The homebuilders (XHB) are always an interesting group to examine, because it tends to be an “early cycle” group. It’s a stock group that leads the market most likely because it touches so many different areas of the economy (commodities, interest rates, employment, etc.). As evidence of its leading nature, take a look at a stock like DR Horton (DHI), which broke to a new high in late 2000, far in advance of the overall market, which was still beginning its bear market. And, also notice that it (and the group) peaked in the summer of 2005, far in advance of the October 2007 peak for the stock market in general.
Loss of Momentum
So, what is the homebuilders ETF telling us today? Let’s take a look at the XHB and the longer term picture, monthly bar chart featured at the top of the post. It shows a completed five wave rally up from the low in late 2011, so regardless of the trend from the 2009 low, the completed five wave rally from 2011, means a correction is due at a minimum. Now, the overall picture looks like an upward trend which is slowing down and forming shallower trendline supports one after the other. The loss of momentum suggests the trend is about to turn lower. If the structure happened to be an [A]-[B]-[C] then the pattern should be completely retraced. But, it remains to be seen whether that is the correct interpretation, and, on its own, that’s not enough to make it a tradable pattern.
Head & Shoulders Top
But, on the daily chart (Figure 2) we see the homebuilders ETF has made no upward progress since early 2013 (a very large relative underperformance), and it has a “rounded top” type of formation. To be more specific, it does look like a Head & Shoulders top has formed, and prices have now sliced through all three necklines I’ve drawn. By closing below the neckline, that activates the pattern, which calls for a return to the $27 area. That area also happens to be the level of the 2012 high and the 2013 low, so it is support. That’s our target 1, where it seems to make sense to take off the bulk of the position (75-90%), even if the count on the monthly chart is correct. Right now, the only really safe stop is located above the right S. We’ll look to lower that once the pattern breaks down further.
I’d like to make one more point about the Head & Shoulders. Notice on Figure 2 the Head & Shoulders, denoted by three curved lines, prior to the current one. There’s a clear Head & Shoulders, but prices went to a new high after that developed. Two minimum items that Trader Skillset promotes when looking for a “tradable” Head & Shoulders are: 1. A downward sloping neckline, and 2. A trend that’s already shown a loss of momentum. In the case of the first failed H&S, it showed no loss of momentum prior to its development (it was preceded by a very strong upward move), and the neckline was upward sloping. So, keep these in mind when grading your H&S patterns.
The time zone we reference on our charts is Pacific Standard Time. Therefore, the U.S. cash market opens at 6:30 AM PST and closes at 1:00 PM PST.