The Long Anticipated Bounce. . .

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

The long anticipated bounce finally came yesterday, sending stocks sharply higher across the board.  After opening flat, the major indices trended steadily higher throughout the entire session.  This time, the bulls also retained control into the close.  The S&P 500 and Dow Jones Industrial Average posted matching gains of 2.5%, as the Nasdaq Composite climbed 3.1%.  The small-cap Russell 2000 and S&P Midcap 400 indices rallied 3.7% and 2.4% respectively.  Each of the main stock market indexes finished at its best level of the day.

On the surface, yesterday's gains were quite encouraging.  However, lower volume in both exchanges was a concern.  Total volume in the NYSE declined 11% below the previous day's level, while volume in the Nasdaq eased 13%.  If this was a legitimate "capitulation," strong institutional accumulation should have matched the large gains.  Nevertheless, turnover in both exchanges remained firmly above 50-day average levels.  Market internals in the Nasdaq were also quite strong, but not as much so in the NYSE.  Advancing volume in the Nasdaq trounced declining volume by a margin of 9 to 1.  Comparatively, the NYSE adv/dec volume ratio was positive by less than 4 to 1.  This figure alone tells us that mutual funds, hedge funds, and other institutions were more interested in technology-related sectors than the "old economy" sectors.

In yesterday's Wagner Daily, we pointed out the exhaustion pattern that was forming in the UltraShort Financials ProShares (SKF), an inversely correlated ETF proxy for the overall health of financial stocks (SKF moves up as the financial sector moves down).  Specifically, we said that, "SKF became parabolic, and volume surged to its all-time highest levels.  This combination of events may be representative of an "exhaustion" move that usually provides a warning signal to astute traders that a significant top is near. . .If SKF is truly forming a short to intermediate-term top, it means the financial stocks may finally be bottoming.  While this does not mean we should get excited and start buying the financial sector, it does mean that a potential bounce in financials could lead to a significant bounce in the broad market in the coming days."  That "significant bounce" obviously started yesterday.  So, what happened to SKF yesterday?  It tumbled an astronomical 21.7% (44 points)! The follow-up price action to Tuesday's "exhaustion" move in SKF is shown on the daily chart below:"

From an educational perspective, you may wish to make a note of the elements that often represent an "exhaustion" move that marks a top.  Generally, this occurs when a stock or ETF that has already been trending steadily higher for months suddenly becomes parabolic by surging above the upper channel of the primary uptrend line, as SKF did on Monday, and then more so on Tuesday.  Also, volume typically races to its highest historical levels.  This is caused by all the "late to the party Charlies" finally jumping on the bandwagon when the trend becomes so glaringly obvious.  At that point, it's time to be on guard for a sharp reversal.

While the rest of the market zoomed higher yesterday, the Biotechnology sector took a breather from its recent gains.  Still, individual stocks within the sector are showing the most bullish chart patterns of any other industry right now.  In yesterday's commentary, we said that a pullback to the 20-period exponential moving average on the hourly chart would represent a potential buy point in the Biotech HOLDR (BBH) if you missed our initial entry two weeks ago.  Yesterday's 0.5% pullback in BBH caused the ETF to do exactly that.  The gentle BBH retracement to the 20-period EMA is shown on the hourly chart below:

Over the past week, we've been stalking Market Vectors Russia (RSX) for a potential buy entry on a breakout above the hourly downtrend line from its June 19 high.  For seven straight days, RSX had been showing relative strength to the broad market by holding at major support of its 200-day moving average as the S&P 500 moved lower nearly every day. Though it's still within its recent band of consolidation, RSX cruised higher to break out above its hourly downtrend line in the final hour of yesterday's trading.  This triggered our buy entry into the close.  The daily chart of RSX is shown below:

The big question on investors' minds is whether or not yesterday's rally will have legs.  We feel there was enough broad-based momentum to carry stocks higher in the near-term, over the next week or so, but it's way too early to expect much more than that.  We don't like that overall turnover declined yesterday, but trading was still well above average levels.  Simply put, there is a ton of overhead supply the stock market must contend with in order to move much higher in the intermediate-term.  The bulls probably have the upper hand for now, but this is definitely not the time to be complacent on the long side of the market.  As always, focusing exclusively on stocks and ETFs that have been showing relative strength to the broad market is the best way to both limit your risk and maximize profits.  After the close today, look for a slew of key quarterly earnings reports from market-moving companies including Google, IBM, Merrill Lynch, and Microsoft. Biotech leader Gilead Sciences is also slated to report.

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Open ETF positions:


Long - BBH, GLD, UWM, RSX

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.

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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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