Island Reversal Looms For XLF

03/23/06 08:56:49 AM

by Arthur Hill

The Finance SPDR gapped down last week, and negative momentum points to lower prices ahead.

Security: XLF
Position: Sell

The Finance SPDR (XLF) recorded a new reaction high last week and remains in an uptrend over the past few weeks. However, this high did not last long, as the stock gapped down the very next day. Moreover, this gap follows a gap up and the result is an island reversal (black circle, Figure 1). Anyone who went long after the gap is now trapped on the island with a loss. The late February gap down marked a short-term peak for the index (blue oval), and I would treat this gap the same (short-term bearish) as long as 33.2 holds (red resistance line).

FIGURE 1: FINANCE SPDR. XLF recorded a new reaction high and then gapped down, with a resulting island reversal (black circle).

Graphic provided by: MetaStock.

Graphic provided by: MS Quotecenter.

Even though the trend over the last few weeks is up, the stock is trading close to trendline support and a break below 32.7 would be bearish. The trendline extending up from February 7 has been touched three times now, and this makes it a valid trendline. In addition, the bounce on March 22 established a reaction low at 32.7, and this is the level to watch for a trend change. Should the stock hold support, look for a break above 33.2 to revive the uptrend and open the door to new highs.

Momentum is already negative. the moving average convergence/divergence (MACD) peaked with the stock in mid-March and declined below zero. A similar pattern unfolded in early March when MACD turned negative after the gap (gray ovals). Even though XLF did not decline sharply in early March, it certainly did not rise as long as MACD was negative. The same holds true now. Momentum is clearly bearish as long as MACD remains in negative territory, and I would not expect prices to move higher until this changes.

Arthur Hill

Arthur Hill is currently editor of TDTrader.com, a website specializing in trading strategies, sector/industry specific breadth stats and overall technical analysis. He passed the Society of Technical Analysts (STA London) diploma exam with distinction is a Certified Financial Technician (CFTe). Prior to TD Trader, he was the Chief Technical Analyst for Stockcharts.com and the main contributor to the ChartSchool.

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