The Head & Shoulders Top in Regional Banks

August 7, 2014 10:02 AM

Over the last few weeks I’ve been getting more and more emails asking me about this head and shoulder topping pattern in the Regional Bank Index. I think it’s worth discussing because there actually is a pretty high likelihood that it will be completed which would lead to much lower prices in the regional banks. By definition, this is a reversal pattern, so as a technician who tries to find trends, looking for these types of patterns isn’t exactly what I like to do. But I’m not blind to them either.

Today we’re looking at shares of $KRE – the S&P Regional Banking ETF. Here is a weekly chart showing a clear head & shoulders pattern being formed with a bearish momentum divergence in the relative strength index (RSI). I believe this divergence increases the likelihood that we will break the neckline:

8-7-2014 KRE weelly

Look at the left shoulder to start the new year, the head in March and right shoulder throughout the summer. We’re now about 80 cents from breaking the neckline which is well-defined by the lows in January and May. The neckline really is the key here. We constantly find head and shoulders patterns that never confirm, so patience is important. But based on all of the evidence, I think there’s a very good chance this one breaks.

Here is a closer look at regionals on a daily time frame. The pattern is very symmetrical which we like. This means the left shoulder and right shoulder are both about the same height and took around the same amount of time to develop. The measured move based on the size of the pattern is roughly 6 points. So the target here upon completion is just under $31.

8-6-14 kre daily

Another interesting thing about this ETF is how diversified it is. A lot of the ETFs we look at and trade have huge components that really bully around the fund. But in this case, its top holdings like $CIT $HBAN $UBSI and $WTFC each only represent less than 2% of the entire fund. We prefer that.

So as far as $KRE is concerned, we want to see a close below $36.80 for confirmation. But remember that we would only want to be short below that level. These types of patterns are notorious for whipsaws, so keep that in mind. I really think this one breaks. We’ll see.

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