Select Sector SPDR Fund - Financial (XLF)

The Financial Select Sector SPDR (NYSE: XLF) has rallied over 40% from its low on March 6 through to yesterday’s higher opening. The price action this week has triggered a half-day buy signal, which means that it should make at least a three-wave move to the upside. This week’s movement is Part 1 of the Elliott Wave Theory.

When the Wave 2 pullback begins, it should trade below its recent high for nine trading hours or more before Wave 3 takes it up to new recovery highs. The daily chart is also set up to give buy signals, but that could not occur until Monday at the earliest.

The 50-day moving average happens to coincide with the top of a trading channel drawn from a high point last September. Both these technical tools currently show the $9.05 area as a significant level.

If XLF undergoes a decent pullback, short-term traders could try the long side with an upside target of $8.60 or better.

However, if the stock can manage to close above the $9.05 level a couple of times, there’s a good chance that the daily chart will trigger buy signals and we could see additional movement to the upside.

The vital signs for the financial markets continue to improve. The latest indicators include the number of successful public stock offerings floated by financial institutions, the uptick in home sales, and reported profits by some of the largest banks. .

Morgan Stanley ($2.2 billion), JPMorgan ($5 billion), and American Express ($500 million) all have common stock offerings on the street. This year we will see more new stock offerings from financial institutions than in the past 5 years combined. Just six months ago these same financial institutions could not have raised this amount of capital because fear gripped the market place and investors would not have taken on the new shares. The recent success of these offerings points to a significant upswing in investor confidence.

The second indicator of improved health is the very recent uptick in home sales. The National Association of Realtors reported today (June 2) that its seasonally adjusted index of sales contracts signed in April rose 6.7 percent to 90.3. This is the largest single month increase in 8 years. Knowing that faulty home loans were the driving force behind the financial crisis, a turn-around in the home loan market is vital to a recovery in the financial markets.

The FDIC reported on May 27 that the nation’s largest 19 banks, the target of the stress tests, earned a combined first-quarter profit of $7.6 billion, compared with a loss of $36.9 billion in the fourth quarter of 2008.

Of course the patient is not entirely back to “good health” even though vital signs are improving. The FDIC reported that 21 banks failed in the first quarter, the highest number since 1992's fourth quarter. It also said that the number of "problem banks" rose to 305 from 252 a year ago. We are seeing a divergence between good banks and bad banks. The amazing thing is that many of the banks that would have made the “bad” list just 5 months ago are now showing signs of vibrant health. Some analysts speculated that the nationalization of Bank of America and Citi Group was the only way to save them; now it appears that free enterprise system is able to do what the critics thought impossible without a government takeover.

I like the XLF for a trade here ... the index is leading the overall market - SPX:XLF ratio spiked and turned lower today which is a sign that the XLF is increasing at a greater rate than the S&P 500. I also like the relative strength index - no longer oversold. The reversal came on higher volume than the previous day, which is a bullish sign.

I posted a chart of this at http://studentofmarkets.com ... check it out if you want

I see no real resistance until you get to the $11.50 - $12 range ... which could be a tidy 24% profit for a short term trade.