FSO Editorials: "ETF Recon I" by Fernando Gonzalez for OTA 02/05/2007

ETF Recon I
Weekly Review with Fernando Gonzalez
Online Trading Academy
February 5, 2007

Over the next few issues, we shall be taking a look at the ever-growing world of the ETF markets, from the Technical/Price Behavior point of view. This will be the first of three parts, as we take a look at the action over a variety of very popular ETFs. As most active market participants are aware, ETFs such as the SPY, QQQQ and DIA, which are designed to closely track the major US Equity Indices, are extremely popular among Investors and Active Traders alike. Since we spend much time already tracking the major US market indices, we will be taking a look at some "other" very popular ETFs over the next few issues as our journey to discover the markets continues.

The ETFs, which were only introduced in late 90's, have grown to become important pieces of the Financial market puzzle, and these are likely to continue for many reasons ranging across a variety of investment/trading time horizons. "Diversity" was the initial key characteristic of ETFs, and now that it is well on its way to maturity as a financial instrument, there is enough precious liquidity across these instruments so as to augment their place in the financial markets.

Our technical "recon" here will revolve around the weekly time scale. These are useful not just for Investors as we mark key technical points that are likely to play important roles in future price behavior, but also for Active Traders of smaller time horizons. This is because the condition of trends in larger time frames set "the beat" of the smaller time frames, and thus often have a tremendous weight on short-term conditions which are not limited to direction (up, down or flat), but of speed and magnitude as well. So, let's jump right in to take a look at these markets today and over the next few issues:

Chart Notations

The Weekly Chart of the EWJ addresses the Intermediate-to-Long-Term Time Horizon
The EWJ is the 5th most popular ETF, by way of 3-month Average Daily Volume (15m shares/day), and the most popular International ETF as well.
The EWJ is the iShare MSCI Japan: a very diversified ETF that is designed to track the MSCI Japan Index. Its components include major Japanese corporations in multiple sectors such as Canon, Honda, Mitsubishi, Sumitomo and Matsushita.
Notice that the decline in the first half of 2006 was fast, violent and a huge disturbance to the uptrend that preceded it. At this point, the EWJ is deep into an UPward correction of that decline and just recently crossed over its 62% retracement mark (green). It is still quite vulnerable to a downward run, and will likely remain so up until the $15 mark (just above the 78% retrace mark).

Chart Notations

The Weekly Chart of the OIH addresses the Intermediate-to-Long-Term Time Horizon
The OIH is the 7th most popular ETF, by way of 3-month Average Daily Volume (11m shares/day).
The OIH is an industry-specific ETF from the Merrill Lynch Fund Family that tracks the movement of 18 large Oil Service corporations. Its diversity is therefore limited to corporations that fall inside that group. Schlumberger, Halliburton and Baker Hughes are the largest holdings on this ETF and make-up 30% of its composition. As a result, the movement in the prices of Oil, as well as these 3 corporations, have a heavy effect on its price behavior.
The action in the OIH over the last year has been dominated by the bears, since having topped in the spring of 2006 at the $170 area level. At this point, the bears are still in control here. There is a critical down-trendline (in blue) that is likely to come in to play very soon. We shall look for the market to react there, and thereafter put into play a series of targets that are marked accordingly. The speed of the markets trading over the course of the next few weeks play an important role in exactly how we set our directional biases in this market: whether we shall continue to favor and give benefit of the doubt to the bear-side, or shift our biases to Neutral, and thereafter to the Bullish side.

Chart Notations

The Weekly Chart of the XLE addresses the Intermediate-to-Long-Term Time Horizon
The XLE is a very popular ETF, as it holds 4th place by way of 3-month Average Daily Volume (23m shares/day), only behind the mighty SPY, QQQQ and IWM (Russell2000) ETF's.
The XLE is a Sector-specific ETF that focuses on stock from Energy and Natural Resources corporations in multiple industries: Oil, Gas, Energy Equipment and Related Services. Although it is Sector-specific, it is somewhat more diversified than the OIH (preceding discussion) and includes corporations like Exxon, Chevron, Conoco and Schlumberger. Note that Exxon has a tremendous weight on this ETF as it comprises 23% of holdings.
The XLE is a very tricky trading market in comparison to the prior ETF's we discussed. I would like to think that perhaps it may be because of its tremendous weighting of one single stock (Exxon) whose price behavior is very much in the hands of its Specialist Firm in the NYSE, but in either case, its chart should help us understand the XLE.
Note that since early 2006, the uptrend in the XLE had ended as this market has gone range-bound into a flat correction. An attempt to break-out of this range in late 2006 failed as the markets fell deep (and quick) back into its range. I have applied the Stochastic here (in red, bottom of the chart) to help us anticipate future price action.
At this point, the XLE has returned back to the top to its range and has enough momentum to make another attempt for a break-out. Note the Stochastics underneath, if the market rises beyond its upper resitance point, the Stochastic should quickly follow into its over-bought territory, in order to signal enough momentum needed to sustain and later push through to new highs. If the Stoch does not push through to overbought territory (while market is breaking out), it suggests a problem with the momentum and is signaling divergence. Let's keep an eye on these technical marks going forward.

Until next week, happy trading!

Fernando now enters his 10th year as an active trader, technical analyst and content contributor to the Active Trading community and a long list of popular financial media. In 1999 he authored the best-selling book Strategies for the Online Day Trader (McGraw-Hill 1999), one of only a handful of books on the topic that have ever reached the top 5 overall best sellers on Amazon.com. In 1998, he was one of the original founding members of the Online Trading Academy team, having developed the original material and coursework. Fernando continues today as Newsletter author, course developer and Instructor here at OTA, where he teaches his highly regarded "Broad Market Analysis" class.

DISCLAIMER:
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.

ABOUT THE WEEKLY REVIEW:
The weekly review heavily focuses on the application of Technical Analysis on the Broad Market Levels. You will rarely see individual Stock Picks on the Weekly Review! It is the author's belief that most Individual Stocks (certainly not all) will follow the overall direction of the Broad Market that surrounds them, as well as the Sectors they comprise. Discussion is focused heavily upon the Major Market & Sector price activity.

Rarely also will you see discussion of the fundamental, macro-economic or political nature in the Weekly Review. By focusing only on the technical, or price & volume aspects of the major measures of the market, Fernando hopes to satisfy any equity trader's needs for a qualified discussion and forecast of the overall direction of equities, whether it be the Short, Intermediate, or Long-Term time horizons. Whether you trade the Index Futures, Index Tracking Stocks or Individual Equity Market Instruments, having an experienced eye on the conditions of the broad market that surrounds you is extremely important!