Volume Should Return, Now What?

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

The major indices gapped higher on last Friday's open, chopped around throughout the day, then settled near their positive opening prices. Stocks showed little reaction to the morning Fed commentary on the economy, most likely due to the large opening gap that preceded it. The Nasdaq Composite gained 1.2%, the S&P 500 1.1%, and the Dow Jones Industrial Average 0.9%. The small-cap Russell 2000 and S&P Midcap 400 indices advanced 1.2% and 1.5% respectively. Each of the main indexes barely closed in the upper third of their intraday ranges, as a quick drop in the final fifteen minutes of trading caused stocks to finish off their highs. Despite a lot of indecision, most of the major indices were little changed for the week.

Turnover was mixed ahead of the holiday weekend. Total volume in the NYSE rose 8%, enabling the S&P to score a bullish "accumulation day," but volume in the Nasdaq declined 8% below the previous day's level. Considering that trading usually tapers off ahead of a three-day weekend, it was positive that volume in the NYSE still ticked higher. Still, it was the tenth straight day of below-average volume in both exchanges. Now that the Labor Day holiday has passed, we expect to see the return of institutional trading activity over the next several days. The market's direction that coincides with this increased turnover will likely set the overall tone for the rest of the month.

The S&P 500 closed the week above resistance of its intermediate-term downtrend line, but backed off after testing resistance of its prior high from August 24. While a "higher low" has been formed, a subsequent "higher high" has not yet been established. As such, the index remains in its intermediate-term downtrend:

A firm close above last Friday's high would cause a "higher high" to be formed, but overhead resistance of the 50-day MA may prove troublesome. Based on last week's break of the primary downtrend line, we do not advocate being heavily short right now. However, be aware that new long entries in the broad-based ETFs also do not carry a very attractive risk/reward ratio at current levels. It would only require a break of last Friday's lows in the S&P or other main indexes to resume the primary intermediate-term downtrends. Such a move would also put the S&P 500 back below its pivotal 200-day MA. The daily chart pattern in the Dow is similar to the S&P 500, except that it's a bit higher above its 200-day MA.

Due to its recent relative strength, the Nasdaq Composite is looking much better than both the S&P and Dow. It is the only index that closed the week above its 50-day MA, albeit only marginally:

Friday's strength caused several ETFs we were stalking for potential entry to trigger on the long side. The Oil Service HOLDR (OIH) triggered when it gapped up above the August 29 high, then rose to a new intraday high after the first 20 minutes of trading. We bought the iShares Nasdaq Biotech (IBB) when it moved above both its weekly downtrend line and 200-day MA. Both OIH and IBB were looking pretty good throughout most of the day, but the broad-based selling in the final minutes of trading caused both to close near the middle of their intraday ranges. We'll be monitoring both positions closely today, as we don't want to fall victim to failed breakouts if either ETF does not hold above Friday's low. Tight stops on long positions right now is a good idea.

In addition to OIH and IBB, our long entry in the iShares Corporate Bond Fund (LQD) also triggered. We like that LQD not only closed near its intraday high, but also has a low correlation to the overall direction of the main stock market indexes. The same could be said of our long position in the iShares 20+ year Treasury Bond Fund (TLT).

Our bearish position in the Dow Jones Industrials (DXD long) stopped out last Friday when the Dow gapped up and subsequently rose above its 20-minute opening high. However, the closing broad market weakness caused DXD to finish back above our sell price. With resistance of the 50-day MA just overhead in the Dow, the index could easily resume its intermediate-term downtrend from here. This is especially true considering that many shorts have been shaken out now. We're prepared to re-enter bearish positions in the Dow or S&P 500, but only if they fall below Friday's lows and their hourly uptrend lines from the August 16 lows. Avoid shorting the Nasdaq due to its relative strength. If the S&P and Dow close above their August 24 highs and 50-day MAs, all bets are off on the short side of the market.

Open ETF positions:

Long - TLT, LQD, OIH, IBB
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 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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