To remain healthy, trending stocks need to have occasional pullbacks. A bit of profit taking that pulls a stock or index back to the trendline prevents the movement from becoming parabolic. Parabolic movements usually retreat just as violently as they rise. Longer termed investors are actually better served in owning stocks that test their trend lines occasionally. One reader asked me if I would cover the healthcare sector – happy to do so, given this sector’s recent strength. The healthcare sector represents a good example of how to interpret entry points on a trending stock. As you can see in the graph above, this sector (as represented by the iShares Global Healthcare ETF) has been trending positively for quite some time. Higher highs, higher lows, above the MA’s—all of that good stuff.
I’d like you to notice on the chart above what happens when price gets too far ahead of its 200 day Moving Average (red line). I’ll define “too far ahead of the 200 day MA” as about 10% higher –give or take a % or two. In fact, if you do a bit of off-the-cuff measurements, you’ll see that price pulled back pretty regularly at 10% or so over the 200 day MA. And that was a good thing—it kept the market in check, and allowed for a steady, measurable trend up over time. The healthcare sector recently rose to 9% over its 200 day MA. One could suggest that it has been approaching an overbought state according to this indicator. Let’s see what the daily chart shows us after applying some of our more sensitive timing indicators.
The daily chart below shows the sector as healthy from the perspective of moneyflow (top and bottom panes). The short and mid termed momentum indicators that I follow (stochastics and RSI) are overbought, but not rounding over just yet. The longer termed momentum indicator (MACD) is rising and is not rounding over. Comparative relative strength (middle pane of the lower indicators) is rising—the sector continues to outperform the market. Given the above, it’s clear that this sector is quite healthy, technically speaking. However, it would surprise me if we didn’t see some sort of corrective activity in the near-term. Seasonality tends to end for the sector in October, so perhaps that’s when we’ll see a pullback. Whatever the case—if you own the sector, there’s really no call to sell it. Pull backs have been short lived. New buyers might want to wait for a pullback to enter the sector.
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