Clearance in Retail

Retail stocks were rock-solid during the historic spring rally, jumping to six-month highs on speculation that beaten-down consumers would open their pocketbooks after the ugly market crash. But the sector is now under the gun following a wave of bearish economic data and is likely to offer good short sales in the third quarter.

The turnaround might appear to be sudden, but group deterioration has been in progress for many weeks now. Like many other sectors, including banks and semiconductors, retailers topped out in May and eased into sideways patterns right at major resistance levels. This rangebound action is now giving way to a renewed wave of selling pressure.

The Retail HOLDRs Trust (RTH - commentary - Trade Now) dropped into a massive topping pattern in 2004, grinding out a trading range with support near $85 and resistance at $110. The fund broke support on heavy volume in October of last year, midstream in a vertical plunge that started at $100 during the infamous "Paulson spike."

The instrument bottomed out at $60 in November, swung up to $79 and rolled over to test the bear market low in March. Buyers then stepped in and lifted price in a vertical recovery that stalled at broken support in May. Note how this level corresponds with the 200-day moving average, which marks a major barrier for downtrending stocks and indices.

Retail HOLDRs (RTH) -- Weekly Source: eSignal

Now look at the volume bars, comparing selling pressure between September and November with buying pressure between March and May. You'll note that buyers never matched the intensity of selling pressure we saw last year, pointing to insufficient sponsorship for a new bull market impulse. That failure is now coming into play.

From a trading standpoint, the first rally into resistance after a breakdown will always trigger a sell signal. This is true whether we're looking at a 60-minute or weekly price pattern chart. Long-term breakdowns, like the fund selloff through $85 in October, denote even greater selling opportunities because it can be years before price remounts resistance.

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At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.

Alan Farley is a private trader and publisher of Hard Right Edge, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of The Daily Swing Trade, a premium product that outlines his charts and analysis. Farley has also been featured in Barron's, SmartMoney, Tech Week, Active Trader, MoneyCentral, Technical Investor, Bridge Trader and Online Investor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

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