Hopes of bullish follow-through from Thursday afternoon's reversal attempt were dashed last Friday, as stocks gapped sharply lower on the open, then subsequently closed even lower. Buyers stepped in with two hours remaining, briefly lifting the broad market above its opening high, but a wave of selling during the final thirty minutes shoved the major indices to new intraday lows. Weakness in leading tech stocks dominated for the third straight day, causing the Nasdaq Composite to plunge 2.5%. The S&P 500 fell 1.4% and the Dow Jones Industrial Average lost 1.7%. The small-cap Russell 2000 and S&P Midcap 400 indices were lower by 1.1% and 1.3% respectively.

Turnover receded slightly, but remained well above average levels, indicating the continued presence of institutional selling. Total volume in the NYSE declined 17%, while volume in the Nasdaq was 15% lower than the previous day's level. Despite the sharp losses, market internals were only moderately negative. Declining volume in the NYSE exceeded advancing volume by only 2 to 1. The Nasdaq ratio was negative by just over 3 to 1. The combination of substantial losses and only slightly negative market internals tells us the selling was steady and controlled, not driven by panic and fear. Short-term bottoms of steep downtrends are typically not formed until a bit of panic selling and extremely bearish market internals kick in. We haven't yet seen either one.

The S&P 500 again held support of the 61.8% Fibonacci retracement from its August low to October high that we discussed last Friday. This time, however, the index closed just a few points above that 1,449 support level, rather than bouncing off it. This increases the likelihood of a breakdown below last week's low within the next several days. As mentioned in the November 8 issue of The Wagner Daily, a test of the August low should be expected if the S&P 500 falls below support of the 61.8% Fibonacci retracement (1,449). The closing low of August is 1,406, while the intraday low of 1,370 was marked on the morning of August 16. On the longer-term weekly chart below, notice how the intraday low of August also converges with the low of March 2007 (the dashed horizontal red line). This makes support of the August low much more significant, as a break below that would technically trigger a bearish reversal in the long-term trend. Currently, the S&P 500 is in both short and intermediate-term downtrends, but the long-term uptrend is intact:

Above the August low, notice there is a shelf of horizontal price support at the 1,430 area (circled in blue). A test of this level could easily come into play this week, though its support is technically not as significant as the August low of 1,370. As for overhead resistance on any rally attempt, there is plenty! Above all, a double top has formed from last month's failed breakout attempt. This has left an abundance of overhead supply in its wake. New resistance of the 200-day MA will be difficult to overcome, as will the 20 and 50-day moving averages, shown on the daily chart below:

Most notable on the daily chart is the bearish signal that occurred when the 20-day MA crossed below the 50-day MA last Friday. This is one indicator that many traders use as a confirmed sign of an intermediate-term trend change. The 20-day MA last crossed below the 50-day MA in late July, setting in motion a seven-week downtrend.

The Nasdaq Composite is now showing its true colors, as the tech-heavy index plays "catch up" to the prevailing weakness in the S&P, Dow, Russell, and Midcap indices. The former relative strength the Nasdaq was exhibiting just one week ago represented the biggest chance to hold the broad market together, but last week's 6.5% drop, the largest in more than five years, erased any hope of tech stocks saving the market. Within just the past three days, the Nasdaq has given back seven weeks of gains. Heavy selling is no longer confined to the Financial sector, as leading growth stocks including Google, Apple, Research in Motion, and Baidu all fell sharply last week. The only good news is that the Nasdaq still remains above its 200-day moving average, though it is fast approaching that 2,578 level. We'll be monitoring the price action closely as the index nears its 200-day MA, looking for any clear signs of accumulation.

In confirmed broad market downtrends, approximately 75% of stocks move in the same direction as the broad market. Therefore, finding a winning stock ETF on the long side right now is akin to searching for a dropped contact lens on a glass floor (was bored with the "needle in a haystack" analogy). Financials began finding support as money flowed out of the tech sectors last week, but any long entry in financials requires precision trade management. Only advanced traders should consider playing such a counter-trend bounce. Aside from the continuing strength in commodities ETFs, the only other sectors we spotted strength in last week was within Biotech and Medical Devices. Unfortunately, the chart patterns of the corresponding ETFs are not that great, but traders of individual stocks should take a look at the following tickers: UTHR, ONXX, OSIP, IVGN, and CRL. These medical stocks are among the most bullish chart patterns in the market right now, but let us again remind you of the risk of swimming against the tide.

Overall, your odds of profitable trading clearly favor the short side of the market right now, but patience is required there as well. Many ETFs have now broken key support levels, but the astute trader will wait for the next bounce into resistance of a prior low or significant moving average before selling short. After closing our short position in the Russell 2000 for a handsome gain last week, our sole remaining position is the Mexico Index (EWW) short. Currently, it is showing an unrealized gain of just over 2 points. When the broad market's relief rally eventually comes, we'll be looking for new short entries on ETFs that have shown the most relative weakness. Until then, there's no harm in remaining primarily on the sidelines, avoiding the risk of giving back recent gains. For those who prefer to avoid short selling altogether, cash is definitely king!

Open ETF positions:

Long - (none)
Short - EWW

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.