The consumer discretionary sector has been facing headwinds in 2022.

Runaway inflation has forced the Federal Reserve to increase interest rates four times already this year. And there could be several more rate rises to come.

As a result, consumers are keeping their wallets firmly in their pockets.

From its January high to June low, the Consumer Discretionary Select Sector ETF (XLY) dropped a massive 37%.

But when we last checked XLY on July 21 (red arrow on the chart below), it had found a short-term base and was in the early stages of a rally.

Today, we’ll see how that move panned out and discuss what we can expect from here…

Can the Rally Continue?

On the chart below, we can see how XLY’s downtrend kicked off in early January.

First, the 10-day moving average (MA – red line) crossed below the 50-day MA (blue line). From there, the 50-day MA trended lower through July…

Consumer Discretionary Select Sector ETF (XLY)

Source: eSignal

Despite a brief break back above in March and April, the 10-day MA has tracked below the 50-day MA throughout the rest of XLY’s downtrend.

XLY’s downtrend features a series of lower highs at ‘A,’ ‘B,’ and ‘C.’

However, as the Relative Strength Index (RSI) gradually tracked higher through June and July, XLY formed a short-term base along the red line.

Once the RSI bullishly broke up through resistance (green line), XLY began its rally. Then, the rally gained momentum after the 10-day MA crossed back above the 50-day MA…

Consumer Discretionary Select Sector ETF (XLY)

Source: eSignal

As I wrote on July 21, these two signals were crucial for XLY’s rally to continue.

The next test was to break back above XLY’s June 2 high (C) at $158. And on July 29, XLY broke above this level when it gapped higher.

Recently however, XLY has run into a common pattern…

While XLY made a series of higher highs (upper orange line), the RSI showed momentum had already peaked (lower orange line). Divergence between these two lines often means a pullback is in the cards.

After the RSI reversed sharply, XLY’s stock price sold off from its recent high of $174.76. Now the RSI is testing support. So what happens next is crucial to XLY’s direction from here…

A Potential Trade in the Works

If the RSI holds support and remains in the upper half of its range, XLY’s pullback should peter out. And that could provide a base for a long trade.

However, if the RSI breaks through support and gets stuck in the lower half of its range, then this pullback will go further. And that could set us up for a potential short trade.

A prolonged stay in this lower half could then see XLY retest its yearly lows.

Either way, the chart is showing us that a potential trade is not far away.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

Reader Mailbag

What trade (long or short) do you think has the most potential to emerge from XLY’s current pullback?

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