The KBW Banking Index (BKX) has dropped 17% off its April high, in response to financial reform legislation and the European debt contagion. The Regional Bank HOLDRs ETF (RKH) has fallen an equal amount over the same period, which is perfectly logical, except for one thing: This subgroup of the banking sector will face considerably fewer headwinds going forward.

In fact, regional banks should act very well in the next one to three years, despite the obvious risks, because they have re-liquefied since the credit crisis and are now focused on recovering homebuyers and business owners. They'll also benefit from rising interest rates, although the schedule for rate hikes might get pushed back because of the debt crisis.

Meanwhile, money-center banks will face a host of new challenges, including derivative regulation, the possible loss of proprietary trading, increased

SEC

oversight and dwindling opportunities outside of the U.S. Add in deteriorating technicals, and none of the industry's best-known names look like good buying opportunities at this juncture.

On the flip side, it's a good time to prepare a shopping list of regional banks for purchase later this year. No, there's no need to rush in and build sector exposure right here. Instead, look for the prices where these issues show favorable reward/risk characteristics, and then wait for them to "come in," to borrow a phrase from our fearless leader Jim Cramer.

The Regional Bank HOLDRs ETF sold off from $139 to $30 between September 2008 and the March 2009 low. The subsequent recovery stalled near $95 in April, marking a 60% retracement of the prior decline. The early May "flash crash" then dropped the instrument through the 200-day moving average near $81 and into 2009 support in the mid-$70s.

The fund has been testing this price level for the last month and making limited progress. It spent the last eight sessions bouncing near the monthly lows, just like the major indices, trying to establish a tradable bottom. The jury is still out on this effort, but to be frank, odds are high that price will finally break support and head toward the low $60s.

A 50% retracement of the entire bounce between March 2009 and April 2010 would carry the fund down to $62. Without a magical turn to the upside in the next few sessions, that price level marks the most obvious place to watch for a stable basing pattern and re-establishment of the yearlong uptrend.

Two regional banks stand out as prospects for sizable gains when this correction finally comes to an end and we can focus on economic growth once again. Price action on the Regional HOLDRs ETF will assist our entry timing, while keeping in mind that these issues might bottom out and head higher before their regional peers.

BB&T

(BBT) - Get Report

is a mid-Atlantic regional bank with a $20 billion market cap. It swung back and forth in a broad trading range between $30 and $45 through most of the last decade, before selling off into the mid-teens during the bear market. The stock jumped back into the broken range in March and stalled in the mid-$30s about three weeks ago.

It rolled over with the broad market and has now dropped down to range support, which has also aligned with the 200-day moving average. Of course, it will be bullish if the decline ends right here and support holds, because the stock could bounce strongly, perhaps reaching the 2008 peak near $45 in the third or fourth quarter.

However, don't give up if the stock rolls over, even though the breakdown might precede a decline into the lower $20s. Keep watching, because it will issue a "failure of a failure" buy signal whenever it recovers and jumps back across contested support (blue line). That signal should be useful even if it comes several months after a breakdown.

Marshall & Ilsley

(MI)

is a Wisconsin-based regional bank with heavy exposure to the Arizona homebuilding market. The company entered a steep nose dive when all sorts of desert projects fell apart in 2008, knocking the stock down to a 20-year low before it finally bounced and headed higher in March 2009.

Price has been grinding out a broad ascending triangle base for the last 18 months, with well-defined resistance near $11. On-balance volume (OBV) shows steady buying interest during this time, as investors and institutions return to the company, placing bets on a broader-scale recovery in the next few years.

The stock could drop as low as triangle support (green circle) on the current downswing. Aggressive investors can build small positions near this level, but keep stops tight and get out immediately if the rising trendline breaks. Conservative investors can sit back and wait for a breakout over $11. That bullish event should open the door to a profitable trip into the mid-$20s.

Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.

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

Alan Farley is a private trader and publisher of

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