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Short answer: probably not. The long answer is more instructive, so let’s get started.

Context matters, but what does that mean? What is context? In this case, the longer-term relative performance of the broad healthcare sector gives us some insight. The following chart, which I published in my research for clients last week, shows the relative performance of the cash index underlying the XLV to the cash S&P 500 index, going back a few years.

Long-term relative performance of healthcare. Has something changed?

Long-term relative performance of healthcare. Has something changed?

The question we need to ask here is: has something changed? We’ve been overweight healthcare (which is the portfolio-equivalent of having a tactical long position) for over three years, and have captured a nice run of outperformance. It’s interesting to note that the recent selloff (of the spread) has been volatile and sharp, bringing the spread to the lower volatility band for the first time in over three years. If we’re precise about our language, we might say that this is action inconsistent with the established trend. If we want to speak in plain English, we’d say that it looks like the party might be over.

So, with that broad context from the sector, let’s look at a biotech index as an outright. I think there is little to be gained from looking at many different variations of the same index–technical patterns don’t really work like that, so what we need to do is to try to understand broad market dynamics. Are there any themes here in this chart?

Technical structures in XBI appear to point lower.

Technical structures in XBI appear to point lower.

A few things jump out at me, looking at this chart:

  • There have been some pretty sharp selloffs. Keep it simple–this is a chart that has gone down more easily than it has gone up, in recent weeks.
  • Bounces have been reluctant and have set up continuation patterns to the downside.
  • A possible sell climax in August has likely been corrected through a long consolidation.
  • The circled structure, sitting directly on support, is something I would read as a “nested pullback.” I think (am not sure) I invented that term, but it means a smaller pullback that occurs in context of a larger pullback’s resolution. In this case, it could also be a tightening setup before a break of that support.

So, overall, this appears to be very bearish, and it comes in context of a potentially bearish backdrop from the sector. What do we do with this info? Well, at the very least we can not buy weakness–certainly don’t buy the dip. Active traders may wish to drill down another layer, and look at some individual stocks. Here’s a spreadsheet with some of the membership of the Nasdaq Biotech index. An interesting way to screen this is to look at where stocks fall in their own 52 week range (%52wkRng) and also look at where they fall within their volatility-adjusted trading bands (KPos). From there, it’s easy to drill down and find some attractive short candidates. The problem, in this case, is an embarrassment of riches, and figuring out how to filter for only the best possible setups.

The idea of a long-term pattern breaking, then drilling down into indexes and individual names, is a true top-down approach to finding technical trading candidates. The market does not always offer us clear signals like this, and, of course, these trades could be losers. Focus on risk management, but consider using tools and perspectives like this in your own trading plan.

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