The Setup to Anticipate the Breakout - XME Example

Chartists are often faced with a choice: wait for the breakout or anticipate using a mean-reversion setup. The Metals & Mining SPDR (XME) broke out of a bullish consolidation this week and the breakout signals a continuation of its long-term uptrend. Chartists keying off the mean-reversion setup could have anticipated the breakout and gotten the early jump. Let's investigate.

First and foremost, the long-term trend is up for XME. Price is above the 200-day SMA and the TIP Trend Composite has been net bullish since early August. This indicator aggregates five trend-following indicators and turns positive when three of the five are on active bullish signals. It is currently at +5, which means all five indicators are on active bullish signals. You can learn more about this indicator here.

After breaking above the 200-day SMA with a move from 20 to 25 (25%), XME took a rest and consolidated with a falling flag from early August to mid September. This is a bullish continuation pattern and this week's breakout signals a continuation of the bigger uptrend. A 25% advance from the flag lows would project a move to around 30.

Just before the flag breakout, XME produced a mean-reversion setup as the ETF tested the mid August lows and RSI dipped into the 40-50 zone (blue shading). The test of the lows amounted to a support test and an area to watch for a bounce. The RSI dip into the 40-50 zone denotes a mild oversold condition that can give way to a mean-reversion bounce. The combination of a support test and mild oversold condition alerted mean-reversion traders to be on alert for an upturn and breakout. A similar setup occurred in late June and early July when XME formed a falling wedge.

At this point I would consider the flag breakout bullish and valid as long as the flag lows hold (24). As far as the long-term trend is concerned, I would consider it up as long as XME holds the 200-day and the Trend-Composite remains positive.

The TIP Indicator Edge Plug-In for StockCharts ACP contains ten indicators to help you navigate the charts. In addition to the trend indicators, there is also a Momentum Composite and two volatility indicators. See this article for complete explanations and chart examples.

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