10.05.2022
With the S&P 500’s breadth oversold and encouragement from this week’s strong price advance, the KRE ETF might offer a profitable way to trade this budding counter-trend rally.
For educational and informational purposes only.
THE CASE FOR A POTENTIAL COUNTER-TREND RALLY
It’s Wednesday night, and the S&P 500 (SPX) has been racing to the upside. After testing the June low and the 2018 anchored volume-weighted average price last Friday, SPX has rallied roughly 5.5%. See the SPX chart below. These last few days have really fanned the flames of excitement. Talk of this week’s breadth and volume thrusts are loud. While we do not want to fight the trend, which is still down, and we do not want to fight the Fed, which is still tightening monetary conditions, there is some evidence of a counter-trend rally developing. If this is materializing, we would like to participate.
First up is SPX’s bullish percent index. This measure of breadth reached oversold levels and is now rallying as it has in the past. This chart shows breadth has flipped from a down column of Os to an up column of Xs. This signals that breadth is expanding as members of the index print point-and-figure double-top buy signals. For more information on this methodology, consider reading Point & Figure Charting by the great Thomas Dorsey.
SPX Bullish Percent Index. Click to enlarge.
Another chart which screams oversold shows the percent of stocks above their 50- ,150- , and 200-day moving average. Last week saw the lowest levels on this chart since the Covid-low.
Percent of stock above their 50-, 150-, and 200-day moving average. Click to enlarge.
One more measure of breadth is the percentage of SPX stocks with RSI 14 readings of less than or equal to 30. We can see, going into Friday we had more stocks with oversold RSIs than we have had all year.
Percent of stocks with RSI-14 <= 30. Click to enlarge.
Looking at SPX itself, the idea is that oversold mean-reversion and momentum will lead price higher. The levels we are watching for potential resistance are the Covid-low AVWAP around 3,800 in green, then the zone from 3,950 to 4,050 which represents the half and two-thirds retracement of the move from the August high at A to Friday’s test at B, and finally, If we get this far, we are watching the 200-day simple moving average in red and downward sloping trendline around 4,200.
SPX Daily. Click to enlarge.
THE IDEA
Looking though the SPDR ETFs, KRE, the regional banking ETF has been printing 63-day relative strength highs on and off since SPX’s June bottom. Those can be seen when the relative strength line itself turns orange. Price itself held well above its own June bottom. Momentum has broken its downtrend line, hopefully foreshadowing some mean reversion ahead. For more info on KRE and its 143 holdings, click here.
Price has coiled and has the potential for a move higher. We want to place a buy-stop ahead of the move to get the best fill-price, though not waiting for confirmation is also the riskiest type of entry. If price resolves to the upside, first we would look for potential resistance around $66. This is where both the 200-day moving average and the AVWAP from the 2022 high are sitting. Perhaps taking partial profit here might be best. If we can break through $66 and this move has legs, similar to the previous rally, a measured move takes us up to the $76-$77 area.
KRE Daily. Click to enlarge.
TRADE DETAILS
Measured move: (68.75 - 56) + 63 = 75.75.
Sell-limit target: $75.75.
Buy-stop entry: $63. +12.75.
Sell-stop stop-loss: $58.50. -4.5 2.72x ATR10.
Re/Ri: 2.83:1.
ATR10: 1.65.
Note: This is a risky trade. The reward to risk is not quite 3 to 1, we are going long below a falling 200-day moving average, and potential resistance is close by. A small position size is critical to controlling risk here.
WHAT'S NEXT?
We watch for price to breakout of its coil.
If it breaks to the upside, we watch SPX and the levels outlined above to make sure its rally remains in force.
We do the same with the breadth charts above.
We watch KRE itself in order to raise our trailing stop, take partial profits around $66, and watch to see what’s next.
The timeframe here is a few days to a few weeks.
As always, thank you for reading. This article is for educational and informational purposes only. Trade at your own risk. The author may or may not have a position in the securities mentioned. Read our full disclaimer here. Please reach out with any feedback or comments. I would love to know if you agree, disagree, or don't care at all. Louis@eastcoastcharts.com
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