Homebuilder stocks mirrored the decline in the S&P 500 this week, but they’re also showing signs of additional downside ahead. The Trending123 Pattern Scan has detected three key bearish patterns in homebuilder stocks that you should take note of if you want to short or play puts in this area.
Click to Enlarge First off — the sector ETF itself, the S&P Homebuilders ETF (XHB) is showing a top triangle pattern, which could indicate that the sector overall is about to head downward within the next six weeks to nine months.
The price seems to have reached a top, showing signs of reversal as it has broken downward after a period of uncertainty or consolidation. A top triangle shows two converging trendlines as prices reach lower highs and higher (or stable) lows. Volume diminishes as the price swings back and forth between an increasingly narrow range reflecting uncertainty in the market direction. Then well before the triangle reaches its apex, the price breaks down below the lower trendline with a noticeable increase in volume, confirming this bearish pattern as a reversal of the prior uptrend.
XHB Target Price: $24.40 – $25.40
Click to EnlargeToll Brothers (TOL), one of the top 10 holdings in XHB at 3.30% of assets, is also showing a top triangle. It’s not unusual for several names in the same sector to show the same pattern, which is likely the cause of XHB’s pattern.
An important thing to note in both patterns is how long the pattern takes to develop to its apex. The general rule is that prices should break out somewhere between three-quarters and two-thirds of the horizontal width of the formation. The break out, in other words, should occur well before the pattern reaches the apex of the triangle or wedge. The closer the breakout occurs to the apex, the less reliable the formation.
TOL Target Price: $21.50 – $23.25
Head and Shoulders Top
The price seems to have reached the end of a period of “distribution” at the top of a major uptrend; the break down through support signals a reversal to a new downtrend.
The head and shoulders top is created by three successive rallies in the price following a significant uptrend. The highest high (head) is in the middle, flanked by two lower highs (shoulders) at roughly the same level. Volume is highest as the price makes the first two rallies, then diminishes through the right shoulder. Finally volume surges as the price closes below the neckline (drawn between the two lows) to confirm the reversal.
MBI Target Price: $10.25 – $12.25
InvestorPlace advisor John Lansing tracks the charts all day and offers expert technical analysis in his day trading, options and trading services: Power Trading at the Open, Parabolic Options and Trending123. Trending123 members receive access to the Trending123 Pattern Scan powered by Recognia free as part of their membership.