Here's the long setup in Internet stocks

Stocks followed up Tuesday's lethargic session with a strong session of broad based gains yesterday, as higher volume across the board confirmed the rally. Shrugging off the prior day's Federal Reserve interest rate increase, the major indices trended steadily higher throughout the entire session and finished at their intraday highs. A recovery in the Semiconductor Index, which popped back over its 200-day MA, enabled the Nasdaq Composite (COMP | Quote | Chart | News | PowerRating) to power 1.4% higher. The S&P 500 (SPX | Quote | Chart | News | PowerRating) turned in a quite respectable gain of 1.0%, but the Dow Jones (DJX | Quote | Chart | News | PowerRating) lagged behind and closed only 0.6% higher. As we often see during a healthy market, small caps showed relative strength that caused the Russell 2000 to charge 2.2% higher. The S&P 400 Midcap Index similarly advanced 1.8%.

The most important thing about Wednesday's rally is that it was backed by strong institutional demand. Total market volume in the NYSE surged 11% higher, while volume in the Nasdaq was 13% higher than the previous day's level. Not only was volume well above average levels in both exchanges, but it was the highest volume "up" day in the Nasdaq since September 16. This tells us that mutual funds, hedge funds, and other institutional investors supported yesterday's "accumulation day." It is estimated that more than 70% of the stock market's daily volume is the result of institutional activity. As such, participation by institutions, as opposed to solely retail investors, is necessary in order to sustain market rallies. Strong market internals also confirmed the broad-based buying.

Unlike recent rally attempts the broad market has had over the past several weeks, yesterday's gains were broad-based across nearly every industry sector. Only two industry sectors we follow, Software (GSO | Quote | Chart | News | PowerRating) and Pharmaceutical (DRG | Quote | Chart | News | PowerRating), closed in the red yesterday. Conversely, more than half of the 23 sectors we monitor daily gained more than 1.5%. The top sector gainer yesterday was the DJ Home Construction Index ($DJUSHB), which rocketed 5% higher in heavy trade. Upon taking a look at both the short and long-term charts, we noticed the sector closed right at key trendlines yesterday.

The $DJUSHB sector, which we have shorted several times over the past three months, has been in a steady downtrend since its high of July 2005. However, the sector appears to have formed a double bottom last month and closed yesterday right at resistance of its daily downtrend line, as well as its 50 and 200-day moving averages. If the sector is able to power through convergence of these three resistance levels, it will trigger a short-term buy signal because the bears who have been short the downtrend will be forced to cover. If this occurs, the index could attempt to recover back to its prior high, or at least into its 61.8% Fibonacci retracement level. Notice how the index closed right at convergence of its downtrend line and 50/200-day MAs yesterday:

The double bottom that formed last month may provide the technical support necessary for the index to break the resistance levels circled above, but another challenge may be the long-term monthly chart of the sector:

As you can see, the $DJUSHB sector broke below support of its 3-year uptrend line last month and now has rallied into resistance of that prior uptrend line (remember that prior support becomes the new resistance after the support is broken). Obviously, it may be challenging for the sector to break out above this prior uptrend line, but it is entirely possible that a new, less-steep monthly uptrend line will form instead. We point out the long-term chart just to keep the "big picture" of the sector in perspective with the potentially bullish trend reversal on the daily chart. Like we discussed in yesterday's Wagner Daily, looking at long-term charts helps to prevent fighting a greater trend that may be in the opposite direction. If interested in playing the Home Construction sector, there is not an ETF that directly tracks it, but you can make your own "synthetic ETF" by trading a small basket of the leading stocks in the index. Some names to look at, in no particular order, are: (PHM | Quote | Chart | News | PowerRating), (LEN | Quote | Chart | News | PowerRating), (RYL | Quote | Chart | News | PowerRating), (KBH | Quote | Chart | News | PowerRating), (DHI | Quote | Chart | News | PowerRating), (HOV | Quote | Chart | News | PowerRating), (TOL | Quote | Chart | News | PowerRating), and (BZH | Quote | Chart | News | PowerRating).

Upon scanning all the long-term sector charts, the most bullish looking one is the Internet index ($GIN), which just broke out of a weekly cup and handle pattern and closed at a fresh 4-year high:

Because the sector is trading at a multi-year high, there technically is no overhead resistance to contend with. The sector has rallied sharply for three straight days, but we view it as a good play to buy on any pullback to near the breakout level. (HHH | Quote | Chart | News | PowerRating) (Internet HOLDR) is a popular ETF that tracks the Internet stocks. Among the biggest individual stocks within the sector are: (GOOG | Quote | Chart | News | PowerRating), (EBAY | Quote | Chart | News | PowerRating), (YHOO | Quote | Chart | News | PowerRating), and (AMZN | Quote | Chart | News | PowerRating).

As for the broad market, the S&P finally closed above resistance of its 50-day MA yesterday, as well as its daily downtrend line from the September high. This enables us to feel more confident about re-entering the long side of the stock market. The Nasdaq Composite also finished just a hair above resistance of its daily downtrend line from the August high. This further confirms the broad market reversal, but the Dow continues to hang out below its 200-day MA. We are now shifting from a neutral into a cautiously bullish bias, although we are concentrating the most on individual sectors with relative strength to the broad market. This is probably safer than trying to buy the broad market ETFs here. Regular subscribers will see a new sector ETF setup for potential long entry below.