Financial stocks had a horrible week.
After running sharply higher earlier in September, the Financial Select Sector Fund (XLF) gave back all of its gains for the month last week, plus a little more. The sector has traded lower for six straight days.
And since the banking stocks tend to lead the broad stock market, most traders would be prone to look at this action as a bearish omen.
But, there’s a twist. It’s a twist that might actually prove less bearish for stocks in the short term.
Regular readers might recall a situation I pointed out in the financial sector in early July. Back then, XLF had been falling for a few weeks. And weakness in the financial sector was weighing down the broad stock market.
But by early July, the financial sector was so oversold it looked to be setting up for at least a short-term bounce. As that bounce played out in August – and XLF gained 7% during the month – the financial sector led the S&P 500 to just over a 5% gain.
After the brutal downside action last week, XLF looks a lot like it did in early July. Here’s the chart…
XLF closed below its lower Bollinger Band last on Friday. That’s the seventh time that’s happened so far in 2018. Five of the previous times this happened, XLF snapped back higher right away.
The other time – in late January – XLF popped higher for a couple of days. Then it rolled over and dropped again below its lower Bollinger Band. From there, XLF put on a sharp rally that lasted several weeks.
So, it looks like buying XLF whenever it dips below its lower Bollinger Band has been a fairly profitable strategy.
The only question is whether last Friday’s dip is going to turn out like the previous five dips (where XLF popped higher right away) or if it’s going to resemble the dip from late January (where XLF sold off to a lower low before launching a strong rally).
Either way, it seems to me the odds favor the financial sector working higher over the next week. That should help the broad stock market work higher as well.
Believe me… I’m as surprised as anyone to be writing this today. As I pointed out on Friday, the daily chart of the S&P looks vulnerable to me. It has been tracing out a bearish rising wedge pattern, which often resolves in a sharp, downside move.
I did, however, mention this on Friday: “The index might be able to bounce from here. There’s still room inside the wedge for one more push higher.”
And based on the oversold condition of the financial sector – which will likely lead to a bounce this week – we’ll probably get that “one more push higher” in the S&P 500 this week.
Best regards and good trading,
Jeff Clark
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Reader Mailbag
In today’s mailbag, one reader compares Jeff’s analysis to swinging at the perfect pitch…
Hi Jeff. Thanks for your recent thoughts on the Sept./Oct. trading. I would rather stay out and wait for the high-probability, higher-reward setups as well.
I very much appreciate and respect who you are and trust your experience and analysis of the markets. Too many trading advisory services place their own interests above the success of their current subscriber base. I would rather swing at the perfect pitch when presented, rather than trying to swing at every questionable one and striking out more times than getting on base or hitting a home run!
Thanks for your comments and analysis of the markets every morning and your updates throughout the day (and night), I read every single one! And I also appreciate your personal stories and lessons too! Thanks for the regular updates on the precious metals and gold stocks too!
– Ryan
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