Relative Strength In Oil And Oil Service Etfs

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

The main stock market indexes got off to a negative start yesterday, but held support of the previous day's lows. After trading in a narrow, sideways range throughout most of the day, buying interest in the final thirty minutes lifted stocks back towards unchanged levels. The Nasdaq Composite slipped 0.1%, as the S&P 500 advanced by the same percentage. Relative strength in blue chips enabled the Dow Jones Industrial Average to gain 0.3%. The small-cap Russell 2000 Index fell 0.3% and the S&P Midcap 400 was flat. Each of the major indices closed near their intraday highs.

Total volume in the NYSE eased 14%, while turnover in the Nasdaq was 6% lower than the previous day's level. Since the broad market finished with mixed results and near the flat line, the lighter volume was of little significance. Market internals were negative, though not by a wide margin. In both exchanges, declining volume exceeded advancing volume by less than 2 to 1.

With continued strength in the Oil and Oil Service sectors, both the S&P Select Energy SPDR (XLE) and the Oil Service HOLDR (OIH) have been forming bullish consolidations near their highs. When the broad market got slammed on Tuesday afternoon, the oil and oil service sectors dropped as well. However, they immediately snapped back the following day, closing near Tuesday's highs. Stocks and ETFs that quickly brush off negative price action or news are showing relative strength and should be bought on breakouts of consolidation patterns. The daily charts of XLE below illustrates its bullish pattern:

With XLE, a rally above the high of the past two days correlates to a breakout above the prior highs from late October and early November. There is a bit of resistance from the mid-October highs, but bullish momentum should push XLE above that level if it moves above the horizontal price resistance illustrated above. One way to lower your risk on this play is to buy a partial position of XLE on the move above $77.77, then add your remaining shares only on confirmation of the breakout above the mid-October high of $78.50. More conservative traders may prefer to instead wait for a clear breakout to a new 52-week high before buying any shares. Next, take a look at the bullish setup in the Oil Service HOLDR (OIH):

As you can see, the chart pattern in OIH is rather similar to XLE. One slight difference is that XLE has shown a little more relative strength the past two days by rallying above the high of December 11. OIH remains just below that day's high, which is the pivot for the breakout. As per the previous paragraph, an entry into OIH could be managed in similar fashion as XLE.

The price action in the S&P 500 over the past few days is a good example of how the mighty 200-day moving average often acts like a magnet. Yesterday, the S&P settled just above its 200-day MA after closing Wednesday right on it. With the index holding its prior day's low and subsequently closing near its intraday high, it seems the S&P may be trying to put in a short-term bottom. That would not surprise us because the initial knee-jerk reaction from Fed announcements (negative in this case) is often reversed when the real reaction comes a few days later. Nevertheless, a lot of overhead supply remains from the bulls who were trapped in Tuesday afternoon's sell-off. Further, pivotal resistance of the 50-day MA is just ten points above yesterday's close of 1,488. Expect continued choppiness and indecision until the balance of power firmly shifts in one direction or the other.

Open ETF positions:

Long - PPH
Short - FXI

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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