A Top or a Mere Correction?

Visual chart analysis is prone to subjectivity and biases. While we cannot completely remove subjectivity, we can approach chart analysis in a systematic fashion and increase objectivity. This commentary will show an example using the Home Construction ETF (ITB) because the ETF has traded flat since mid October. Is this a top or merely a correction?

First things first. What is the direction of the bigger trend? Three indications point to an uptrend. First, the ETF exceeded its February high in July and recorded 52-week highs into October. Second, ITB is above the 200-day SMA and the 200-day SMA is rising. Third, the RSI Trend-Range (65,5) indicator turned bullish in late May and remains bullish. This is the 5-day SMA of 65-day RSI and this indicator is part of the TIP Indicator Edge Plugin for StockCharts ACP. It turns bullish with a move above 51 (green) and bearish with a move below 49 (red).

Now that we have established that the bigger trend is up, we can set our trading bias as bullish. This means I will focus on bullish setups and expect bullish outcomes because the odds favor a move in the direction of the bigger trend. Consolidations are considered mere pauses within the uptrend and pullbacks are viewed as opportunities, not threats.

The next chart shows ITB with bullish continuation patterns marked in blue and oversold RSI marked with green shading. An RSI move into the 30-50 zone denotes an oversold condition of varying degrees and alerts chartists to be on guard for a bullish setup. RSI has been flirting with this zone for several months as ITB consolidates with a long and narrowing triangle. Prices are winding up and the expectation is for an upside breakout. Why? I think you can figure that one out! A breakout would signal an end to the pause (correction) and a continuation of the bigger uptrend.  

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