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Playing Defense

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The defense sector has been on the year's best performing industry groups. Both defense narrow-based sector indexes are trading near yearly highs.

The AMEX and PHLX introduced defense indexes following September 11. The AMEX sector trades under the symbol DFI.X; the PHLX sector trades under the symbol DFX.X. The components of the two sectors are very similar, there's only a few minor differences between each. For this update, we'll focus on the PHLX's index, the DFX.X.

The sector has become a favorite among momentum investors, who pushed the index to a new high last week at 201.62. Through today, the DFX.X is better by about 20 percent year-to-date. It's clearly one of the best performing sectors for the year. But its limited trading history makes it difficult to gauge risk in the sector, as well as define upside.

We have only about five and a half months of data to work with, but it's at least a start. I have a retracement from the opening print early last November down around 144, to the high hit last week up around 202. There are a few loose observations at the levels of the bracket, such as the gyrating in early March around the 19.1 percent level, and the resistance near the 38.2 percent level in late February.

DFX - Five Months of Trading

In an attempt to explain the DFX.X's trade up to 201.62 last week, I turned to the point and figure chart. Curiously, the very first buy signal in the DFX.X generated a bullish price objective of 202 -- pretty darn close to last week's high. Obviously like the bar chart, the PnF data is limited to five months worth of trading. But I find the level at which the DFX.X traded up to last week curious. The buy signal to focus on is the one in early December, when the DFX.X traded past 160.

DFX - PnF

There are a few things to think about in the DFX.X as it trades near its vertical count. The first is that if the bullish price objective is exceeded, it would then reveal that the DFX.X remains very strong, and is most likely headed higher. At the same time, though, bulls with big gains in this group should consider that the vertical count has been reached. That could lead to a pullback in the group over the intermediate-term. As such, tightening stops on open bullish plays makes a lot of sense.

Eric Utley
Option Investor

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