This sector is stabilizing

The major indices scored their strongest gains in weeks yesterday, as stocks trended steadily upwards throughout the entire session and finished at their intraday highs. Continued strength in the Semiconductor Index (SOX | Quote | Chart | News | PowerRating), which rallied 3.8%, helped the Nasdaq (COMP | Quote | Chart | News | PowerRating) to post a 2.0% gain. Both the S&P 500 and Dow Jones Industrial Average (DJX | Quote | Chart | News | PowerRating) turned in solid performances as well, gaining 1.0% and 0.9% respectively. Even the small and mid-cap arenas that have been lagging in recent days suddenly woke up. The Russell 2000 advanced 2.4%, while the S&P Midcap 400 closed 1.7% higher.

Turnover picked up across the board, enabling the Nasdaq to register its second consecutive "accumulation day." Total volume in the Nasdaq was 19% higher than the previous day's level, while volume in the NYSE increased by 8%. This time, the higher volume gains in the S&P pointed to institutional buying in the NYSE in addition to the Nasdaq. Volume in both exchanges was well above average levels, and was the highest in approximately one month. Volume also was higher than it was on both "distribution days" that occurred on September 6 and 7. Clearly, the buying power of mutual funds, hedge funds, and other institutional traders were behind yesterday's broad-based rally.

In addition to the strength in techs that we have noted over the past several days, institutional money has also begun to rotate into a few other sectors that have been dormant for a long time. The DJ U.S. Home Construction Index (DJUSB | Quote | Chart | News | PowerRating), for example, has been in a steady downtrend the entire year, but it rocketed 6% higher yesterday. The first sign of stabilization in the index occurred when it formed a slightly "higher low" on August 14. After a small bounce, the $DJUSHB sold off to test support of that August 14 low on September 7. It formed a "double bottom" at that point, which helped the index to break out firmly above a four-week base of consolidation and its 50-day moving average yesterday. There is still a substantial area of resistance that is marked by the red dashed horizontal line on the chart below, but we feel there is a good chance that yesterday's momentum will carry the index above that level within a few days:

As indicated on the Morpheus ETF Roundup are two different ETF families that are correlated to the Home Construction sector. They are the iShares DJ U.S. Home Construction (ITB) and the StreetTRACKS Homebuilders (XHB). The former moves pretty much in lockstep with the $DJUSHB index, while the latter is weighted differently. But of the two, XHB is more popular because it trades an average daily volume of 1 million shares versus 100,000 shares for ITB.

Yesterday's gain in the Nasdaq was impressive because it enabled the index to erase all of its losses from the September 6 and 7 "distribution days." As mentioned earlier, it also did so on higher volume than both of those sessions. Looking at the chart below, you will see that the Nasdaq closed above is prior high from September 5, but the 200-day moving average now looms overhead. It's anyone's guess as to how easily the index will overcome its 200-day MA, assuming it even does, but this pivotal resistance level provides a good reason to be cautious with new trade entries in this vicinity:

As we have been mentioning all along, the S&P 500 has much less overhead resistance than the Nasdaq and is only one percent off its multi-year high. Obviously, a breakout to a new 52-week high would be extremely bullish for the S&P 500, but resistance of a prior high also provides a good excuse for traders to sell into strength. Because of the key resistance areas that both the S&P and Nasdaq are approaching, don't become complacent! Yesterday's session definitely showed a lot of bullish momentum, but just remember that none of the indices are at their 52-week highs and therefore still must contend with varying degrees of overhead supply.

Open ETF positions:

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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 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 .