Consult the Sector - Option

Consult the Sector

When a sector or industry group is in favor, the component stocks may run up for several weeks or even months. Eventually the overbought condition will cause a period of consolidation or a correction. A correction can be identified by a retracement of the previous trend.

A stock in a strong sector may resume the uptrend once price has corrected sufficiently. Traders who wish to participate in the resumption of the prior uptrend should watch closely for signals indicating that the correction may be ending.

Many stocks in the Energy sector made significant advances during 2005. Figure 8-4 shows XLE, the Spider Sector ETF for the Energy group. After the price advance from the January low to the March high, price retraced a signifi­cant amount of the previous uptrend. The retracement was approximately 62%, a well-known Fibonacci level.

A bullish Morning Star also formed near that level indicating a possible end of the correction. Several days later price closed above the top trend-line of a falling channel giving further evidence that price was rising again. The cor­rection provided an excellent opportunity for traders to purchase shares at lower prices.

Oil stocks were a hot commodity during 2005. They were a major con­tributor to the run up in the XLE chart illustrated above. A challenge for traders was to know at what point the stocks in this industry had run up too far. Figure 8-5 shows a significant run up on Exxon Mobil. Traders who watched closely for reversal signals received timely warnings that Exxon was about to reverse direction.

Reversal candlestick patterns formed on both the daily and weekly time frames. Figure 8-5 shows a bearish Harami-Doji (also referred to as a Harami Cross) on the weekly chart. Figure 8-5a shows a Tower Top on the daily chart.

Traders who primarily view charts on the daily time-frame can gain an edge by also incorporating the weekly chart in their analysis. Support and resistance levels, that may not be seen within the time-period displayed on the daily chart, can easily be seen on the weekly chart.

Sometimes support and resistance levels formed months, or even years, in the past. However, they will be seen by chartists consulting the higher time­frames, such as weekly or monthly. Just because a support or resistance level is “old,” does not mean it is not still strong.

Figure 8-6 shows a weekly chart of Hudson City Bancorp. On this view, it is easy to see that the stock has traded in a range for a couple of years. Looking at just a few months of data on a daily chart does not give as thorough a picture as can be seen on the weekly chart.

Candlestick patterns are visible on all timeframes. The higher the time frame the more meaningful the implication of the pattern. If a bearish reversal pat­tern forms at the end of an advance on the weekly or monthly chart, ignore it at your own peril!