Brandon Wendell, CMT
Brandon Wendell
Most traders I talk to are very nervous about the potential for this bull market to continue. They are wondering when the next bear will start to roar. When the economy and markets show weakness, the majority of people worldwide focus on saving money and spending wisely. Especially those hit by unemployment or credit reduction. Could we use this natural tendency of swinging between miserly and extravagance to help predict the movements of the markets? Of course, we can!
According to Investopedia, the Consumer Discretionary Sector is, “A sector of the economy that consists of businesses that sell nonessential goods and services. Companies in this sector include retailers, media companies, consumer services companies, consumer durables and apparel companies, and automobiles and components companies.” They define Consumer Staples as, “The industries that manufacture and sell food/beverages, tobacco, prescription drugs and household products.” Therefore, during times of economic bust, one would expect the discretionary companies to underperform staples as investors would not buy companies facing slow or no growth.
Of course, as the markets turn positive, you would expect the opposite.
As a chartist, there is a way to use this relationship and fine-tune turning points in the market. TradeStation has a useful technical indicator called the Spread Ratio. This tool allows the trader to see a visual representation of the price of one security divided by another. By using trend lines, a trader can observe changes in the performance of two securities and make decisions about the broad markets.
To see changes in the overall market, I use a spread ratio that divides the closing price of the XLY, the consumer discretionary ETF, by the closing price of the XLP, the consumer staples ETF. If the ratio line is rising, the discretionary are outperforming the staples and we are in a bullish trend. Should the trend break and the ratio line decline, we are experiencing a bearish move and trend in the markets. Support and resistance work the same on the ratio as they would on a stock.
Notice the monthly charts of the XLY and XLP with the spread ratio. The breaks in trend correctly identified the shifts from bullish to bearish markets. Although this technique will not give you exact tops and bottoms, it will alert you to major changes in the markets.
The larger time frames on charts show us the major trends and we can adjust our biases accordingly. However, as traders, we often want to look at shorter time frames to see smaller tradable trends. This ratio analysis will also help with that. Simply adjust the chart’s time frame to your needs but keep in mind that the larger time frame trends always dominate over the shorter.
By looking at the rotation between staples and discretionary sectors, traders can gain additional insight as to the future direction of the markets. Until next time, honor your stops, trade safe and trade well!
Neither Freedom Management Partners nor any of its personnel are registered broker-dealers or investment advisers. I will mention that I consider certain securities or positions to be good candidates for the types of strategies we are discussing or illustrating. Because I consider the securities or positions appropriate to the discussion or for illustration purposes does not mean that I am telling you to trade the strategies or securities. Keep in mind that we are not providing you with recommendations or personalized advice about your trading activities. The information we are providing is not tailored to any individual. Any mention of a particular security is not a recommendation to buy, sell, or hold that or any other security or a suggestion that it is suitable for any specific person. Keep in mind that all trading involves a risk of loss, and this will always be the situation, regardless of whether we are discussing strategies that are intended to limit risk. Also, Freedom Management Partners’ personnel are not subject to trading restrictions. I and others at Freedom Management Partners could have a position in a security or initiate a position in a security at any time.
Editors’ Picks
EUR/USD struggles for direction amid USD gains
EUR/USD is trimming part of its earlier gains, coming under some mild downside pressure near 1.1730 as the US Dollar edges higher. Markets are still digesting the Fed’s latest rate decision, while also looking ahead to more commentary from Fed officials in the sessions ahead.
GBP/USD drops to daily lows near 1.3360
Disappointing UK data weighed on the Sterling towards the end of the week, triggering a pullback in GBP/USD to fresh daily lows near 1.3360. Looking ahead, the next key event across the Channel is the BoE meeting on December 18.
Japanese Yen bulls have the upper hand as hawkish BoJ outlook offsets risk-on mood
The Japanese Yen remains on the back foot through the early European session on Friday, though it lacks bearish conviction amid hawkish Bank of Japan expectations. Traders have been pricing in the possibility that the BoJ will hike interest rates as early as next week.
Editors’ Picks
EUR/USD struggles for direction amid USD gains
EUR/USD is trimming part of its earlier gains, coming under some mild downside pressure near 1.1730 as the US Dollar edges higher. Markets are still digesting the Fed’s latest rate decision, while also looking ahead to more commentary from Fed officials in the sessions ahead.
GBP/USD drops to daily lows near 1.3360
Disappointing UK data weighed on the Sterling towards the end of the week, triggering a pullback in GBP/USD to fresh daily lows near 1.3360. Looking ahead, the next key event across the Channel is the BoE meeting on December 18.
Gold losses momentum, challenges $4,300
Gold now gives away some gains and disputes the key $4,300 zone per troy ounce following earlier multi-week highs. The move is being driven by expectations that the Fed will deliver further rate cuts next year, with the yellow metal climbing despite a firmer Greenback and rising US Treasury yields across the board.
Litecoin Price Forecast: LTC struggles to extend gains, bullish bets at risk
Litecoin (LTC) price steadies above $80 at press time on Friday, following a reversal from the $87 resistance level on Wednesday. Derivatives data suggests a bullish positional buildup while the LTC futures Open Interest declines, flashing a long squeeze risk.
Big week ends with big doubts
The S&P 500 continued to push higher yesterday as the US 2-year yield wavered around the 3.50% mark following a Federal Reserve (Fed) rate cut earlier this week that was ultimately perceived as not that hawkish after all. The cut is especially boosting the non-tech pockets of the market.
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