Up until the start of this month, the Consumer Discretionary Select Sector ETF (XLY) was having a lackluster year…

It started off 2023 by initially rallying strongly. But XLY peaked and reversed in February, giving up a big chunk of those gains.

It then traded sideways in a tight band for three months.

Now strong buying momentum in its two largest constituent stocks – Tesla (TSLA) and Amazon (AMZN) – has seen XLY start to rally strongly. Combined, those two stocks represent just under 40% of XLY’s holdings.

Only halfway through June, XLY is already up 11% for the month.

Yet that strong buying is pushing XLY into overbought territory. So today, I want to see how things might play out from here…

A Common Reversal Pattern

On the left-hand side of the chart below, you can see the tail of XLY’s downtrend, which began back in November 2021.

The August peak was a lower high than earlier declining peaks. And XLY bottomed out in late December.

Consumer Discretionary Select Sector ETF (XLY)

Source: eSignal

XLY then found a base when the Relative Strength Index (RSI) began to track higher (orange line) out of oversold territory.

XLY began to rally in conjunction with two bullish signals:

1. The RSI broke through resistance (green line) and rallied strongly into the upper half of its range.

2. The 10-day Moving Average (MA, red line) broke above the 50-day MA. Both then tracked higher.

That sharp rally in January came to an end, though, with a common reversal pattern…

As we saw when we checked in on XLY on March 13 (red arrow), the RSI made an inverse ‘V’ and reversed (left red circle) from overbought territory. That caused XLY to roll over and fall.

XLY’s retracement petered out when the RSI recovered and began moving along support in the upper half of its range.

As the chart shows, that sideways pattern began to develop into an uptrend at the start of June.

Take another look:

Consumer Discretionary Select Sector ETF (XLY)

Source: eSignal

That move higher coincided with the RSI rallying strongly… and a bullish signal from our MAs.

The 10-day MA crossed above the 50-day MA and then tracked it closely. It then began to accelerate above it toward the end of May. That strong momentum is now bullishly pulling the 50-day MA higher too.

But the RSI is once again back in overbought territory (right red circle).

So what am I looking for around here?

Watch for Any Decisive Move Down

When a stock surges like XLY, we can expect to see a pullback as profit-takers sell out of their long positions.

However, we need to let the RSI dictate any reversal and not preempt any move.

That’s why I’ll continue to watch the RSI closely. It is well inside overbought territory. But we need to see it make a clear move down before looking to enter a short position.

The other thing I’ll keep a watch on is our MAs…

As I mentioned, the 10-day MA is currently accelerating strongly above the 50-day MA. This suggests that the current up-move might still have further to play out.

However, if the RSI makes a decisive move down and the 10-day MA’s climb stalls, then that will increase the odds of a pullback.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

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