GENERAL ELECTRIC LEADS INDUSTRIAL SECTOR HIGHER WHICH BODES WELL FOR MARKET -- HOW TO USE MOVING AVERAGE LINES

INDUSTRIAL ETF NEARS SUMMER HIGH ... So far this week I've written about relative strength in biotech, the Internet, and the consumer discretionary groups. In each case, I first found a sector index that was displaying rising relative strength combined with strong chart action. The chart action is usually an upside chart breakout, the breaking of a significant down trendline, or the upside penetration of the 50 or 200-day moving averages -- or some combination of those three. Rising volume is also taken into consideration. Once the sector is found, the investor has two choices. The first is to buy the entire sector via an Exchange Traded Fund (ETF) or a sector mutual fund. A second choice is to buy leading stocks in that sector. Another factor is the weighting of the stock in the index or ETF. The stocks with the greatest weighting have a strong influence on the sector move. An investor might want to concentrate on the biggest stocks with the best chart pictures. That's the approach I'm going to take here. Chart 1 shows the Industrials Select Sector SPDR (XLI) hitting a new recovery high today and moving closer to its summer high. Its relative strength line has been flat during the summer, but is starting to rise. If the stock market rally continues at least to yearend (as I believe it will) the XLI should be one of the first sector ETFs to breakout to the upside. If an investor doesn't like the ETF, he or she can look at one of the bigger sector stocks -- like GE.

Chart 1

GENERAL ELECTRIC LEADING XLI HIGHER... Generals are supposed to lead and this one is. And that's important. Not only is General Electric considered to a bellwether for the NYSE, but it's the most heavily-weighted stock in the Industrial ETF shown in Chart 1. GE accounts for 20% of the Industial Select Sector SPDR which puts it in the top spot. That means it carries a big influence on the direction of the entire sector. As we did yesterday, we'll look at GE from three different time spans. The daily bars in Chart 2 show the GE moving up to a new recovery high after recently breaking through resistance at its summer high. [That bodes well for Industrial ETF eventually doing the same]. Its daily relative strength line is also rising. GE is one of today's most actively-traded stocks which means the volume is there as well. But there's more.

Chart 2

GE NEARS TEST OF EARLY 2004 HIGH... It's always a good idea to consult weekly and monthly charts to put short-term trends into perspective. The next two charts show why. The weekly bars in Chart 3 show that GE is within a point of its early 2004 peak. That will be an important test for the stock, the industrial sector, and the entire market. A close in new high ground (which appears likely) would be bullish for all three. The weekly ratio line is also instructive. Notice that it broke its 2004 down trendline a couple of months ago and is now rising. That also puts the stock in a leadership role. That's a good thing for a bellwether stock. A glance at the daily and weekly charts, however, might lead one to conclude that the stock is "too high" to buy. Not according to the monthly chart.

Chart 3

GE LOOKS CHEAP ON MONTHLY CHART... The monthly chart of GE dispels the idea that the stock is "too high". After peaking in the high 50s three years ago, the stock has retraced only a third of that bear trend. The horizontal Fibonacci retracement lines show some potential upside targets. A 50% retracement of the previous bear trend would put the stock at 40, which also corresponds with chart resistance along the early 2002 high. A 62% retracement would carry the stock to 45. The relative strength ratio line has just broken a down trendline starting during the first half of 2001. That means that GE is now outperforming the S&P 500 for the first time in three years. That bodes well for the market and the industral sector.

Chart 4

WHY WE USE MOVING AVERAGES ... You've probably noticed that I rely very heavily on moving average lines. There are some good reasons for that. The main one is that they are one of the simplest ways to spot trend changes. But not all moving averages are equal. The 50-day moving average, for example, is most useful in spotting "intermediate" trend changes which can last anywhere from one to three months. A 20-day moving average is better for spotting "short-term" trend changes which can last for days or weeks. The 200-day average helps determine the direction of the "long-term" trend of a market, which can last for months and even years. Of the three, the 200-day average carries the most weight. For timing purposes, however, the 20- and 50-day lines are more useful. My favorite is the 50-day line. While a crossing of the 20-day line gives an earlier trend signal, the crossing of the 50-day line suggests that the trend has more staying power. This is true for the timing of entry and exit points. Buy signals are given when the price crosses over a moving average line. In that sense, upside moving average crossings are good for buying purposes. Crossings below the moving average lines can be used for selling purposes. They're not perfect, but they are very helpful. Moving averages also provide good discipline. A simple rule to sell a stock that closes under its 50-day moving average can prevent a lot of losses.

USING THE 50-DAY AVERAGE ON GE... The next chart shows why I find the 50-day most useful. Since we're following GE today, let's compare the daily price of GE to its 50-day average for the last year. The blue line is the 50-day average. [That's computed by adding up the closes for the last 50 trading days and dividing the total by 50]. Buy signals are given when the price closes over the blue line (see green circles); sell signals are given when the stock closes below the blue line (see red circles). The first two buy signals were given last December and May. In both cases, the stock rose after that. The first sell signal was given during March. The stock fell heavily after that. [The signals don't always work out that well, but they did in the case of GE]. Let's examine the last two signals more closely and bring the 200-day average into play for GE.

Chart 5

COMBING MOVING AVERAGE LINES... Chart 6 examines the last two GE moving average "signals" and also shows why it's important to keep an eye on the 200-day average. GE gapped under its blue 50-day average in early August (see red circle). As it turns out, that wasn't a great signal. Notice, however, that GE stabilized above its (red) 200-day average (see red arrow). That suggested that the "long-term" trend was still up. Within two weeks of issuing a "sell" signal, GE crossed back over its 50-day line to issue a new "buy" signal. That signal is still in effect. Notice that GE never closed back under its 50-day line after issuing a buy signal. That's another test of a moving average signal. Once a market closes above a moving average, that line becomes a support level. If it closes under the moving average, the signal becomes suspect. The blue arrow in late August shows the stock dipping under the blue line "intra-day" before closing higher. Intra-day moves don't count. Only the "closes" matter. This example shows the strength and weakness of moving averages. They may cause occasional "whipsaws", but they help keep us on the right side of the market. That's why we use them and why I call your attention to markets that cross their 50- and 200-day averages. It's a simple way to alert you to potential trend changes. You can then examine the market more closely using other charting tools. For weekly charting, the 10-week average replaces the 50-day, and the 40-week replaces the 200-day.

Chart 6