Wednesday, April 22, 2009

Sector Non-Confirmations: Recognizing the False Breakout

A trending move in a market is one in which there is a fundamental revaluation: value that was established in one region shifts to another. If a trend is valid, we should see evidence of that revaluation across the board, not just among certain stocks or sectors.

Here we see the ES futures break out to a new high for the day in the afternoon (top chart), but there is dramatic non-participation in the very important banking sector (middle chart). We also fail to get a confirmation among consumer discretionary shares (bottom chart). Once ES falls back into its morning range, the false breakout becomes clear and we retrace most the morning's gains.

These false breakouts are often quite profitable trades, especially late in the day when trapped traders who don't want to take overnight risk scramble to exit the market. Identifying sector non-confirmations--the occasions in which the rising tide is not lifting all boats--is often the first step in recognizing the failing breakout.