Bears Winning The Tug-of-War?

NOTE: Please click on the charts below to enlarge them if they do not appear clearly.

Just looking at the closing figures, one may understandably assume that yesterday's session was relatively tame. A quick glance at the intraday charts, however, shows a rather bearish day. Although the S&P 500 only closed 0.3% lower, the index dropped more than 1% from its mid-day intraday high. The Nasdaq Composite and Dow Jones Industrial Average showed gains of 0.7% and 1.0% after the broad-based morning rally, but the indexes eventually shed 0.5% and 0.1% respectively. The small-cap Russell 2000 fell 0.9% and the S&P Midcap 400 lost 0.7%. A modest bounce in the final thirty minutes of trading lifted the market off its low, but each of the major indices still finished in the bottom quarter of its intraday range.

Total volume in the NYSE came in 34% below the previous day's level, while volume in the Nasdaq receded 46%. Remember that last Friday's volume levels were inflated by the annual rebalancing of the Russell indexes. Factoring that out of the equation, volume actually would have increased yesterday, giving both the S&P and Nasdaq another "distribution day." Turnover in the NYSE remained above its 50-day average level, as the Nasdaq volume registered just shy of its average. Market internals deteriorated alongside of prices throughout the day. Declining volume in the NYSE exceeded advancing volume by nearly 3 to 1. The Nasdaq ratio was negative by a little more than 2 to 1.

The S&P 500 made a valiant attempt to recover back above its 50-day MA in the morning session, but the afternoon weakness caused the index to close below the pivotal level for the second consecutive day. Resistance of the 20-day EMA marked yesterday's intraday high and bearish reversal point. Still, the index held above its June low, a level that is undoubtedly being closely watched by institutional traders and investors. If the S&P closes below the 1,490 level, two points below yesterday's intraday low, stock market action could get pretty ugly:

Joining the S&P 500, both the Russell 2000 and S&P Midcap 400 indices closed below their 50-day MAs. It was the first time the latter has done so since March 16. Both indexes have been showing relative weakness to the broad market, as they failed to even touch resistance of their prior highs when the Nasdaq posted a new high on June 15. The S&P Midcap 400 also closed yesterday perilously close to its June low. If the broad market shows any further weakness in the days ahead, expect this index to be the first to break down below its prior low. A breakdown to a new June low would also represent a drop below the "neckline" of the bearish "head and shoulders" chart pattern that has developed. This is illustrated on the daily chart of the S&P Midcap SPDR (MDY) below:

Between the two, the Russell 2000 has been choppier than the S&P Midcap. It also has more price support below its current level. Therefore, if considering a short sale, MDY is a better bet than IWM (iShares Russell 2000). On the chart of IWM below, notice the recent chop and price congestion from several months ago. This is not what we want to see if initiating a short sale:

Recently, we've been discussing how money flow into the tech stocks was trying to prop up the Nasdaq, while weakness in the S&P 500 was simultaneously countering the tech bullishness. Sooner or later, the tug-of-war is bound to be resolved. Based on the action of the past two days, it looks as though the bears are winning. Nevertheless, this can't be confirmed until one or more of the major indices begin forming "lower lows" by falling below their prior lows from June. If this happens, tech strength may not be able to save the Nasdaq. Again, a healthy mix of long and short positions is a good way to handle the current market. On the long side, Internets, Semiconductors, Computer Hardware, Oil, and Solar Power sectors are holding up the best. On the short side, many industries have recently rolled over below their 50-day MAs. These include Securities Broker-Dealers, Banking, Retail, Utilities, and Transportation. Several opportunities can also be found in the International sector ETFs.

Open ETF positions:

Long - SMH, SDS

Short - EWO, XME

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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