A Short Term Buy Signal for Financial Sector ETF XLF?

A Short Term Buy Signal for Financial Sector ETF XLF?

PMO Buy Signal: Financial SPDR (XLF)

by Carl Swenlin

(This is an excerpt from July 22, 2011 issue of the blog for Decision Point subscribers.)

In our ETF Tracker Daily Report, which tracks over 90 index and sector ETFs, there is a section that tracks the status of PMO buy and sell signals for these securities. This section is sorted by signal, with the newest signals listed at the top. These are mechanical signals, but you have to look at the chart to determine if action is appropriate.

Below is an extract of Thursday’s Report. On the day of a new signal the “Calendar Days Elapsed” is always shown as zero (0), and the “Today P/L” column shows the profit or loss of the previous signal just closed. On the live report you can just click on the line to generate a chart.

The financial sector is an important one, so let’s take a closer look at that chart.

First note that there was PMO buy signal in June. The good thing was that it was generated with the PMO at oversold levels, but the bad thing was that the 50-EMA was below the 200-EMA, meaning that XLF is in a bear market. Under those circumstances it is prudent to wait for a second price bounce before acting.

As is common, the second bounce did materialize with a rally off a lower price low in July. This was accompanied by a higher PMO bottom, which produced a positive divergence. This setup looks promising, but there are no guarantees. Mechanical PMO signals are information flags that are intended to attract our attention, but discretion should be used in any action taken, and stops should be used for managing/exiting positions, not the next PMO signal.

As part of my analysis I like to check the long-term technical picture. While XLF is about 200% higher than its 2009 lows, it is well off its 2007 highs, and it has been moving sideways for two years. It may have found support, but there is resistance at about 17.00.

Bottom Line: A new PMO buy signal on XLF draws our attention to what looks like a good setup for a short-term trade — double bottom, positive divergence, and expanding volume. The long-term chart does not hold much promise.

This is not a recommendation to buy or sell this security, but an example of how to use charts to clarify mechanical signals.