Monday, March 03, 2008

Using Stock Sector ETFs to Identify Short-Term Market Reversals

As you can see from the chart of the ES futures above, the market made a marginal low for the day at the second blue arrow before retracing much of the day's range. My research finds that, when stock indexes make relative highs or lows that are not confirmed by a significant number of the index components, the odds of reversal are greatly enhanced.

With the ES, an easy way to check on the behavior of index components is to track the S&P 500 sector ETFs, most of which are quite actively traded. The new lows in the afternoon in ES were confirmed by new lows in the energy sector (XLE); technology sector (XLK); and a very marginal new low in the materials sector (XLB). The new lows were not confirmed by the important financial sector (XLF); industrials (XLI); consumer discretionary sector (XLY); consumer staples (XLP) ; or (narrowly) healthcare (XLV).

In general, when half or more of sectors or stocks are not confirming a move, that's when you want to be on the lookout for reversal. In practice that means that short-term traders need to be watching more than the cap-weighted index they're trading, as a few highly weighted stocks can paint a misleading price picture on the screen.


Using Intraday New Highs/Lows to Gauge Market Trends

What We Can Learn From New Highs/Lows