The area of the market involving the discovery, development and processing of raw materials, known as basic materials, tends to be one of the go-to sectors for investors seeking stability from volatility due to factors such as geopolitical risk. While the underlying products of the sector are sensitive to supply and demand fluctuations like other market segments, the long-term cyclical nature of the swings can often be more predictable than products from other sectors such as technology. In this article, we take a look at charts from the basic materials sector and try to determine how active traders will position themselves over the weeks or months to come. (For more, see: Materials Sector: Industries Snapshot.)
With the rise in popularity of exchange-traded products such as the Materials Select Sector SPDR Fund, retail investors can now can gain exposure to niche market segments such as basics materials. Taking a look at the chart below, you can see that the fund is trading within a symmetrical triangle pattern, which is commonly identified by the converging trendlines. The pattern is known as a continuation pattern, which means it appears during a period of consolidation amid a defined trend. The breakout generally signals the continuation of the primary trend and provides active traders with a clear entry level as well as placement for stop-loss orders. In the case of XLB, the recent break beyond the resistance is a clear buy signal and suggests that the bulls will control the momentum over the weeks to come and that many will look to set their price targets near $65, which is equal to the entry plus the height of the pattern. (For further reading, see: 3 Reasons to Be Bullish on Commodities in 2018.)
Another triangle pattern that is commonly used to generate trading signals is the ascending triangle. The series of higher lows capped by a clear level of resistance such as the one shown on the chart of Air Products and Chemicals offers traders with lucrative risk/reward. Buy-stop orders will likely be placed above $170 and could lead to a move toward price targets of $190, which is also calculated by adding the height of the pattern to the entry. The nearby support of the 200-day moving average will also likely be looked at by traders for the purposes of determining where to place stop-loss orders. Traders will likely remain bullish on the long-term trend of the stock until the price closes below $159.50. (For more on this topic, see: Top 3 Commodities ETFs for 2018.)
Sometimes traders are not quite lucky enough to spot well-defined patterns such as the ones mentioned above and must then rely solely on one or two medium-term trendlines to put together a trading strategy. Taking a look at the chart of Sherwin-Williams, you can see that the price recently closed back above its 200-day moving average and an influential trendline. The combination of these signals suggests that the bulls are in control of the momentum and that the price could follow the broad sector higher over the weeks to come. Stops will likely be placed below $388.49 in case of a sudden pullback. (For further reading, see: Trade Broken Trendlines Without Going Broke)
The Bottom Line
The basic materials sector appears to represent a pocket of strength in the broader market. Clearly defined chart patterns, such as those shown on the charts above, suggest that prices could be headed sharply higher from here. (For more, see: Active Traders Remain Bullish on Materials.)
Charts courtesy of StockCharts.com. At the time of writing, Casey Murphy did not own a position in any of the securities mentioned.