The trend in financials has clearly been down for the past 12 months. You may be wondering if financials have finally hit bottom after seeing positive reports from Wells Fargo and JP Morgan lift financial shares this week. If we believe Bridgewater Associates, then the short answer is probably not yet. John Mauldin‘s most recent letter reported that Bridgewater warns that bank losses from the worldwide credit crisis may reach $1.6 trillion. This is four times official estimates and means that at least another $1.1 trillion of losses that will have to be written off by financial institutions all over the world.

For trend followers it’s too early to tell if we’ve hit bottom. Trend followers don’t predict or time the changes in the market. Trend followers specialize in IDENTIFYING the trend and investing with it. So, let’s take a look at a few charts to see what we can find.

First, we have a 3-year weekly chart of XLF, the Finacial Sector ETF:

  • Notice that we have had a declining trend since last July when the price dropped through the 40-week moving average. This was a definite red flag and a signal of danger ahead.
  • The fund is now down 42% over the last 12 months.

Now let’s look at at a daily chart of the recent price action of XLF:

  • Notice the sharp rise created by this week’s price action.
  • RSI and MACD have both turned up.
  • The price is still below the 50-day moving average.

Conclusion: Don’t try to predict the bottom or time the turn in financials. Somewhere ahead lies a great opportunity to invest in financials. But, trend followers should be patient. Remember that trends often last longer than you think. Many thought the worst was over for financials after the Bear Stearns bailout in May. As Bridgewater reports, it could get worse before it gets better. Wait until a bottom can be identified along with a rising trend before investing. Things to look for:

  • The first sign of a new trend will be when the price crosses the 50 day moving average.
  • For a long-term trend to be established you want to see prices above the 200 day (40 week) moving average. When you see this you may then want to consider following this trend. This will provide confidence that the bottom has been established and a new trend is in force.