Both the Materials and Industrials sectors look technically vulnerable, meaning investors should exercise caution and have tight stops in place.

Since the March 2009 lows, two of the best-performing sector ETFs have been the Select Sector SPDR - Industrial (XLI) and the Select Sector SPDR - Materials (XLB). XLI is up 148% from the March lows and XLB is up 117%, while the S&P is up 100%.

Of course, many of the individual stocks in these sectors have seen even more dramatic gains, and soon after the lows were formed, the relative performance analysis of these groups identified them as the star performers.

In the August 13, 2009 Trading Lesson, I noted that the S&P Industrials had completed a reverse head-and-shoulders bottom formation. The sector closed that week at 219 and hit a high last week of 336.

In that same article, I discussed the weekly analysis of the Materials sector, which had formed strong bullish divergences at the March 2009 low. The sector closed that week at 178 and hit a high in early April of 256. By early May, the technical picture had deteriorated (see “Will the Materials Slump Continue?”)

Both the Industrials and Materials sectors have now formed weekly negative divergences, which are consistent with a significant correction, but not a major top. By analyzing both the weekly and daily charts of the corresponding sector ETFs, we can get a better idea of the type of correction we should expect.

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Chart Analysis: The weekly chart of the Select Sector SPDR - Industrial (XLI) shows that it made a new high the week ending May 6 at $38.98 (point 2) and then closed Friday just above the prior week’s low.

  • This high was well above the February high of $38.08 (point 1)
  • The weekly on-balance volume (OBV) made its high in February but formed a lower high in May (point 2), just barely making it above its flat weighted moving average (WMA). This is a negative divergence consistent with a top formation
  • The divergence has been confirmed this week, as the OBV has dropped below its prior low and is now in a downtrend
  • The weekly OBV support at line b is well below current levels
  • Support for XLI on the weekly chart is at $34.44 and the 40-week moving average (MA). Chart support from the 2010 highs is at $33.50

The daily chart of XLI appears to show a rising wedge formation, lines c and d. A close below $37.17 will complete this formation.

  • The chart formation has initial downside targets at $34.50 with the 38.2% retracement support at $34.35. The 50% support is at $32.90
  • The daily OBV did make a new high with prices, but I have found the weekly OBV to be more important when the weekly and daily disagree
  • Daily OBV has also just turned down from its weighted moving average, and a break of support at line e should precede a break of price support
  • Short-term resistance is now at $38.60 and then $39.00

NEXT: Latest Chart Action for Materials Sector ETF XLB

Tickers Mentioned: Tickers: XLI, XLB