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Using Relative Strength to Spot Trend Changes and Pick Market Tops

Jul 26, 2012
Chad Karnes, CMT

Leaders become laggards and laggards become leaders. It's the way of the market and investors can use Relative Strength Analysis to help spot trend changes as they occur.

The S&P 500 is up 8.1% year to date through 7/26 and up 6.4% since its 6/5 low of 1268.  If we dissect the rally into the nine different S&P Sectors there are some major changes between those sectors that have led the market year to date and those that have led since the June lows.

Knowing the leaders year to date versus the leaders over the near term can help us detect and stay ahead of changes in the market’s trend.

Year to date through 7/26, the Technology Select Sector SPDR (NYSEArca: XLK), the Healthcare Select Sector SPDR (NYSEArca: XLV) and the Consumer Discretionary Select Sector SPDR (NYSEArca: XLY) have led the S&P 500 (SNP: ^GSPC) up 13.2%, 11.0%, and 12.0%, respectively.

However, when looking at the trend since the 6/5 low the mix of leaders is drastically different as Consumer Discretionary and Technology are now the two largest laggards, underperforming the S&P 500 as a whole by 2.4% and 1.6%, respectively.

The Energy Select Sector SPDR (NYSEArca: XLE) is the major and pretty much sole leader since 6/5, outperforming the S&P 500 by 3.8% and up 10.2% overall since 6/5.  The next best gainers are healthcare, the Materials Select Sector SPDR (NYSEArca: XLB), and the Financials Select Sector SPDR (NYSEArca: XLF).  The leaders year to date are no longer the leaders since 6/5, and this is important.

In the August ETF Profit Strategy Newsletter and shown in the chart below, we identified the financial sector’s relative strength breakdown as a key driver of the market’s topping pattern in early May.  Its leadership in early June also identified the market’s bottom and potential for a rally.  Using relative strength on the XLF as well as the energy sector we called out both these sectors as leaders becoming laggards on Friday (7/20) as we said, “Since financials and energy have led the market higher, they also will likely lead the market lower”.  The financials have already broken down as leaders which helped us call a market top on Friday (7/20) as we wrote to our subscribers, “This is a big warning sign that the market is likely breaking down as it did in early and mid-May”. 

We continue to watch energy’s leadership as it continues to perform inline or better than the S&P.  A breakdown in Energy will likely lead the market on its next down move.

 

The ETF Profit Strategy Newsletter and its Technical Forecast uses relative strength, sentiment, and other technical analysis tools to identify market topping and bottoming patterns.  By following the leaders and laggards we are able to see the market moving from growth sectors to more defensive areas before the market breaks down or rallies. 

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