The financial sector could use a rest.

Bank stocks have been leading the market higher for the past six months. The KBW Bank Index (BKX) is up 73% since late
September. That’s on par with the energy sector’s 75% gain over the same time frame.

And, just like the situation that caused us to turn cautious on energy stocks last week, traders might want to wait a bit before buying the bank stocks right here.

The S&P Financial Sector Bullish Percent Index (BPFINA) is on the verge of triggering a sell signal.

Look at this chart…

Longtime readers know that a bullish percent index (BPI) shows the percentage of stocks in a sector that are trading in bullish technical patterns. It’s an easy way to measure overbought and oversold conditions for a sector.

Typically, a reading above 80 – meaning 80% of the stocks are trading in bullish technical patterns – means a sector is overbought. Readings below 30 indicate oversold conditions.

Buy and sell signals occur when a BPI reaches extreme levels and then reverses. For example, when a BPI rallies above 80 and then turns lower it generates a sell signal. When a BPI dips below 30 and then turns higher, that’s usually time to buy. At least, those are the general rules…

But, each sector trades a bit differently. And, in the case of the financials, the 20-day exponential moving average (EMA) plays a key role in this chart.

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As you can see from the chart, the financial sector got deeply oversold last September. The BPFINA dipped below 25. Then, it turned higher and generated a buy signal.

That proved to be an excellent time to buy the banks.

You can also see from the chart the financial sector got quite overbought in early November when the BPFINA rallied above 80. It generated a sell signal when it turned lower. But, that would have been a horrible time to sell the bank stocks. The sector has moved sharply higher since then, as the BPI chopped around and generated a number of “false” sell signals.

Rather than selling the banks as soon as the BPFINA turns lower from overbought conditions, we’re better off waiting until the index crosses below its 20-day EMA. That would have eliminated all the false sell signals in November and December. The only actionable sell signal came in mid-January, just before the KBW Bank Index sold off 14%.

Now, after another solid rally in February and March, the BPFINA has once again turned lower from overbought conditions. And, it’s on the verge of crossing below its 20-day EMA.

We don’t have an actionable sell signal just yet. But, it’s getting close.

So, just as waiting a bit before buying into the energy sector proved to be good advice last week… I suspect a little patience, when it comes to the banking sector, will be rewarded as well.

Best regards and good trading,

Jeff Clark

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