Dead Cat Bounce?

The energy sector has been the whipping boy of the US market for the past 18 months or so. XLE, one of the big “2” energy sector ETFs, has lost more than 40%, high to low, during this time. In the weekly chart below you can see in August price bounced off prior support in the $57.5 area as it did in mid-2012. It should be easy to recognize we are in a downtrend as price continues to make lower highs and lower lows and has stayed below the downward pointing 40wk moving average which has acted as resistance the entire move. Additionally, RSI momentum in the upper pane has confirmed the bearish trend change as it has transitioned from the bullish range (40-80) to the bearish zone (20-65). When all of these align up together as they have, it is an indication of a strong downtrend.

All trends eventually end and at some point energy investments will turn out to be a compelling long term buy but until the following occurs I view the current bounce off support as a short term trade only.

1)      Price makes one two higher highs and one higher low

2)      Price moves above the 40wk moving average

3)      The 40wk moving average has a positive slope

4)      Volume needs to confirm the upward price movement by rising as prices rises and decline as price consolidates.

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While it is not ideal, the current movement looks eerily similar to the prior other 2 bear flags that formed since price peaked last year. I hope my analysis is wrong but when looking at the weight of the analysis, I expect we get another leg down, likely occurring after finding resistance at the upcoming 40wk moving average. Traders will see that as an ideal time to short and capitalize on the ongoing energy weakness entering on a dead cat bounce.  For longer term (long only) investors, look for the next leg down (the $40 level looks like a logical target) to create an oversold divergent low which, if it occurs and is confirmed by the 4 requirements above, will present an excellent long term entry signal.