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On November 17, we took a deep dive into the oil sector…
After rallying a massive 70% in the first half of 2022, the Energy Select Sector SPDR Fund (XLE) pulled back sharply and dropped 30% by mid-July.
Since then, it’s been a slow grind higher. XLE didn’t surpass its June high until November.
When we last looked at XLE, it had just peaked at its current high for the year.
However, the chart warned of a potential change in direction. So today, we’ll see how that unfolded and what to expect as we scope out trades.
Reversal Out of Overbought Territory
On the chart below, the 50-day moving average (MA – blue line) shows XLE’s long-term uptrend that began at the start of 2022.
That trend retraced from June to August before heading higher again. Also, notice the pattern of the Relative Strength Index (RSI)…
Energy Select Sector SPDR Fund (XLE)
Source: eSignal
When the RSI formed an inverse ‘V’ (red circles) at or near overbought territory (upper grey dashed line), and then dropped lower – XLE also reversed.
However, what happened around support (green line) in those moves is key…
When the RSI reversed at ‘A’ and ‘B,’ the down move petered out at support. With the RSI bouncing off that support, XLE then went on to rally.
But we see a different pattern with the reversals from ‘C’ and ‘D’…
In both cases, the RSI traded straight down through support and continued into oversold territory (lower grey dashed line). That led to a much bigger pullback than the ones marked ‘A’ and ‘B.’
Then, when the RSI formed a ‘V’ out of oversold territory (lower grey dashed line), it tracked back higher. And XLE bottomed out before rallying.
Take another look at the chart…
Energy Select Sector SPDR Fund (XLE)
Source: eSignal
On November 17 (red arrow), we saw how that rally out of oversold territory in September had carried right up through resistance and into overbought territory.
From there, I noted how an emerging pattern warned of a change in direction…
While XLE was making higher highs (upper orange line), the RSI made inverted ‘Vs’ and began tracking lower… making lower highs (lower orange line).
When buying momentum is falling like this in the RSI, a stock pullback is typically in the cards.
And that’s exactly how things have played out. XLE is pulling back and could soon break below the 50-day MA.
So what am I looking for around here now?
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Tracking Below Resistance
Right now, I’m keeping a close watch on the RSI…
Recently, it just broke below support. For XLE’s uptrend to resume, the RSI must first break back through resistance and remain in the upper half of its range.
However, if the RSI continues to track lower below resistance, then that’ll likely mean XLE’s current pullback will increase in momentum.
The longer the RSI stays in its lower half, then the bigger that pullback will become.
I’ll also be watching our MAs…
Right now, the two MAs are converging. If the 10-day MA crosses below the 50-day MA – and then accelerates lower – then that’ll add further confirmation of XLE’s down move.
And that would set us up for a potential short trade…
With the RSI stuck in its lower band and the MAs bearishly crossing lower, XLE could soon trade back around $80.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
Reader Mailbag
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