Watching the latest chart patterns is a vital activity for traders. We can anticipate what’s coming next based on how the market is moving right now.
Yet checking out previous chart patterns is also crucial to our trading success. And today, I’m going to show a great example of why…
A few weeks ago, we looked at the Utilities Select SPDR Fund (XLU). Despite being a “mundane” exchange-traded fund (ETF), XLU has moved around a lot since the start of 2022.
In fact, on August 4 (red arrow on the chart below), XLU was in its seventh major move since January. And it was about to test a key technical level.
So let’s take a look at what’s happened to XLU since then, and see what it can teach us about making great trades.
XLU Goes Overbought
In the chart below, we can see how XLU’s most recent rally began in mid-June at ‘A.’
After making a double ‘V’ out of oversold territory (lower grey dashed line), the Relative Strength Index (RSI) rallied strongly, causing XLU to bounce off its June lows.
Take a look…
Utilities Select SPDR Fund (XLU)
Source: eSignal
However, XLU’s rally petered out as the RSI ran into resistance (green line).
The RSI wasn’t able to break into the upper half of its range and stay there, so XLU began to drift lower before bottoming out at ‘B.’
From there, the RSI finally broke up through resistance and XLU’s rally resumed. Then, the rally was further confirmed once the 10-day moving average (MA – red line) broke above the 50-day MA (blue line).
When we last looked at XLU on August 4, the rally had pushed it right into overbought territory (upper grey dashed line)…
These overbought and oversold signals are important because they often show the setup for a potential trade.
However, inexperienced traders anticipating XLU’s turnaround might’ve thought this was the perfect moment to act. But the RSI going overbought or oversold isn’t enough to enter a trade by itself.
Instead, we need to see it reverse from that level before considering opening a new position. And the previous patterns on the chart (red circles) show why…
Utilities Select SPDR Fund (XLU)
Source: eSignal
When XLU previously reversed, the RSI traded sideways for days (sometimes weeks) before breaking lower. That’s why patience is key in these situations.
If we had entered a short trade on August 4 simply because the RSI was overbought, then we would’ve lost money. Since then, XLU has climbed from around $74 to nearly $78.
And after rallying these past couple of weeks, XLU is even further into overbought territory.
We Profit From Reversions
So, what can we expect from here?
Again, the RSI’s action is key. Right now, it’s still tracking higher and pushing XLU’s stock price up. Plus, the 10-day MA is still accelerating bullishly above the 50-day MA.
However, if the RSI forms an inverse ‘V’ and begins to track lower, then that could provide the setup for a potential short trade.
Remember, we’re looking for stocks that have been pushed too far in either direction so we can profit when they revert to their mean.
A break back below overbought territory toward support would add further momentum to a down move – just like we saw in April.
So in the coming days, traders should keep a close watch for the right moment to act.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
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