Market reversal or just a bounce? This tool can tell you

consecutive session last Friday, as trading activity slowed ahead of

the holiday weekend. The S&P 500
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PowerRating), Nasdaq Composite
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PowerRating), Dow

Jones Industrial Average
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PowerRating), S&P Midcap 400, and small-cap Russell 2000

indices each gained 0.6%. Each of the major indices also finished near their

intraday highs, although the Nasdaq was relatively choppy. Overall, last week’s

one percent bounce in the S&P 500 was a welcome relief for the bulls, but the

index still remains 2.3% lower for the month. With two days remaining in May,

Friday’s session. Traders cutting out early for the Memorial Day holiday

contributed to total volume in both the NYSE and Nasdaq coming in 23% below

their respective levels of the prior day. It was the lightest volume day for

both exchanges in more than five weeks. The broad market registered solid price

gains between last Thursday and Friday’s sessions, but the problem is that total

volume levels fell off substantially both days. Preceding Friday’s 23% decline

in volume was 24% lighter volume in both exchanges the previous day. As such,

the stock market’s gains of the past two days certainly have not been confirmed

by higher volume. While higher volume is not always necessary in order to

signify a market bottom, there generally needs to be an overall pattern of

accumulation either when the rally starts or immediately preceding it. So far,

the only accumulation we have seen was the higher volume gains of the May 24

reversal day. Conversely, a vast majority of the market’s down days in recent

bottom or was it merely a technical bounce within the context of the downtrend

that began earlier this month? One tool that is useful for answering this

question in situations such as this is the use of

Fibonacci retracements. Simply put, the three major Fibonacci retracement

levels we follow are 38.2%, 50%, and 61.8%. In a downtrend, the less an index or

stock retraces, the more likely it is to head back down and continue its

downtrend (the opposite is true in uptrends). A market that is steadily trending

lower will commonly retrace up to 38.2% or even 50% of its last downward move

before resuming the current trend and setting new lows. However, if a

downtrending market retraces more than 61.8% of the last move, that is often a

warning sign that a bottom may have formed and the trend is about to reverse.

Conversely, markets that are VERY weak may not even bounce up to the 38.2%

retracement level. Since stocks have rallied off their lows for the past several

days, let’s take a look at where both the S&P 500 and Nasdaq-100 indices stand

in relation to their Fibonacci retracement levels. We’ll begin by looking at the

bounced off support of its 200-day moving average last week. However, despite

three straight days of gains, SPY has only recovered a little more than 38.2% of

the slide from its May 5 high down to its May 24 low. The 61.8% retracement

level, often a reversal point in short-term trends, lies between resistance of

the 20 and 50-day moving averages. Not only is the 61.8% retracement level a

major area of resistance, but both the 20 and 50-day MAs have now become major

resistance levels as well. Given the lack of power behind the broad market’s

rally over the past few days, it seems unlikely that SPY will rally up to its

61.8% retracement level on this move before the bears step back in. Even if it

does, there is now additional overhead supply created by the break of the 20 and

50-day MAs. Therefore, the daily chart points to decent odds that SPY will at

least re-test last week’s low before it sees its 50-day moving average again.

Next, take a look at the daily chart of the Nasdaq-100 Tracking Stock (QQQQ):

in QQQQ lagged the recovery in SPY. When measured from its most recent peak on

May 8 down to its May 24 low, QQQQ has not yet even rallied up to its 38.2%

retracement level and remains well below its 20, 50, and even 200-day moving

averages. While this is obviously bearish, it is not surprising considering that

QQQQ also showed more relative weakness than SPY by losing a greater percentage

on the way down. In fact, notice that QQQQ formed its top a full month before

SPY. When SPY broke out to a new high on May 5, QQQQ merely formed a “lower

high.” You may recall our analysis at that time in which we suggested that the

relative weakness in the Nasdaq would eventually drag down the S&P and Dow as

for a lengthy period of time, we tend to focus our analysis on specific industry

sector ETFs that are showing the most relative strength or weakness to the

broad-based indices. Such is the reason why a vast majority of our daily

technical analysis focused on individual sectors, rather than the broad market,

throughout March and April of this year. However, when the major indices are

trending steadily in either direction, we find it makes sense to trade the

broad-based ETFs such as SPY or QQQQ instead. In a steady uptrend, relatively

easy profits can be realized through buying each price retracement down to a

major Fibonacci support level and subsequently selling into strength a week or

two later. Conversely, we have had an equal amount of success over the years

through selling short the broad-based ETFs on rallies into Fibonacci resistance

levels. Presently, we remain short the Dow Jones DIAMONDS (DIA) and regular

subscribers will see our specific trigger price for adding shares to that

new ETF that was launched on the American Stock Exchange last week — the

Market Vectors Gold Miners ETF, which trades under the ticker symbol GDX.

Unlike the GLD or IAU exchange traded funds, both of which mirror the price of

the spot gold commodity, GDX follows the price of the Amex Gold Mining Index, a

composite of 43 individual gold mining stocks. Because the price of the

commodity itself is often out of sync with the performance of the mining stocks,

the new Gold Miners ETF provides a way to easily participate in the mining index

without the need to determine which are the best performing stocks in such a

volatile sector. GDX has been added to the

Roundup report and will be included in the next revision that is

Short DIA (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

deron@morpheustrading.com .