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This Sector Shows Promising Signs of a Bounce

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Larry’s note: Welcome to Trading with Larry Benedict, my free daily eletter, designed and written to help you make sense of today’s markets. I’m glad you can join us.

My name is Larry Benedict. I’ve been trading the markets for over 30 years. I got my start in 1984, working in the Chicago Board Options Exchange. From there, I moved on to manage my own $800 million hedge fund, where I had 20 profitable years in a row. And, I’m featured in the book Market Wizards, alongside investors like Paul Tudor Jones.

But these days, rather than just trading for billionaires, I spend a large part of my time helping regular investors make money from the markets. My goal with these essays is to give you insight on the most interesting areas of the market for traders right now. Let’s get right into it…

One sector that has fared even worse than the broader market this year is the Consumer Discretionary Select Sector ETF (XLY).

While the Nasdaq had falls of around 30% in 2022, XLY has fallen even further.

From its January high to its low last week, XLY fell a whopping 35%.

The problem for XLY has been twofold…

First, 40-year high inflation along with rising interest rates, caused consumers to cut back on discretionary spending.

Plus, the two stocks that represent over 40% of its holdings – Amazon (AMZN) and Tesla (TSLA) – have been hit hard by the re-rating of tech stocks.

Amazon is down around 40% so far this year, while Tesla shares have nearly halved.

When you see massive falls like that, stocks often look for any reason to bounce.

And since XLY is showing some early positive signs, today I’m going to see what we can expect next.

Let’s look at XLY’s chart…

Consumer Discretionary Select Sector ETF (XLY)

Source: eSignal

The 50-day moving average (MA – blue line) shows XLY’s long-term trend has been down since the start of 2022.

That selling in XLY began when the 10-day MA (red line) crossed down below the 50-day MA in early January.

This down move coincided with the Relative Strength Index (RSI) breaking into the lower half of its band (below the green line), where it remained until XLY’s bounce in mid-March.

However, when we last checked XLY on April 20 (red arrow), that bounce was running out of steam.

After temporarily breaking back above the 50-day MA, the 10-day MA soon crossed back down and headed lower again.

The RSI showed a similar bearish story…

As you can see, after briefly breaking back into the upper half of its band, the RSI also lost momentum and fell back below the green line. This lead to further selling.

But recently, there have been some promising signs… as shown by the divergence between the orange lines.

At the same time XLY made a lower low last week, the RSI made a higher low out of oversold territory (below the lower grey dashed line).

This chart pattern often precedes a change in direction, which is why XLY bounced off its recent low.

It’s still early with this recent move, but what am I expecting from here?

Well, let’s take another look…

Consumer Discretionary Select Sector ETF (XLY)

Source: eSignal

For XLY to keep rallying, the RSI needs to continue its move higher. Right now, it’s moving back up toward the green line.

For the up move to really gain traction, the RSI will need to break back above the green line and stay there. This pattern could provide a setup for a potential long trade.

However, breaking above the RSI is key.

Back in February through early March, the RSI traded right up to the green line but failed to break higher.

Each time the RSI peaked on resistance (green line) and rebounded lower, XLY’s stock price followed it down.

If a similar pattern repeats with the RSI’s current move, then this bounce will quickly lose momentum.

We would then need to wait for the RSI to form an inverse ‘V’ and be ready to sell into this rally.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

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