Retail's Volatility Will Be Trader's Delight

America's retailers have rallied into a critical position this summer, with rising hopes for an economic recovery lifting sector stocks to five-month highs. There are sound arguments for higher and lower prices from now into year's end, which is good news for traders because the disagreement should yield great opportunities to profit.

At a minimum, expect sector volatility to heat up with the holiday season starting in just three months. The run-up into this time of year usually supports retail momentum plays, with hot stocks getting bid up in hopes of catching a consumer buying wave. That could unfold in the next few weeks, but the leadership group is likely to be smaller than usual due to anxiety about economic growth and an overbought market environment.

Retail HOLDR (RTH) -- Weekly Source: eSignal

The Retail HOLDRs Trust(RTH Quote) broke five-year support between $83 and $86 last September and bottomed out near $60 in March. It's now rallied back to new resistance, which predicts a downturn and the start of a new decline. To make matters worse, the fund just filled the gap posted on October 6, triggering a sell signal for observant short-sellers. If bears finally take control here, the fund should roll over and drop through the green zone between $80 and $82. That downswing would trigger an initial sell signal for a further decline to the red line, currently near $73. Keep in mind I'm not recommending any short positions in this instrument until that green zone of support gets violated.

Retailers are getting no help from Wal-Mart(WMT Quote), the highest capitalized stock in the sector. This Dow component has been running in place for months and missed the entire summer rally. This isn't the kind of price action you'd expect during a broad market recovery and it certainly won't help the retail ETF to lift over major resistance.

This underperformance points out another troubling aspect of the retail rally since the March low. Leadership has been relatively narrow, with a selection of top prospects doing most of the heavy lifting while entire subsectors like the drug stores, catalog companies and supermarkets are going nowhere and marking time.