Given the spike in market volatility, the rise in correlation among stocks and the impending avalanche of earnings reports in coming weeks, the risk/reward prospect for trading individual stocks isn’t great at the moment.
Instead, you would be better off focusing on the broader indices and sectors for trades.
Banks are set to report earnings next week, and the all-important financial sector — as represented by the Financial SPDR (NYSEARCA:XLF) — will be in focus again. The sector ETF currently has very defined support, but a near-term break below that support could provide more volatility.
So here’s why investors should buy any good dip in financials:
XLF ETF Charts
Because the financial sector was at the heart of the latest financial crisis in the late 2000s, seismic shifts in the sector’s landscape has kept the financials from rallying as much as the broader market. In fact, as we can see on the below chart that stretches back to 2009, the XLF ETF is badly lagging the S&P 500 (blue line).
As the financial sector gets back on its feet, this gap will likely begin to fill over time as financials show relative strength — another way of saying that over the next six to 12 months, any 10% dips in this sector should be bought.
Considering the importance of the financial sector for the economy, it is difficult for broader stock market indices to hold up without participation of the XLF’s holdings, such as JPMorgan Chase & Co. (NYSE:JPM) or Bank of America Corp (NYSE:BAC). I expect another good rally to higher highs in the S&P 500 into the first half of 2016, which I foresee being led in part by the financial sector.
For the XLF ETF, the 200-day simple moving average (red line on the chart below) has held as good support since the year 2012. With exception of the wash-out move lower from October 2014, the 200-day MA has been a good area to watch for support. If this area gives, it could lead to another swoosh lower, causing or reflecting more volatility in the broader stock market.
I also will point to the declining relative strength index (RSI) at the bottom of the chart, which saw a lower high in June versus its December 2014 highs while price pushed to a higher high in June.
Active investors may find an opportunity to short the XLF ETF on a break below the 200-day MA for a momentum trade lower into the $22.50-$23 area, while any major bullish reversals after such wash-outs can be bought.
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Successful trading and investing starts with a plan. Download Serge’s essential trading plan, The Essence of Swing Trading e-book. As of this writing, he did not hold a position in any of the aforementioned securities.
