Net short, and staying that way for now

Just as quickly as the Nasdaq scored a 1.8% gain in the previous session, the tech-heavy index gave it all back and then some. The Nasdaq (COMP | Quote | Chart | News | PowerRating) trended steadily lower throughout the day before finishing with a 2.0% loss and at the bottom of the prior day's range. The S&P 500 (SPX | Quote | Chart | News | PowerRating) and Dow Jones Industrial Average (DJX | Quote | Chart | News | PowerRating) fared better, as both indices retraced "only" half of their gains from the previous day. The S&P and Dow each declined 0.8%. Small and mid-cap stocks led the broad market higher yesterday, so it is not surprising those segments also lost the most yesterday. The Russell 2000 slid 2.7% and the S&P Midcap 400 closed 2.3% lower.

It was certainly negative that the Nasdaq was unable to hold on to any of Wednesday's solid gain, but the sole glimmer of hope for the bulls is that the index fell on lighter volume. Total volume in the Nasdaq was 25% lower than the previous day's level, while the NYSE volume declined by 8%. Obviously, yesterday's price action in the broad market was not encouraging for the bulls, but recent volume patterns actually have been. On Tuesday and Wednesday of this week, the broad market scored two straight "accumulation days" by gaining on higher volume. Then, stocks subsequently sold off pretty hard, but a drop off in turnover prevented a bearish "distribution day" from forming. In the NYSE, declining volume exceeded advancing volume by a margin of 3 to 1, while the Nasdaq was negative by nearly 5 to 1.

Several sectors sustained significant losses and technical damage to their charts yesterday. The Oil Service Index (OSX | Quote | Chart | News | PowerRating) plummeted 4.7% and was the biggest percentage loser of all the industry sectors we follow. After bouncing off support of its 200-day moving average in mid-June, the Oil Service HOLDR (OIH | Quote | Chart | News | PowerRating)), which closely follows the $OSX index, attempted to reverse its downtrend. But after trading above its 200-day MA for a month, OIH dropped back down to that key support level. Yesterday's loss caused it to close firmly below its 200-MA and near its June low. If that low of June 13 fails to hold over the next few days, we could see a lot of downside momentum develop. Note the break of support on the daily chart below:

Another industry sector that fell sharply yesterday was the Dow Jones Transportation Average (DJT | Quote | Chart | News | PowerRating), which lost 4.4%. Until recently, transports were one of the strongest sectors in the stock market, but its pattern has become rather bearish, with yesterday's action confirming the weakness. The sector first ran into problems when it formed a double top at resistance of its prior high on July 3. Upon doing so, the sector sold off until it broke below its 50-day moving average on July 13. The $DJT rallied nicely on July 19, but closed right below its 50-day MA. As such, resistance of that 50-day MA triggered selling in the sector yesterday, prompting the $DJT to break below its prior low from July 14. We now expect the index to test support of its 200-day MA within the next several days. The only ETF tied directly to transportation is the iShares DJ Transportation Index (IYT | Quote | Chart | News | PowerRating), which is shown below:

Yesterday's bearish reversal in the Nasdaq was a good example of why we warned against trying to call a market bottom without first having confirmation of the major indices breaking out above their downtrend lines. We illustrated resistance of those downtrend lines, as well as several key moving averages, on the daily charts of both the S&P 500 and Nasdaq Composite in yesterday's Wagner Daily. Regardless of technical bounces along the way, we must assume the current downtrend in the broad market will continue until the charts prove otherwise. The most consistently profitable method for short-term trading is to merely follow the direction of the stock market's trend, then reacting to changes in trend when they occur. If those trend changes don't happen, changes to our plan are not necessary either. We remain net short in the Morpheus Capital hedge fund and will stay that way until the market gives us a good reason not to be. Remember to always trade what you see, not what you think!

Open ETF positions:

Long LQD (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 .