Why We Took The Quick Profit On SMH

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

Stocks followed through with their second straight day of gains yesterday, but volume continued to decline as well. After opening flat, the major indices moved higher in the first thirty minutes of trading, but subsequently oscillated in a lethargic, sideways range throughout the rest of the session. Even the final hour of the session was uneventful. Both the S&P 500 and Dow Jones Industrial Average gained 0.5%, while the Nasdaq Composite advanced 0.7%. The small-cap Russell 2000 and S&P Midcap 400 indices were higher by 0.6% and 0.8% respectively. All the broad-based indexes finished just above the middle of their intraday ranges.

As with every other "up" day since the June correction began, turnover declined across the board. Total volume in the NYSE was 9% lighter than the previous day's level. Volume in the Nasdaq similarly dipped 7%. In both exchanges, advancing volume exceeded declining volume by a ratio of approximately 5 to 2. Since the S&P 500 peaked on June 4, the index has had four "down" days and four "up" days. Each of the "down" days occurred on expanding volume ("distribution days"), while all four of the "up" days had receding volume. Obviously, this is the exact opposite of what a healthy market should be. Yet, the market continues to display resilience in the face of weak underlying internals.

The Semiconductor HOLDR (SMH) put in a solid performance yesterday, prompting us to sell our long position into strength near yesterday's high. We bought SMH on June 13 when it broke out above its daily downtrend line, then sold only one day later as it neared resistance of its 52-week high. We netted a quick gain of 2.5% with a holding time of just 24 hours:

At the time of initial entry on Wednesday, our plan was to hold SMH for a longer period of time, in anticipation of an eventual breakout to new highs. However, even with the best laid out plans, traders must always account for general market conditions once they enter a new trade.

As discussed in yesterday's commentary, the stock market has whipped around in an erratic manner over the past week. The tug-of-war between the bulls and bears that recently commenced means that taking profits quickly on new positions is probably a good idea. If one does not, there's a very realistic risk of giving all the profits back. Because SMH has been showing relative strength, we could have held it longer, in hopes of a shallow pullback, followed by a breakout to new highs. But given what we've seen recently, there's a good chance a subsequent pullback in SMH might be deep enough to trigger a stop. For that reason, we made a judgment call to simply take the quick and easy profit from a one-day hold. Nevertheless, we will continue to monitor the action in SMH. If it forms a base of consolidation over the next several days, a bullish "cup and handle" chart pattern will form. From that, we could re-enter SMH if/when it breaks about above the high of its "handle." This would enable us to re-buy SMH at nearly the same price, but without the risk of holding it over the next week or so.

Today is "quadruple witching" options expiration, the day on which contracts for stock options, stock index options, stock index futures, and single stock futures all simultaneously expire. Volatility is typically quite high on this day each quarter, as big institutional traders attempt to push stocks towards their desired strike prices. For that reason, any new analysis on support or resistance levels in the broad market would be a moot point. We'll dive in next Monday with an updated look at the strongest and weakest sectors, as well as support and resistance levels on the major indices. In the meantime, we suggest laying low with new trade entries today.

Open ETF positions:

Short XME, EWO, EWW (regular subscribers to The Wagner Daily receive detailed stop and target prices on open positions and detailed setup information on new ETF trade entry prices. Intraday e-mail alerts are also sent as needed.)


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. For a free trial to the full version of The Wagner Daily or to learn about Deron's other services, visit morpheustrading.com or send an e-mail to deron@morpheustrading.com .

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