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Financials: A Home Run, But Avoid The "Triple" Play

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Happy New Year!!!
 
The financial sector looks superb as we bring in a new year.  I am of the opinion, at least based on current technicals, that 2011 will be a solid stock market year and financials will be a primary reason.  I'm looking for solid quarterly earnings reports from this group over the next few weeks - much better than expected and with guidance raised in many instances.  I've written articles in the past about the performance of financials and the relative performance of financials vs. the S&P 500, and how that correlates to overall stock market performance.  Generally speaking, if financials are performing well, the market moves higher.  With that in mind, take a look at the relative performance of financials during 2010 and how it changed over the past 5-6 weeks:

DJUSFN vs. S&P 500 1.8.11

Now let's discuss this chart as a few things stand out to me.  The topping of financials and the relative underperformance that transpired through early December 2010 kept a lid on overall market performance.  From the April highs to the start of December, the S&P 500 lost 3-4%, while the relative weakness in financials was quite apparent.  Most of the stock market's 2010 gains were attributable to December strength.  It was during this period that financials exploded higher on a relative basis, no coincidence in my opinion.  So far in 2011, financials are among the leaders once again.  Should this continue, there's a VERY strong likelihood the U.S. stock market heads higher from here.  Now back to the chart.  Look at the "Relative Support" level near the .231 level.  Once that relative support level failed, it became relative resistance.  The strength in financials in December sent this relative ratio above the relative downtrend line - a bullish development - but the relative resistance line remains intact for now.  If money continues to flow into financials on a relative basis and we can break back above the .231 level with force, it's likely to signal much higher prices for financials in 2011 and that will only add to the recent bullish market behavior.  I have a few short-term concerns about market direction, but my longer-term view is bullish for now.
 
Here's an obvious follow up to the discussion above.  If the financials are strengthening and the outlook looks great for 2011, why not "triple" our pleasure with a 3x leveraged ETF that tracks the sector.  The Direxion Daily Financial Bull 3x Shares (FAS is the ticker symbol) uses leverage to track the return of financials at a 3 to 1 clip.  It would seem reasonable that if financials grew at a rate of 10% in 2011, then the FAS would grow by 30%, right?  The answer is a clear and resounding NOOO!

In my last article, I discussed four New Year's trading resolutions for 2011.  If I added a fifth, it would likely be to avoid trading leveraged ETFs.  There is just so much that many traders don't understand about their appropriate uses and limitations that I generally cringe when I'm asked to comment on a particular one.  Despite my increasingly bullish outlook on financials, I'd avoid holding onto FAS for any length of time.  "Trading Leveraged ETFs For Profit While Minimizing Risk" is my topic for this month's Online Trader's Series event at Invested Central.  CLICK HERE to register for this event and to view a brief video that I produced on the basics of leveraged ETFs.
 
Invested Central has also added a brand new feature, "Anatomy of a Trade", that will debut this weekend.  The purpose of this feature will be to tear apart a recent trade idea that we communicated to members, identifying the risk/reward indications of that trade.  We'll pass along both successful and unsuccessful trade candidates, illustrating the importance of patience and discipline.  I believe it will be highly educational in nature and a real benefit to those who trade stocks, either casually or actively.  CLICK HERE for more details.  

Announcement from the Author

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Tom Bowley
About the author: co-founded Invested Central in 2004 and served as the site's Chief Market Strategist for more than 10 years. Invested Central provides stock market education and guidance for those interested in making their own financial decisions. During his tenure at Invested Central, Tom co-hosted Market Open LIVE, a national radio broadcast that covered many of the largest markets across the U.S. Learn More
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