Utilities Moving Sideways

02/18/09 09:27:03 AM

by Paolo Pezzutti

Trading a breakout of the long consolidation is an option.

Security: XLU
Position: N/A

In June 2008, when I wrote an article about utilities, the price of the Utilities Select Sector SPDR (XLU) was about $40. Prices were in a trading range and after the breakout to the downside, they moved to print a new low at $23.28 in October. Since then, XLU has started a long consolidation. If you see the weekly chart in Figure 1, it looks as if a congestion with prices contained within the wide-ranging bar printed during the first week of October. Basically after the panic selling, XLU has managed to build a base and move slightly higher to the present value of $28. If this is the premise for another leg to the downside, it is difficult to say. In this time frame, the force index indicator, which I used to indicate the trend, is still negative. This indicator takes into account price and volume. A 13-bar exponential moving average (EMA) of the force index is used to track longer-term changes in the force of the market's participants. In the figure you can also see the %b indicator, which is derived from the Bollinger bands. It measures where the last price is in relation to the bands. The %b moved up from the oversold level; its value is about 40 and it does not provide useful indications. Prices are in the middle between the bands, which are converging quickly as a result of the ongoing sideways phase.

FIGURE 1: XLU, WEEKLY. Prices are developing a long congestion. The Bollinger bands are still converging in this time frame.

Graphic provided by: TradeStation.

Moving to the daily time frame (Figure 2), the formation is more evident and it displays the interesting feature of having higher lows. The resistance at $30 has been tested many times and its breakout to the upside would be a very reliable signal. To the upside, XLU would have a potential to reach the area at $32–33. Prices are now testing the rising trendline. The force index indicator is negative also in this time frame. The %b indicator after printing a negative divergence in coincidence with the last test of the resistance at $30 has managed to break out its trendline to the downside. It is difficult to say if the indicator is anticipating a price move. The Bollinger bands are parallel and narrow; the price is close to the lower band, which has acted as a support in the past.

FIGURE 2: XLU, DAILY. Higher lows of the long formation indicate that prices could break out to the upside. You can see that the $30 level has been tested many times and a breakout would be a reliable signal.

Graphic provided by: TradeStation.

It is hard to predict on which side the breakout will occur. The higher lows in the formation indicate that chances are that we will see an exit to the upside. But I would not bet on it. There are different options on how to open a trade; one is trading the breakout on either side, while the other is trying to anticipate the exit based on a pattern or risk-reward considerations.

Paolo Pezzutti

He is the author of the book "Trading the US Markets - A Comprehensive Guide to US Markets for International Traders and Investors" - Harriman House (July 2008)