks and ETFs. This analysis becomes particularly useful during the sort of volatile periods we’ve seen for the past few weeks.

Panic Creates Opportunity

It’s hard not to be concerned when the market starts crashing. But over the years I’ve learned that panic often creates opportunity to buy stocks and ETFs at bargain prices. This is especially true when the panic is based on news items that are not fully vetted, such as current market volatility associated with the Omicron variant of COVID-19.

Watch This Video: The Omicron Conundrum

Make no mistake, even as new data suggest that Omicron may be less harmful than its predecessors such as Delta, I take this virus seriously. I don’t wish it on anyone, and as a medical doctor, I am fully on board with the available protection against it.

Certainly, those who are the most pessimistic about this virus could be proven to be correct. Yet, stocks seem to have recovered after a few days of heavy selling.

Thus, from an investment standpoint, as we wait for developments, there is no harm in looking at areas of the market that are getting beaten up the hardest. And one of them is the software sector, as with the Invesco Dynamic Software ETF (PSJ).

A Round Trip in Software

Let’s take a trip back to early 2020 when the initial COVID pandemic emerged. After the six-week bear market that ensued in response to not just the virus but the lockdowns and related events, when the market turned around, software stocks powered by the likes of Zoom (NSDQ: ZM) and other so-called “stay at home” stocks blossomed and delivered huge gains.

This bull market in software precisely ended in March 2021, as the chart of the PSJ ETF clearly shows. Moreover, the decline in the sector corresponded to the recovery phase from the original COVID scare because the use of platforms like Zoom plateaued and life regained a semblance of normalcy.

Now, let’s look at the PSJ price chart from March to December 2021. And what we see is the following:

• A broad trading range between $147 and $165 until September.
• After September, PSJ began to flounder presumably over the Delta variant scare.
• Shares broke down completely in October and made new lows in late November.

Indicator Breakdown

Price is the ultimate truth in stock trading, but indicators help us understand the price action. Personally, I like to use Accumulation Distribution Indicator (ADI), On Balance Volume (OBV), Rate of Change (ROC), Volume by Price (VBP), and Relative Strength Index (RSI) to analyze prices.

• ADI: measures short seller activity. When the line points down it means short sellers are active.
• OBV: when this gauge rises, it tells me when dip buyers are active.
• ROC: A rise in ROC means that current price direction is gaining strength.
• VBP: Designated by those large bars on the left side of the chart, VBP is a sign of how much actual interest there is in the stock/ETF at the current price level. The larger the bar, the more the interest and the more important a price move above or below this price means.
• RSI: a measure of whether the price is oversold or overbought.

And here is what they are telling me as of the rally which started on 12/6/21:

Prior to the huge rebound since 12/6, ADI essentially was neutral, so short sellers weren’t very active. OBV fell from April to September and moved sideways prior to the big move up, which meant the sellers were exhausted. ROC was falling, which meant the downtrend was losing steam. The VBP bars near the bottom were tiny, which means that interest in the sector was low. RSI was hovering around 30, which is a very oversold reading.

A Classic Bottom Setup

There are two old Wall Street adages that are acutely applicable here. One is “Buy them when no one wants them.” And the other is “Buy when there is blood in the streets.”

But if that’s not enough, here is another way to look at this situation from purely a trading standpoint.

Prices were falling. Yet, there were few short sellers, profit takers were exhausted, downside momentum was fading, and there was little interest in this ETF.

Therefore, this was a moment when being contrarian made serious sense.

P.S. If you’re looking for market-beating gains with mitigated risk, consider the trading strategies of my colleague Jim Fink.

As chief investment strategist of Velocity Trader, Jim Fink has devised methodologies that reap big profits, regardless of economic ups and downs or the pandemic’s unpredictable path. Click here for details.