Let's See What Happens When Volume Returns. . .

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

Stocks followed through on the previous day's strength in Tuesday's holiday-shortened session, enabling the Nasdaq to close at another new six-year high. The Nasdaq Composite gained 0.5%, the S&P 500 advanced 0.4%, and the Dow Jones Industrial Average closed 0.3% higher. Both the small-cap Russell 2000 and S&P Midcap 400 indices rallied 0.4%. The Nasdaq finished at its intraday high, while the other major stock market indexes settled in the upper quarter of their intraday ranges.

As one would expect in a session that closed three hours early, turnover in both exchanges fell sharply. Total volume in both the NYSE and Nasdaq was 44% lighter than the previous day's level. Even factoring out the early close, trading was still on track to come in much lighter. When institutional trading participation is lacking, it doesn't take a lot of volume to move the market in one direction or the other. Therefore, we caution you against placing too much importance on the market's gains of the past two days. Certainly, it was positive that the S&P 500 moved back above its 50-day MA and the Nasdaq closed at a new high. However, buying stocks and ETFs will be much safer if those gains are retained when the mutual funds, hedge funds, pension funds, and other institutional traders return to the scene today.

After a false start two weeks ago, the Nasdaq 100 Tracking Stock (QQQQ) firmly closed at a new six-year high:

The dashed horizontal line on the chart above marks the pivotal breakout level that should now act as support on any pullback. When an index is in new high territory, there is a lack of overhead supply that usually enables them to continue higher. Therefore, any retracement down to the breakout level, around the $47.90 to $48 area, constitutes a low-risk buy entry. Tuesday's low of $48.04 should also act as support. If QQQQ pulls back today, we will be looking for a potential long entry. The caveat, however, is that any retracement should be on relatively light volume. If turnover surges sharply higher on a pullback, it would be indicative of bearish distribution.

The Semiconductor HOLDR (SMH) has been consolidating near its high of the past three weeks, but we are more hesitant to buy a potential breakout. Recent price action in SMH has been erratic, so there is a greater chance of getting chopped up and stopped out. As you may recall, we bought a very strong breakout from a "cup and handle" pattern and to a new high on June 21. Three days later, SMH had not only failed the breakout, but also dropped to below the low of the breakout day. The next day, it zoomed back to within 26 cents of the June 21 high, only to retrace nearly two-thirds of that move two days later. It has tightened up a bit over the past two days and it's still not a bad idea to buy a breakout above the June 21 high. Just be aware that its recent price action has been challenging:

While the Nasdaq brothers have been acting well, the biggest area of concern remains the relative weakness in the broad-based S&P 500. Granted, the recent strength in the Nasdaq pulled the S&P back above its 50-day MA. However, it did so in two days of much lighter than average volume that preceded the holiday. Again, we'll feel a lot more comfortable jumping back on the long side of the market after stocks prove they will retain their gains when the "smart money" begins returning today. There is still a considerable amount of overhead supply the S&P must contend with before moving back to a new record high. The big picture remains pretty much the same as it has been for weeks. Buy the tech sectors of the Nasdaq, but avoid the ambiguity of the chart patterns in the S&P and Dow. Shorts in the S&P and Dow to hedge long positions in the Nasdaq are not a bad idea.

Open ETF positions:

Long - (none)

Short - EWO, KCE, XLE

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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