Banking bounce under way?

For the second straight day, stocks got off to a higher start, but promptly turned tail and headed south throughout the rest of the day. This time, there was no last-minute rally to minimize market losses. However, at least the major indices managed to hold above their previous day's lows. The S&P 500 lost 1.0%, the Dow Jones Industrial Average 1.2%, and the Nasdaq Composite 2.0%. The small-cap Russell 2000 and S&P Midcap 400 indices declined 2.2% and 0.9% respectively. The main stock market indexes closed near their lowest levels of the day.

Total volume in the NYSE declined 12%, while volume in the Nasdaq was 17% lighter than the previous day's level. Notably, turnover in the Nasdaq slipped below its average level for the first time in a month. This indicates yesterday's losses were more the result of a lack of buying interest, as opposed to heavy selling amongst mutual funds, hedge funds, and other institutions. Although a simple lack of buying interest in the market can lead to losses that are just as sharp as those suffered under heavy institutional selling, there is one substantial difference. When the eventual impetus to buy stocks sparks the market, upside gains will usually be more significant when there is not an abundance of heavy selling (overhead supply) to overcome while the market is rallying.

What news or technical event will finally give traders and investors a reason to step back in the markets to at least spark a short-term rally? One possibility could be a rebound in the annihilated financial sector, particularly the banks. If bank stocks start to bounce off their lows, it could pull the rest of the broad market with it. After all, it has primarily been the banking stocks that have led the overall market lower on the down days.

We bring up the banking stocks because there was quite apparent relative strength in the sector yesterday. As the S&P 500 closed 1.0% lower, a vast majority of industry sectors registered losses as well. But one exception was the S&P Banking Index ($BIX), which zoomed 10.7% higher yesterday. Another important financial sector, Real Estate ($DJR), notched a respectable 2.1% gain. Within the banking index, it's interesting to note Bank of America jumped 19% and Wells Fargo gained 18%. Granted, both stocks were merely bouncing off their lows, but the large gains were nevertheless encouraging. On the hourly chart of the $BIX, notice the index just broke out above resistance of a two-week downtrend line:

If the $BIX holds the lows of yesterday afternoon's price consolidation, it will remain above the short-term downtrend line it just rallied above. From there, a confirmed rally above yesterday's high could propel the index into its 20-day exponential moving average (presently at $66.20), a significant area of price resistance that stopped rally attempts twice last month. The 20-day exponential moving average is annotated on the daily chart of the $BIX below:

The big question, of course, is whether yesterday's strength in financials was just a one-day fluke that will fade away within the next several days, or if the sudden upside momentum will continue to strengthen. If the latter situation occurs, it's hard to imagine the overall stock market would not be inclined to move higher alongside of the financials, at least in the short-term. Nevertheless, because the financials are still at their lows, we are not suggesting buy entries into specific banking ETFs. Rather, our point is merely that you may want to keep an eye on the performance of financials in the coming days, as a potential barometer of what may follow in the broad market. ONLY FOR ADVANCED DAYTRADERS, who may wish to capitalize on potential intraday strength in the financials, here are tickers of some of the more popular ETFs to put on your watchlist: RKH, IAT, XLF, UYH, IYF, and IYR.

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Open ETF positions:

Long - DGP, SLV, UGA
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's new book, Trading ETFs: Gaining An Edge With Technical Analysis, was published by Bloomberg Press in August, 2008. Wagner also 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 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.