While most major sectors plummeted at the start of 2022, the financial services sector held up relatively well.

When the Financial Select Sector SPDR Fund (XLF) peaked in mid-March, it was barely a few dollars lower than its January high.

However, as the year progressed, the wide-spread selling caught up with XLF as it made a series of lower highs.

By the time XLF bottomed out in June through July, it had fallen 27%.

But when we last checked XLF on July 12, it was showing tentative signs of a new rally.

Now that rally is gathering pace as it plays catch-up to the broader market. So today, we’ll see what’s next for XLF.

Taking a Fresh Look at XLF

Let’s check out XLF’s chart…

Financial Select Sector SPDR Fund (XLF)

Image

Source: eSignal

The 50-day moving average (MA – blue line) shows XLF’s long-term trend.

After trading flat at the start of 2022, the 50-day MA accelerated lower in March before flattening out again in July. The 10-day MA (red line) shows just how much XLF moved during that downtrend.

In three months, the 10-day MA zig-zagged across the 50-day MA six different times.

Then, it tracked below the 50-day MA up until the end of July – which is when the current rally began.

There are several technical signals that have combined to underscore XLF’s rally…

  1. Around mid-June, the Relative Strength Index (RSI) formed a double ‘V’ out of oversold territory (lower grey dashed line) – which caused selling in XLF to wane.

  2. As the RSI slowly built momentum (red line in the bottom half of chart), XLF formed a base along the orange line.

  3. Then, as the RSI broke through resistance (green line) into the upper half of its range, XLF’s rally gained traction.

The 10-day MA breaking back above the 50-day MA further confirmed this bullish trend. Since then, the 10-day MA has continued to accelerate above the 50-day MA.

If this pattern continues and the 50-day MA trends higher, then XLF’s rally will likely go further.

XLF’s Setting Up a Couple Trades

So, what can we expect from here?

Well, let’s take another look at the chart…

Financial Select Sector SPDR Fund (XLF)

Image

Source: eSignal

Just as a series of lower highs identifies a downtrend, the opposite applies in an uptrend. So XLF will need to make higher highs for this rally to continue long term.

As we saw above, this recent burst higher put XLF just above its May high. The next test for any prolonged rally would be for XLF to break above its April high at $38.31.

While this break above the May high is a positive sign for XLF’s long-term prospects, the RSI is now in overbought territory (upper grey dashed line).

And that means we’re looking at a few potential trades…

If the RSI reverses sharply and tracks lower, then we could have a setup for a potential short trade.

But if the RSI pulls back and holds support (green line) – meaning it stays in the upper half of its band – then we could use any pullback as the setup for a potential long trade.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

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