Measured Moves In Housing

05/07/07 02:51:51 PM

by David Penn

How far will the bounce in housing stocks go?

Security: $HGX
Position: N/A

I've written lately about measured move patterns for both Traders.com Advantage ("Measured Moves In The Swiss Franc," March 7, 2007) and Working-Money.com ("Measures And Half Measures," May 4, 2007). With markets across the board moving toward new highs, I went searching for markets that were taking advantage of market strength to rally from significant lows. Unsurprisingly, the housing market was one of the first places I looked.

FIGURE 1: PHILADELPHIA HOUSING SECTOR INDEX, DAILY. A month-on-month positive divergence in the MACD histogram signaled an end to the correction in housing stocks that began in February.

Graphic provided by: Prophet Financial, Inc.

What I saw in the index of housing stocks (the Philadelphia Housing Sector Index, or $HGX) was a market that had topped in earliest February 2007, and corrected more than 15% before making a low in mid-April (Figure 1). This mid-April low was accompanied by a positive divergence in the moving average convergence/divergence (MACD) histogram, which helped identify the low as a significant bottom. The $HGX rallied over the balance of April, breaking back above the 20-day exponential moving average (EMA) and moving almost vertically by the end of the month.

Since that bounce, $HGX has retraced mildly to successfully test the 20-day EMA for support and is currently en route to taking out the April high just north of 235. (See Figure 2.)

Treating the bounce and successful test of the 20-day exponential moving average (EMA) as a potential ABCD pattern allows us to use the same sort of rules that can effectively project the upside (or downside, in the case of a breakdown) of a measured move. Here we have a point A (the April low) at 214, point B (the April high) at 237, and point C (the low of the 20-day EMA test) at 225. If the advance in $HGX is a successful ABCD/measured move pattern, then the market should rally to AB + C, the distance between points A and B added to the value at point C. This suggests an upside target near 248.

FIGURE 2: PHILADELPHIA HOUSING SECTOR INDEX, DAILY. As a measured move pattern, the rally from the April lows projects an upside to 248 if the $HGX can first clear the 1/2 AB + C point near the April highs.

Graphic provided by: Prophet Financial, Inc.

As I note in "Measures And Half Measures," one strategy for determining whether the odds are good that a market will reach point D is whether or not the market can first reach a point halfway between C and D. This halfway point is the same as 1/2 D AB + C, and here is approximately 235. This level also represents the April high, so there is likely to be some measure of resistance as the market makes its test. But a strong move through the 235 level in the $HGX is likely to translate into higher highs for housing stocks in the near term.

David Penn

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

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