Waiting on a Breakout in Banking and Financial ETFs (KBE, IYG)

After a strong run-up in late 2016, financial and bank ETFs have lagged. The financial sector has been one of the worst-performing sectors (next to basic materials) over the last three months. That's mainly because most sectors have continued to move higher, while financials are stuck in neutral. Since peaking in early March, financial services and banking ETFs have been drifting lower, stuck in a large triangle pattern. As the price nears the apex of the triangle, a breakout from this pattern is expected.

The SPDR S&P Bank ETF (KBE) hit a high of $47 on March 2 and has been drifting lower since. A descending trendline along the swing highs shows resistance is currently near $42. Two swing lows, in March and May, mark support between $40.55 and $40.50. The long-term uptrend favors an upside breakout, but the sharp sell-off in March indicates a downside breakout can't be ruled out.  Because of this, taking trades within the triangle is more of a gamble. A daily close above $42 signals an upside breakout and a move back to $46 to $47 or slightly above. A daily close below $40.50 signals a downside breakout and a target near $35. $35 is also where the price started its strong run back in November.

The iShares US Financial Services ETF (IYG) has been forming a triangle pattern since March after the ETF peaked at $116.22. IYG has a slightly different pattern than KBE, though. IYG didn't break definitively below January support (swing low), whereas KBE did. IYG is also currently right on the upside breakout point of the triangle at $108.40. A closing price above $108.40 helps confirm an upside breakout. Based on the size of the triangle the upside target is $119. Also, watch the $112 to $113 region. That is a shorter-term target and another possible resistance area. The pattern is more bullish than the KBE pattern, but a downside breakout can't be ruled out. A daily close below $104.83 could result in an $11 drop, based on the size of the pattern. That puts the target near $94.

Financial services and bank ETFs have been lagging the last few months, but that could change if an upside breakout develops. Both of these ETFs are moving in triangle patterns, and typically the contracting volatility doesn't last long, especially after a big move like the one in late 2016. The overall trend is up, so it is reasonable to assume the price will break to the upside -- that may end up being the case. However, if the price breaks higher and then quickly reverses below the low of the triangle, that is a warning sign for lower prices to come. If going long place a stop loss below the triangle, and if going short, place a stop loss above upper trend line of the triangle. If a strong move develops in either direction, the pattern provides a very favorable risk/reward ratio.

Disclosure: The author doesn't have positions in the stocks mentioned.