The discussion in Wednesday's commentary about the KBW Banking Index (^BKX) received further validation in trading yesterday. The 14% plus rise in the index has now provided, at least for the time being, a positive divergence which suggests that the sector has further gains ahead.

I would not expect this to be a smooth ride at all and there will almost certainly be significant reversals.

One of the topics that I have discussed at length in Long/Short Market Dynamics is the fact that gaps are often found in clusters. Yesterday's big upward gap for the KBE fund which tracks the index (see below) as well as several of the major individual banking stocks was encouraging but the clustering of gaps phenomenon shows that there are often co-occurrences of big upward and big downward gaps associated with significant turning points.



The S&P 500 (^SPX) has further potential for upward progress but in some ways it would be more constructive for the bulls at the moment if the progress is based on more evidence of long fund managers buying rather than lots of funds covering short positions in the financials.



Just to repeat yesterday's comment which applies again for today's session.

I shall be tracking the sector fund, HYG, a tradable vehicle for those interested in the high yield debt sector. The pullback could be near to completion and another move towards $80 is feasible.



The FTSE rallied exactly back to resistance at the 50-day EMA and is seeing a retreat in Thursday morning's session.

Upside targets around 4600 are still attainable in the intermediate term as this index appears to be in a mode of repeatedly testing the upper and lower limits of a well defined trading range.



I mentioned on Tuesday that I was looking at Legg Mason (LM) for a short-term opportunity on the short side as a bearish pullback pattern was emerging.

Even with yesterday's rally in the financials, a short position established during Tuesday's session could have delivered more than ten percent profit as the stock sank quickly on the open but recovered somewhat into the close.



The intraday chart for KBE, the exchange traded fund which tracks the Banking Sector index referred to above, shows a good example of the upward gap that would have frustrated a number of traders who placed market on open orders although it eventually resolved itself with a small profit towards the end of the session for day traders.



My favorite chart from yesterday, which also provided a great trading opportunity for day traders, is the one below for Wells Fargo (WFC). There was a gap on the open but there was still plenty of scope for what could have been a 25% plus gain in a few hours of trading.

This chart illustrates that the best long trades are often to be found when others are steadily covering short positions throughout the whole session.

Pullbacks should be seen as further opportunities on the long side as this bank may be better placed than most to benefit from a change in sentiment regarding financials.



EBAY could be vulnerable as it approaches the level indicated on the chart.



Seagate Technology (STX) also looks vulnerable and a good entry would be close to the 20-day EMA around $4.20



Clive Corcoran is the publisher of TradeWithForm.com, which provides daily analysis and commentary on the US stock market. He specializes in market neutral investing and and is currently working on a book about the benefits of trading with long/short strategies, which is scheduled for publication later this year.

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