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A 'Bull Trap'
Yesterday was a tale of two markets, as the major indices diverged sharply. A 3% pop and relative strength in the Semiconductor Index ($SOX) enabled the Nasdaq to secure a respectable 0.6% gain, but the S&P 500 merely spun its wheels and finished unchanged. The Dow Jones Industrial Average, small-cap Russell 2000, and S&P Midcap 400 indices each advanced 0.2%. Though the Nasdaq fared best, it was a choppy and indecisive day for the major stock market indexes. The S&P 500 oscillated between positive and unchanged territory throughout the session before closing near its intraday low. The Nasdaq came to rest just above the middle of its range.
Substantial institutional money flow into a handful of semiconductor stocks caused volume in the Nasdaq to surge 25% above the previous day's level. The Nasdaq's higher volume gain represented a bullish "accumulation day" that made it easy to overlook Monday's loss on slightly increasing turnover. Unfortunately, the same could not be said of the S&P. Total volume in the NYSE increased 5%, but this was not necessarily good considering the S&P closed flat. When trading rises and an index doesn't go anywhere, it is often indicative of "churning" caused by institutional selling into strength. Conversely, turnover should recede during periods of consolidation and increase on "up" days. Market internals were mixed. Advancing volume in the Nasdaq exceeded declining volume by a margin of approximately 2 to 1. In the NYSE, declining volume was greater than advancing volume by nearly 3 to 2.
Before the market closed yesterday afternoon, we were prepared to analyze and illustrate the impressive strength that several tech sectors displayed. But the situation quickly changed after Intel (INTC) and Yahoo! (YHOO) announced their latest quarterly results after the close. Unimpressive earnings reports caused both stocks to sell off sharply in the after-hours market, dragging the rest of the market lower as well. Both INTC and YHOO were last seen trading about 5% below their official closing prices, with heavy volume to boot. The Semiconductor HOLDR (SMH), which rallied as much as 2.7% during the regular session, gave back all of the day's gain in after-hours trading. Both the S&P and Nasdaq futures were trading 0.6% lower after-hours. So, what might we expect to happen today?
One way or the other, stocks are likely to trend sharply. The first possible scenario, common in bull markets, is that stocks gap sharply lower on the open, but buyers immediately step in, causing the major indices to reverse and "fill the gap" within the first 30 minutes. If this happens, it would certainly lay to rest any concerns about the true strength of this market. Momentum from such a bullish move would probably lead to further gains throughout the day.
The bearish scenario is that institutions fail to support the stock market after the initial gap down. If this happens, traders who aggressively bought yesterday's numerous tech breakouts will be trapped well below their entry prices. Such a "bull trap" would cause those traders to sell their positions, further compounding the market's weakness and subsequently attracting short sellers. The end result is a downtrending day that follow the opening losses. You may want to review yesterday's commentary for a detailed listing and illustration of key support levels in the S&P, Nasdaq, and Dow.
In yesterday's Wagner Daily, we said that, "The reaction to the onslaught of corporate earnings reports on tap over the next week will be the biggest determinant of whether or not last week's rally will hold up. With quarterly earnings season in full swing, expect greater than usual day-to-day volatility and erratic movements in the broad market." Clearly, we're going to get a taste of that volatility in today's session. We have no opinion as to whether the bullish or bearish possibility will prevail, but we do feel confident the market will quickly show its hand. The best advice is to be mentally prepared for either situation. As earnings season is just getting under way, stay alert and prepared for other such shocks to the system along the way.
Long - INP, FXC, GDX, IBB
Short - (none)
NOTE: Regular subscribers to The Wagner Daily receive daily updates on the open positions above, as well as new ETF trade setups, including trigger, stop, and target prices. Intraday e-mail alerts are also sent on as-needed basis.
Deron Wagner is the head trader of Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com), which he launched in 2001. Wagner appears on his best-selling video, Sector Trading Strategies (Marketplace Books, June 2002), and is co-author of both The Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader (McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and Yahoo! FinanceVision. He is also a frequent guest speaker at various trading and financial conferences around the world. Wagner is currently working on this third book, scheduled for publication in early 2008.
For a free trial to the full version of The Wagner Daily above, which includes detailed ETF trade setups and daily position updates, or to learn about our other newsletters, visit morpheustrading.com or send an e-mail to deron@morpheustrading.com .
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