This Red-Hot Sector Is in Danger of Overheating

Two weeks ago, we took a close look at the Industrial Select Sector SPDR ETF (XLI).

XLI has benefited from the flow of money out of “Big Tech” and into older-style, large-cap valuation plays – such as that of the SPDR Dow Jones Industrial Average ETF Trust (DIA).

That rotation helped XLI post a healthy 15% gain in the last two weeks in October.

However, as I noted on November 1 (red arrow on the chart below), that sharp rally put XLI in danger of overheating.

While XLI did initially have a brief pullback, it has rallied even further in recent days… raising the temperature gauge once more.

XLI is now up over 20% since mid-October and is just 7% below its January high.

So after such a strong run-up, today I’m going to see what’s in store for XLI from here…

Finding a Base

On the chart below, you can see a classic bear pattern in action with XLI making a series of lower highs. The two moving averages (MAs) further illustrate the downtrend.

The 50-day MA (blue line) has steadily declined. And the 10-day MA (red line) bearishly crossed below it each time a new down leg began.

Take a look…

Industrial Select Sector SPDR ETF (XLI)

Source: eSignal

You can also see that the Relative Strength Index (RSI) has bearishly remained in the bottom half of its range (below the green line) throughout most of the down move.

When XLI rallied strongly from July to mid-August, the RSI formed a ‘V’ in oversold territory (lower grey dashed line) and then rallied higher, helping it find a base.

Then, as the RSI broke up through resistance into the upper half of its range, XLI’s strong uptrend gathered pace.

But that rally petered out and then reversed, when the RSI formed an inverse ‘V’ from overbought territory (upper grey dashed line) before tracking lower (red circle).

Then, after drifting lower from late August through September (when the RSI reversed from overbought to oversold territory), the same pattern repeated…

Take another look at the chart…

Industrial Select Sector SPDR ETF (XLI)

Source: eSignal

Again, XLI found a base with the RSI forming a ‘V.’ It then rallied as the RSI began to track higher and broke into the upper half of its range.

That strong upward move was further confirmed when the 10-day MA broke strongly above the 50-day MA.

But the RSI has recently climbed upward into overbought territory. So what can we expect from here?

Overbought Territory

After the strong up move, XLI is now tracking within a dollar of its August peak…

And with the RSI in overbought territory, I’ll be watching closely to see if the pattern from August repeats (red circle).

If the RSI forms an inverse ‘V’ and then reverses sharply, that’ll mean XLI’s current upward trend has likely peaked – for now.

That could provide the setup for a potential short trade.

But we need to see a definitive reversal in the RSI before committing to any short trade.

If the RSI tracks sideways along the overbought line – without a clear move lower – then this current upward move could still have further to run…

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

Reader Mailbag

In today’s mailbag, One Ticker Trader member William thanks Larry on a recent gain…

I really like the One Ticker Trader nimbleness to take a quick, small profit rather than hold out for a bigger profit – but risk taking a loss. Early on in my membership, I took a loss because I didn’t get the sell message in time.

I solved this by downloading the One Ticker Trader phone app that sends me text messages. Thanks Larry. (I just made several hundred dollars in the recent one-day turnaround of the DIA ticker.)

– William T.

Thank you, as always, for your thoughtful comments. We look forward to reading them every day at [email protected].