XLY In Trading Range

02/04/10 09:03:31 AM

by Alan R. Northam

The consumer discretionary market sector is one of the leading market sectors of the economy and the future direction of the stock market. This market sector is currently in a trading range and its breakout will determine the direction of the economy and the stock market.

Security: XLY
Position: N/A

The Consumer Discretionary market sector SPDR (XLY) exchange traded fund is made up of a basket of stocks that consumers normally buy when they feel comfortable about the economy but can do without when they tighten their purse strings during times of economic uncertainty. By monitoring this market sector, it is possible to get a feel about the future of the economy and the overall stock market.

Figure 1 shows that XLY has broken down below its primary trendline indicating that the primary upward trend has ended. There are three different directions a market can move after completing a primary uptrend, or any trend, for that matter. The market can move sideways in a trading range, it can start a new uptrend, or it can start a new downtrend. The first thing I do after the completion of a trend is to assume that the market has entered into a sideways trading range. I then find the most recent support and resistance areas and draw a sideways trading channel as shown. Now I wait to see what the market is going to do. If the market breaks out above the high of the trading range, then the market has started a new uptrend with most likely a different rate of climb than the previous uptrend. However, if the market eventually moves below the trading range, then the market has started a new downward trend. Until the market makes up its mind which direction it is going to move, I do nothing.

FIGURE 1: XLY, DAILY. Here's XLY breaking down below its trendline and entering into a trading range.

Graphic provided by: AmiBroker.com.

To take our analysis one step further, just because the market breaks out above the trading range does not mean that the market is going to continue significantly higher. The market could simply make a slightly higher high and then reverse its trend back down. The same could be said for a market that breaks down below the trading range. It could simply make a slightly lower low and then turn back up. These possibilities are known as false breakouts.

To reduce the chance of false breakouts, I like to use the on-balance volume indicator (OBV). Note that I have drawn a trendline and a resistance line on the OBV chart below the price chart in Figure 1. If XLY breaks out above its trading range, then to help minimize the possibility of a false breakout, I want to see OBV break out above its resistance line. This tells me that buying volume is expanding, which is necessary for a market to move significantly higher. If XLY breaks out below the trading range, then I want to see OBV break down below its trendline. This tells me that selling volume is expanding, which helps to minimize the possibility of a false breakdown. There is one caveat to this analysis that I need to point out. Selling volume does not need to expand for price to move significantly lower. Price can fall without the help of increased selling volume. However, if selling volume does expand or break down below its trendline, then the probability of price moving significantly lower increases.

In conclusion, XLY is currently in a trading range. This tells me that consumers are concerned about the future of the economy but have not necessarily given up. A breakout above the trading range will signal renewed hopes about the economy and the stock market should continue to advance, but a breakdown below the trading range will indicate that consumers have given up on the economy and are tightening their purse strings, and as a result, the stock market should move lower.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.

	Garland, Tx
Website:	www.tradersclassroom.com
E-mail address:	inquiry@tradersclassroom.com

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XLY In Trading Range

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