Bank Index at Critical Resistance Level

12/16/2010 12:01 am EST

Focus: STRATEGIES

Market pundits and prognosticators are all worried as to whether Santa is going to deliver presents to Wall Street this year. While we have seen the S&P 500 reach new highs in December, the S&P 500 is facing a wall of resistance around the S&P 1250 area. Based on price action today, Santa may not be coming to Wall Street in 2010.

Market participants are aware that the holiday season tends to usher in light volume and declining volatility, historically. When volume is light and volatility is declining, there is generally a bias to the upside as equities typically grind their way higher. In the recent past, Santa has come to Wall Street and delivered gifts of good fortune to those that were heavily invested in the domestic financial markets.

Unfortunately, Santa may not deliver presents to Wall Street this year, as apparently one sector in particular has behaved poorly. If the financial sector does not start behaving, Santa may not come to Wall Street at all in 2010. Apparently, Santa and Mr. Market are good friends and they both like to watch the financial sector closely.

The action in the KBW Banking Index (BKX) recently has not been inspiring. In fact, the action suggests that the financial sector may potentially be putting in an intermediate- to longer-term top. Before coming to any conclusions, however, we need to watch the price action in the financial sector play out. As Minyanville founder Todd Harrison often writes, "As go the piggies, so goes the poke."

Essentially, what he is saying is that without the banks participating in a rally, the broader market will have limited upside. If the banks are sold heavily, the broader market is likely to follow. As can be seen from the chart illustrated below, BKX tested recent highs and has failed on its first attempt to break out. As most traders are already aware, every time a level is tested, it becomes weaker, so we will be watching to see if this level is tested again in the near future. Illustrated below is the daily chart of the BKX Banking Index:



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Price action in coming days will help us determine if this is just a pause before a breakout or whether the BKX index is telling us that prices are headed lower in the financial sector. If the funds BKX, XLF, and KRE start to break down, as traders, we should anticipate that the broad markets such as the S&P 500 will likely follow.



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The Tuesday morning session saw the S&P 500 climb higher, only to be sold off in the afternoon, eventually closing up around 1.13 points (+0.09%) while the Dow Jones Industrial Average rose 47.98 points (+0.42). However, the Financial Select Sector ETF (XLF) closed the day down 0.89%, the SPDR KBW Bank ETF (KBE) closed down 1.55%, the KBW Banking Index (BKX) was down 1.52%, and the SPDR KBW Regional Banking ETF (KRE) closed up 0.28%. While the broader markets were in positive territory, the banks for the most part were under suspicious selling pressure.

The S&P 500 weekly chart indicates that we are approaching some major overhead resistance levels. Is the financial sector trying to warn us of potential downside? Is the rollover in the banking sector a head fake before they break higher and the S&P 500 follows suit? It is impossible to know for sure at this point, but I for one will be monitoring the financial sector quite closely for any possible clues about possible direction on the broad domestic indices.

Is Santa going to put a lump of coal in Wall Street's stocking this year? That question will be answered in due time, but for now, investors and traders alike should be watching the banks as the broader markets will struggle to rally without their participation.

By J.W. Jones of OptionsTradingSignals.com

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