STRATEGIES

Chasing high-flying sectors or stocks is dangerous and not necessary when careful daily chart analysis can predict inevitable corrections that present new, high-quality buying opportunities.

Often when a sector or industry group takes off, there are many astute investors or traders who miss out because they do not get a timely buy signal or secure the right entry price and as a result are left on the sidelines. Some finally lose their patience and jump in as the market is topping, only to be stopped out at levels where they were previously hoping to buy.

This can create a level of frustration that results in them avoiding or ignoring that sector or industry group in the future. This is a mistake, as in the majority of cases, a several-month rally is often enough to turn the weekly and/or monthly analysis positive. Therefore, any correction forecasted by the daily analysis is likely to present another excellent buying opportunity.

Since the latter part of January, I have become cautious on two of the best-performing industry groups, the homebuilders and regional banks. The SPDR S&P Homebuilders ETF (XHB) was up almost 67% from the October 2011 lows to the February highs, while the SPDR KBW Bank ETF (KBE) was up almost 40% during the same period.

These two ETFs and the industry groups they track now appear to be completing daily top formations. A few days of further weakness will confirm this view and set the stage for what could be a three- to eight-week correction. Therefore, now is a good time, in my opinion, to determine the price levels and a game plan for getting back into these ETFs as well as the leading stocks in each of these industry groups.

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This weekly chart of the SPDR S&P Homebuilders ETF (XHB) shows that resistance from the 2010 high, line a, was overcome early in the year. The next major level of resistance is in the $24-$25 area, which corresponds to the highs formed in 2008.

The all-time high for the ETF, which was actually created after the top in homebuilding, was at $46.55, so the major 38.2% Fibonacci retracement resistance stands at $22.68 with the 50% retracement resistance at $27.24.

The relative performance, or RS analysis, shows that the long-term downtrend, line b, was overcome in early-December 2011. The RS had completed its bottom formation in October (see circle) prior to moving above its weighted moving average (WMA). The WMA is now rising strongly but could be tested on a pullback.

The weekly on-balance volume (OBV) looks very impressive, as it has moved well above major resistance at line c and is now rising quite sharply. A pullback in the OBV to its weighted moving average would not be surprising.

The daily chart shows that XHB has been moving sideways since early February and is currently filling the gap formed on February 3. The daily uptrend, line d, is currently just below $19 with additional chart support in the $18-$18.50 area. The 38.2% Fibonacci retracement support stands at $17.27 with the 50% support at $16.30.

The daily RS line is now testing its uptrend, line e, which could be broken in the next few days. The daily OBV shows a negative divergence, line f, and the OBV has dropped back below its flat weighted moving average. The long-term support for the OBV stands at line g.

There is initial resistance at $20.35 and two daily closes above this level will signal that a top is not yet complete. There is first good support in the $18.50 area, which would require a 9% decline from the recent highs. Given the current high level of bullish sentiment, a decline back to the $17.60-$18 area would not be very surprising.

Strategy for the SPDR S&P Homebuilders ETF (XHB): Go 50% long XHB at $18.68 and 50% long at $17.56 with a stop at $16.44 (risk of approx. 9.3%).

The prior long position in XHB, as recommended on October 19 was established at $15.22. Half of the position was sold at $17.46 and the remaining position was sold on January 24 at $19.44.

NEXT: Catch the Next Uptrends in Top Homebuilders

Tickers Mentioned: XHB, KBE, KBH, DHI, RF