Why traders should focus on the ‘old economy’
The major indices fell modestly during the first
thirty minutes of last Friday’s session, but reversed and drifted higher
throughout the rest of the session. By day’s end, the broad market had managed
to shake off early losses and mount its fifth straight day of gains. Both the
S&P 500 and Dow Jones Industrial Average gained 0.3%, but the NASDAQ Composite
showed relative weakness this time and advanced only 0.3%. Dell Computer, which
opened 9% lower due to a disappointing earnings report, weighed on the tech
sectors. The small-cap Russell 2000 eked out a gain of 0.1%, while the S&P
Midcap 400 finished 0.2% higher. Stocks finished near their best levels of the
session, but strong or weak action into the close is often deceiving on options
expiration days.
Total volume in the NYSE declined by 12%, and was
11% lower than the previous day’s level in the NASDAQ. The broad market has
rallied in each of the past two sessions, but turnover declined on both days.
Once again, volume in both exchanges also came in below average levels.
Nevertheless, market internals confirmed the bullish price action by reversing
from negative territory. In the NASDAQ, declining volume was outpacing advancing
volume by 3 to 1 after the first half hour of trading, but the ratio reversed to
finish in marginally positive territory. Advancing volume exceeded declining
volume by more than 3 to 2 in the NYSE.
The S&P 500 gained 2.8% last week, but the NASDAQ
zoomed 5.1% higher. Strength in the Semiconductor Index ($SOX), always a sector
that is capable of moving the entire stock market, was largely responsible for
sparking the whole rally. The $SOX gained more than 10% for the week. Based
purely on the difference in last week’s price gains, one may conclude that the
NASDAQ presents the most favorable odds for profitability right now. However,
don’t forget the big picture of what has happened since the broad-based selloff
began on May 10. Prior to last week, the NASDAQ was showing major relative
weakness to both the S&P and Dow for many weeks. Each decline in the S&P was
exceeded by the NASDAQ, while the NASDAQ failed to match the gains of nearly
every S&P bounce. The end result was that a lot more overhead supply was created
in the NASDAQ than in the S&P and Dow. The S&P 500 has recovered seventy-five
percent of the loss from its May high down to its June low, but, regardless of
last weeks 5.1% gain, the NASDAQ Composite has still made up less than half of
its corresponding loss. To illustrate this, compare the daily charts of the S&P
and NASDAQ below.
Fibonacci retracement lines have been drawn so that you can easily spot the
NASDAQ’s relative weakness:
As you can see, the S&P 500 clearly has less
overhead resistance than the NASDAQ, especially if you consider that the NASDAQ
still remains below its 200-day
moving average.
In the “big picture,” it would appear that you’re still better off buying stocks
and ETFs in the “old economy” S&P and Dow sectors as opposed to the tech
sectors. However, those S&P and Dow-related sectors have now begun to show
relative weakness while the $SOX leads a NASDAQ recovery. With the NASDAQ
presently showing the most relative-strength in the short-term, but the S&P
presenting a healthier intermediate-term chart, what’s a smart trader to do? We
suggest you take a step away from the broad-based ETFs such as
(
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PowerRating) or
(
QQQQ |
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and instead focus your efforts on the individual sector ETFs that are showing
the most relative strength or weakness. We discussed which sectors we like best
throughout last week’s commentary, but here is a refresher. Sectors with
relative strength: Semiconductors (and most other tech sectors), Utilities, and
Pharmaceuticals. Sectors with relative weakness: Oil, Gold, Financials
(especially the brokers), Real Estate (REITs), and Transportation. Check out the
free
Morpheus ETF Roundup for a list of which ETF ticker symbols correspond
to those sectors. To learn how to spot which sector ETFs have the most relative
strength or weakness, consider attending an
upcoming ETF trading workshop at a location near you.
Because many traders and investors take a
vacation in the month of August, market activity has been slow beneath the
surface. The S&P 500, for example, has closed higher in each of the past five
sessions, but volume has only exceeded its 50-day average level in one of
the past ten days. This begs the question of whether or not market sentiment
will remain the same when institutional activity returns to the scene, most
likely after the Labor Day holiday. One certainly can not deny that the stock
market’s price action alone was rather positive last week, but astute traders
know that volume is the lifeblood of the market’s health. Because institutions
are responsible for more than fifty percent of the shares that trade hands on an
average day, stocks will always mirror the overall bias of mutual, hedge, and
pension funds. It’s okay to ride the momentum of the market’s recent strength,
but consider using tight trailing stops to protect your gains or minimize losses
on any late-stage long entries.
Open ETF positions:
Short
(
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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.