Faltering Financials

01/24/06 08:19:33 AM

by David Penn

A head & shoulders top sends financial stocks tumbling on a day of widespread selling in the market.

Security: $BKX
Position: N/A

I recently wrote about consolidations in trends for Traders.com Advantage ("From Consolidation To Top," January 20, 2006). In that article, I used the Internet HOLDRS (HHH) to show how while many if not most consolidations in trends are resolved with the market moving in the direction of the previous trend, it is not always the case. In those contrary cases, consolidations serve as tops.

"Now you tell us!" whine the financials.

FIGURE 1: PHILADELPHIA BANKING INDEX, DAILY. Triple top or head & shoulders top, the consolidation in the $BKX turned into a top on the day of January options expiration as the index plunged nearly 2%.

Graphic provided by: Prophet Financial, Inc.

The breakdown in financial stocks hasn't gotten nearly as much attention as disappointing outlooks from the likes of Yahoo! (YHOO) and Intel (INTC). But everybody who's spent any time studying or even thinking about stocks knows that when financials break, there's precious little progress to be expected from the rest of the market.

The financial stocks moved higher in late 2005, along with the rest of the market. Come December, the financials began a sideways consolidation movement that would last well into January. As Figure 1 shows, the nearly two-month range allowed the Philadelphia Banking Index ($BKX) to climb as high as 106.50 and fall as low as roughly 103. And it was the 103 level that was broken decisively on the day that the January options expired, sending the banking index down almost 2% in a day.

FIGURE 2: PHILADELPHIA BANKING INDEX, DAILY. The correction in the $BKX retraced a little over a third of the rally from the October lows. Additional potential support exists at the 50% retracement level (just under 100) and 61.8% retracement level (approximately 98).

Graphic provided by: Prophet Financial, Inc.

The size of the pattern suggests a decline at least to 100, if not a bit lower. There is some measure of potential support just below 102, a level at which the Friday selloff ended. This level is incidentally right at a Fibonacci 38.2% retracement of the October-December rally, which also underscores the 102 level's "bona fides" as a source of support (see Figure 2).

The stochastics in January have just made a lower low vis-a-vis the late December low. The fact that the MACD histogram has also already made a lower low in January compared to December means that it is increasingly likely that the price lows in January will not be the lows for the decline. While it is certainly possible for the $BKX to bounce from this level on its own, there is not the sort of abundant technical support for a bottom that a bottom-picker might prefer. As Mad Money host Jim Cramer might say, traders and speculators are probably better off letting the financial stocks come in a bit more before stepping up to the cash register with wallets in hand.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Faltering Financials

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