SMALL-CAPS START SHOWING RELATIVE STRENGTH -- TREND, SETUP AND TRIGGER FOR IWM -- XRT BREAKS RESISTANCE ZONE -- SOCIAL MEDIA ETF FORMS BULLISH CONTINUATION PATTERN -- COAL STOCKS TURN INTO MARKET LEADERS -- XME BREAKS RIM RESISTANCE
SMALL-CAPS SHOW A LITTLE RELATIVE STRENGTH ... Video note: I am on the road today and there is no video for Monday. Video will return on Tuesday when I get back to the office. Even though it is just one week, small-caps are starting to show relative strength by outperforming. Note that the Russell 2000 iShares (IWM) gained 2.4% over the last six days and is outperforming the Russell 1000 iShares (IWB), which gained just .74%. Keep in mind that IWM represents small-caps and IWB is dominated by large-caps. Chart 1 shows IWM breaking below its 200-day moving average in late July and moving back above this key average today. Despite a strong open, the ETF closed off its high to affirm first resistance in the 114 area. A follow thru close above this level is needed to complete the breakout. Failure to follow through and a break below 111 would be quite negative. The indicator window shows IWM relative to IWB using the price relative. Notice that the ratio bottomed in late July and turned up the last few weeks. It is just a week so chartists should watch for follow thru and to see if the price relative (IWM:IWB ratio) can break above the early July high. Chart 2 shows the Russell 1000 iShares with an indecisive candlestick after Monday's strong open.
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Chart 1
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Chart 2
TREND, SETUP AND TRIGGER FOR IWM... I presented a basic trading strategy at ChartCon this year. Today I would like to review this system and apply it to the Russell 2000 iShares. Overall, I think a trading strategy requires at least three parts: trend, setup and trigger. First, and foremost, trend is used to identify overall direction. We want to look for bullish setups in an uptrend and bearish setups in the downtrend. Second, a setup is used to identify a price level with reduced risk. This would be a pullback within an uptrend or an oversold bounce within a downtrend. Third, we need a trigger to indicate that the bigger trend is resuming. During a pullback within an uptrend, a security can become oversold and remain oversold. This is why we need a bullish trigger to indicate that buying interest is returning. Next, let's look at the indicator details.
Chart 3 shows the Russell 2000 iShares with the 125-day TRIX, RSI(14) and StochRSI(14). TRIX is used for trend identification. TRIX measures the 1-period Rate-of-Change of the 125-period triple smoothed exponential moving average (TEMA). TRIX is positive when TEMA is rising (uptrend) and negative when TEMA is falling (downtrend). 14-period RSI is used to generate the setup by identifying a pullback within the uptrend. A move below 40 signals a slightly oversold condition that warrants our attention. I used 10-period RSI for SPY, but changed to 14-period RSI for IWM because it is more volatile. StochRSI is used for the trigger. A move to 1 indicates an upthrust in momentum that signals an end to the pullback. This three step process is certainly not infallible, but it does provide us with a framework for trading in the direction of the bigger trend. As far as stops are concerned, a quick move below .20 in StochRSI would signal a momentum failure or chartist can set a trailing stop using the Chandelier exit.
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Chart 3
The current IWM chart shows a long-term uptrend because 125-day TRIX is firmly positive. Keep in mind that we are not concerned with the immediate direction of the TRIX oscillator. We just want to know if it is positive or negative. 14-period RSI moved below 40 to become oversold in mid July. The first two pieces of the puzzle were in place three weeks ago, but we did not get the trigger until today when StochRSI surged to 1. IWM became oversold twice as RSI did a double dip. Though certainly not fool proof, waiting for a StockRSI trigger would have prevented a whipsaw. There are no guarantees that Monday's signal will work. Frankly, it will work until its does (i.e. it is proven otherwise). And finally, notice that this indicator signal has triggered before a breakout signal on the first chart. Momentum indicators often trigger before a price breakout.
XRT BREAKS RESISTANCE ZONE... Retailers are showing some life as the Retail SPDR (XRT) breaks above the late July highs. Price action after the breakout was indecisive, but the breakout is holding for now. Chart 4 shows XRT hitting a new high in early July and then retracing around 62% with a decline to the 83-84 area. After firming for a few weeks, the ETF broke out with a surge over the last two days. This signals a successful support test, a higher low and a resumption of the bigger uptrend. The indicator window shows momentum improving as MACD turns up and breaks above its signal line. The chart signal is valid as long as 83.5 holds on a closing basis and the momentum signal is valid as long as MACD holds above its signal line.
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Chart 4
SOCIAL MEDIA ETF FORMS BULLISH CONTINUATION PATTERN... I featured the Internet ETF (FDN) last week as the ETF consolidated with a triangle and the Bollinger Bands contracted. Chart 5 shows FDN challenging resistance and the upper Bollinger Band with an advance on Monday. Aroon Up remains above Aroon Down to keep this indicator pair bullish. A move above 70 in Aroon Down would provide the first sign of an uptick in selling pressure. With Facebook, LinkedIn and other social media stocks, it is little surprise that the Social Media Global ETF (SOCL) is also showing strength. This ETF includes Russian and Chinese internet stocks.
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Chart 5
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Chart 6
Chart 6 shows SOCL advancing from early May to early July and then forming a cup-with-handle. This bullish continuation pattern, which was popularized by William O'Neil of IBD, is basically a large consolidation within an uptrend. The cup represents a dip and recovery, the handle represent a smaller dip-recover near the highs and rim resistance represents overhead supply. A breakout would signal a continuation of the prior advance and project a move similar to the size of the cup. The cup extends around 2 points and a breakout at 20.2 would target a move to the 22 area.
COAL STOCKS TURN INTO MARKET LEADERS... Something is making coal shine again as the Coal ETF (KOL) leads the market with a surge above its May highs. Not many ETFs are currently above their May highs. Chart 7 show KOL firming in February-March and then breaking above two key moving averages with a surge in April. After choppy trading around the 200 and 50 day moving average, KOL got its mojo back with a breakout surge in late July. Notice that the 200 and 50 day moving averages held during the late July pullback to 18.75 and chartists can use this level to mark support. The indicator window shows MACD turning positive at the end of July and remaining positive. Note that KOL consists of several international stocks and US coal stocks may perform differently.
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Chart 7
XME BREAKS RIM RESISTANCE ... John Murphy noted strength in industrial metals at this year's ChartCon event and strength in metals appears to be playing out in the Metals & Miners SPDR (XME). Chart 8 shows XME with a bullish cup-with-handle pattern since April. This pattern was featured last week and we are seeing a confirmation breakout this week. Notice how the ETF surged above the April-July highs for a clear break above rim resistance. This resistance zone now turns into first support in the 43 area. The indicator window shows MACD turning up and breaking above its signal line as momentum confirmed the breakout.
