A Textbook Setup

A Textbook Setup

January 11, 2017 Off By Chuck

Like the broader market, financial stocks have been in a funk since mid-2015, consolidating sideways forming a couple of interesting bullish patterns during this time. While not illustrated, if you look closely there is both an inverse head and shoulders and/or cup and handle that formed between the 2 red horizontal boundaries. The US market was looking for a catalyst and the elections triggered the move out of the consolidation.

A student who was looking for a close to ideal set up got it with the financial sector ETF, XLF, as you can see in the chart below. Firstly, notice how, during the consolidation, RSI momentum never reached oversold conditions which kept the door open for a big move to the upside. The week of the election price broke decisively above the upper red horizontal resistance on huge volume. It created the biggest white (upside) candle over the past 5 years. In addition, the following week gapped higher, again on the 3rd largest volume day in 5 years. XLF rose more than 20% in 5 short weeks. Also it should be obvious that moved pushed the momentum into overbought territory which, when it occurs, eventually requires the stock to take a breather and unwind the overbought condition as you eventually run out of buyers.

This is what a bull market looks like. It also shows how, unless you were already invested in the position it was virtually impossible to participate in this move because those waiting for a pullback (and who didn’t want to chase) stayed on the sidelines as the opportunity never arrived. Well, at least not until (possibly) now. Notice how price has once again consolidated over the past 4 weeks, going nowhere, but has allowed the overbought RSI to start unwinding.

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If you are a believer like the market apparently does that Trump = higher interest rates which is bullish for bank stocks then it’s possible this may just be the beginning of a much bigger move. What has formed since the Trump election is the possibility of a high and tight bull flag signaling this recent move was a midpoint to its end target. Investors looking to capitalize would be looking for continued sideways chop and then a price moving out of the upper boundary of the flag. Ideally, like the initial move, greater than average volume would go a long ways to confirm the setup.