In this post I want to look at a way to use volatility-based support and resistance to gain insights on sector relative strength. If you want to better understand the support and resistance discussed herein you can see the VBSR QuickStart chart.
Last month we looked at the overhead resistance that faced the XLK (Technology SPDR), and the XLB (Materials SPDR). The resistance for the XLK was further away than for the XLB. I also mentioned that the XLY (Consumer Discretionary SPDR) resistance was similar to the XLK, and that all were more overbought than not.
As soon as I posted, poor economic news clobbered stocks across the board. That set up a great opportunity to watch them claw their way back up within their respective resistance environments. As shown in the percentage relative strength chart below the XLB outperformed the S&P and the XLK. Also the XLY beat them all and was the best performing sector. It is at this point that their resistance levels become more critical if the market continues to rise.
Source: http://www.sectorspdr.com/spdrchart/
Another important consideration is the relative strength demonstrated during this last month. Here is a different way to look at relative strength.
In this analysis we can look at a smaller time frame by using hourly charts. Therefore this analysis is for shorter term trading decision support. An hourly time frame enables us to look at specific price action with respect to recent and current resistance areas.
When price reaches higher and pushes into previously established resistance, volatility measurement responds by defining new and higher levels of resistance.
In the chart below the XLY establishes a volatility peak on 8/19/2010; see circle 1. Forward to circle 2 and you can see that on 9/3/2010 the XLY moves into the resistance zone established by the 8/19 peak. Consequently the price action of 9/1 through 9/8 ultimately causes a new and higher peak to form. This effectively moves resistance higher. When this occurs the odds that price will move higher increase.
Now contrast that to the chart below of the XLK. Examine the same dates as labeled with the same numbers. It also established a new volatility peak on 8/19/2010; see circle 1. However at point two, also on 9/3, its price action does not reach the previous volatility peak the way that XLY did. Subsequently its resistance zone does not climb higher. In this respect the XLK sector is showing less relative strength, compared to the XLY, over the previous eight trading sessions.
Of the nine sector SPDR ETF's the one that seems to be demonstrating the most relative strength is the XLP (Consumer Staples SPDR), shown in the chart below. Like the other two it set a new resistance peak on 8/19/2010. The main difference for the XLP is that it's price action has not allowed enough band retracement to cause a new peak to form. Also its upper N band is now moving up rapidly, which serves to establish a relatively higher resistance zone in the future. This clears the way for price action to move higher, less impeded by resistance.
It's also worth noting that two other sectors pushed resistance higher. The XLU (Utilities SPDR) pushed its resistance lines higher with a band peak that occurred on 9/2/2010, and the XLF (Financials SPDR) did so on 9/3/2010. With utilities and consumer staples showing strength, is bearish sentiment showing itself?
I think there are many good ways to measure relative strength, and this is one of them. If price is pushing the levels set by its previous boundaries, even as measured by a derivative, then it could be said that it is performing past its potential.
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