Homebuilders have made an incredible run over the past year or so. If you have been familiar with this industry, then you know names like D.R. Horton (DHI), Toll Brothers (TOL), Ryland (RYL), Lennar (LEN), and KB Homes (KBH) have been some serious outperformers. Featured below is a weekly chart of the homebuilders ETF (XHB), dating back to this current cyclical bull run that began in March, 2009.
I wanted to point out this chart to demonstrate a key aspect of technical analysis (TA), and to provide some awareness around this industry. If you now look at the daily chart below, you can see that the XHB looks great on the daily timeframe, but has had some pullbacks throughout this bull market. Recently (this chart was after the close on 2/20), homebuilders have sold off a bit.
If you look at the chart again, you can see what is known as a “divergence” between price and momentum. The indicator at the bottom of the chart is known as the MACD–moving average convergence-divergence. You should read about it at the embedded link.
The divergence focuses on price action versus momentum, as measured by the MACD. In September of 2012, homebuilders made a high that was followed by a slightly higher-high in early November. If you also look at the MACD below, for this same time period, you will see that while price made a new high, momentum did not. When momentum does not confirm bullish price action, this is known as a bearish divergence—and if you followed this closely it would have paid off. Homebuilders took a big hit the rest of November.
Now let’s look at the price action so far in 2013 on the same chart posted above—in late January, XHB made a new high and this was then followed by a slightly higher-high early this month (February). You should again notice the MACD below (indicated by the arrows). Momentum did not confirm price action. Homebuilders have taken a hit since that peak, and the biggest down day in the market so far on Wednesday (2/20), showed some serious weakness in the XHB.
Now, divergences can always play out the other way. No single indicator should be a buy/sell signal. Combine this with your other methods of TA and use what you see to make the best possible risk/reward decisions when trading in this industry. Just be aware that homebuilders may be poised for a slight pullback and/or consolidation for the time being.