Can XLI Be Shorted at Current Levels?

06/26/2009 12:01 am EST

Focus: ETFS

A sharp pullback rally of the Industrial Select Sector (XLI) from $15 converted the previous high's resistance to support. The rally was accompanied by good volume until XLI hit a 200-day moving average (MA) resistance. After retesting the newly formed support (see the support-resistance tool) in Figure 1, XLI surged higher at $24. The full stochastic (14,3,3) sustained in an overbought zone during the entire bullish rally. The oscillator formed a first peak as the price reached $23.

Further, XLI turned the 200-day MA resistance to support and formed a higher high, but the stochastic oscillator showed a negative divergence by forming a lower high (see the dashed line) in Figure 1. The moving average convergence/divergence (MACD) (12,26,9) showed negative divergence as well. In addition, the average directional movement index (ADX) (14) failed to move above the 30 level, indicating lack of bullish pressure to pull the trend in their favor. The technical weaknesses resulted in a minor correction in XLI.

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FIGURE 1: XLI, DAILY. After forming lower highs, the stochastic (14,3,3) has reached an oversold area below the 20 level. The XLI would witness a fresh bullish rally if the oscillator moves above the 20 level.

Gradually, XLI dropped below the 200-day and 50-day MA support and continued to decline further. The volatile session of June 23 closed below the support/resistance tool, indicating more downside. I would recommend watching the sector movement carefully at the current level, since major support has been breached. The weak uptrend, as indicated by the ADX (14), is likely to reverse above the 20 level. The MACD (12,26,9) is ready to plunge below the zero line, so the XLI is likely to drift down further. Hence, traders can grab this new short-selling signal with an appropriate stop loss around $22, which would be above the 200-day MA resistance. Hereafter, the trading sessions are likely to be highly volatile, and the MA resistance can be challenged. So placing a stop loss above resistance would avoid whipsaw.

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FIGURE 2: XLI, WEEKLY. XLI has violated the lower range of consolidation at $22.

On the weekly time frame in Figure 2, you can see three resistance levels: $24.50, $26.11, $27.53. These levels are areas to where XLI retraced from the second high at $24.13. The index consolidated in a wide range of $22.50 and $24. The shaky stochastic (14,3,3) is likely to move below the highly overbought area. The bullish flag and pennant, formed due to consolidation on the price chart, is therefore likely to break downward.

The blue box in Figure 2 shows the consolidation, and we can also see that XLI has marginally moved below the lower range. Although the ADX (14) has largely declined to the 23 level, the upward-rallying, negative directional index (-DI) suggests a developing downtrend. The MACD (12,26,9) may take a U-turn in negative territory.

Therefore, the failure of the bullish continuation to break upward can be considered an intermediate-trend reversal indication. Traders can keep small targets on their short sell and shift the stop loss to protect the profits as XLI has already rallied downward. The target can be the support levels at $20 and $18. Thus, the downside for XLI looks limited, but the bullish rally has various resistances. The index would require robust bullish momentum to cross an upper range of consolidation, which is not currently indicated on the chart.

By Chaitali Mohile


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