Computer Networking Sector Waking Up

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

Bearish momentum from the previous afternoon's weakness caused the major indices to move lower last Friday morning, but stocks found support and stabilized after the first hour of trading. Preferring to be non-committal ahead of the weekend, traders kept the main stock market indexes in a choppy, sideways range throughout the rest of the day. The Dow Jones Industrial Average lost 0.5%, as both the S&P 500 and Nasdaq Composite declined 0.6%. Continued relative strength in small-caps enabled the Russell 2000 to eke out a gain of 0.2%, benefiting our position in Ultra Russell 2000 ProShares (UWM). The S&P Midcap 400 closed lower, but only by 0.2%. For the week, the main stock market indexes all finished near the flat line.

The most positive aspect of last Friday's session is that the market's losses occurred on lighter turnover. Total volume in the NYSE eased 10%, while volume in the Nasdaq was 4% lower than the previous day's level. Despite choppy price action last week, the stock market's volume patterns clearly remained bullish. Last week, the S&P 500 only advanced in two of the five days, but both sessions were "accumulation days" that showed institutional buying. Similarly, all three days of losses were accompanied by lower volume. Higher volume on the "up" days, and lower volume on the "down" days, is one sign of a market that is healthy "under the hood." by advancing on higher volume.

One ETF that has showed bullish divergence to the broad market recently is the Broadband HOLDR (BDH), which stealthily climbed 3.2% last week. BDH is comprised of a basket of 17 stocks related to the computer and mobile networking industry, although Qualcomm (QCOM) currently represents a weighting of more than 50%. Not only has BDH been showing relative strength, but the daily and weekly charts are both positioned for breakouts. First, take a look at the daily chart of BDH:

The dashed horizontal line on the chart above marks resistance of the prior highs of BDH, just over the $14.50 level. Last Thursday, BDH tested that resistance level, but pulled back slightly when the major indices sold off. Nevertheless, the ETF held up pretty well against the broad market weakness, so the slightest rally in the major indices this week should enable BDH to break out above the horizontal price resistance level shown above. Next, check out its longer-term weekly chart:

Notice that a rally above the resistance level illustrated in the first chart will also correspond to a breakout above the multi-year downtrend line of BDH, which began with the high of April 2006. When charts of various time frames line up with one another, it increases the chance of a rally following through to the upside. This is much better than, for example, if BDH was about to break out on its daily chart, but still would be trading below resistance of a primary downtrend line on the weekly chart. Since it now has convergence of bullish patterns on both time frames, we like BDH for a potential buy entry. Our trigger is simply above the horizontal price resistance shown above, over the $14.70 area. If buying BDH, just remember that it's heavily weighted by just one stock, unlike more diversified ETFs.

Speaking of diversification, last Friday's 28% drop in Biogen Idec (BIIB), which resulted from negative news of one of its leading drugs, was a great reminder of the benefits of trading ETFs. If you happened to be holding individual Biogen Idec stock in your portfolio, you would have instantly woken up to a massive loss of more than 20% last Friday. But by comparison, the S&P Biotech SPDR (XBI), which we bought on July 31, only lost 1.9% on Friday. This is because BIIB only comprised about 4% of XBI's basket of biotech stocks. With the rest of the biotech sector still technically looking quite bullish, XBI should still move to new highs in the near future, despite the drag created by BIIB.

The main stock market indexes have now formed clearly defined "swing lows" and "swing highs" within the broad market's developing intermediate-term uptrend. It's still an obvious concern that the long-term trends are bearish, but we must assume further gains in the intermediate-term, unless the "swing low" support levels of July 28 become violated. On the upside, a rally above last week's highs should spark another round of broad-based buying to new "swing highs" in the major indices. But until we see such confirmation of further upside, consider laying low with new position entries.

Open ETF positions:

Long - UWM, XBI, EWH, UUP, TAN, UNG
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 Trade Alerts are also sent via e-mail and/or mobile phone text message 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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