The 3 to watch, if you’re looking for longs

The major indices managed their third
straight day of gains Thursday, as the Dow Jones
(
DJX |
Quote |
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News |
PowerRating) closed at
a fresh four and half year high. The Nasdaq Composite
(
COMP |
Quote |
Chart |
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PowerRating) again showed
indecision, retracing back to the flat line at one point, but the index finished
the day 0.8% higher. Both the small-cap Russell 2000
(
RUT |
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Chart |
News |
PowerRating) and mid-cap S&P
400 similarly gained 0.9%. The Dow Jones Industrial Average kept pace with a
0.6% gain, while the S&P 500 advanced 0.7%. Each of the major indices finished
at their intraday highs, hinting at institutional support into the close.

Total volume in the Nasdaq increased by 9% yesterday, enabling
the index to register a bullish “accumulation day” because it closed higher
and on higher volume. However, total volume in the NYSE was 6% lighter than
the previous day. Of the past three “up” days, the NYSE has only had one
“accumulation day.” This tells us that the bears may have been kept at bay over
the past several days, but institutions have not been overly anxious to gobble
up shares on the long side. Nevertheless, market internals were quite strong
yesterday. Advancing volume exceeded declining volume by an impressive ratio of
4 to 1 in the NYSE, but the ratio was positive by only 2 to 1 in the Nasdaq.
Generally speaking, any adv/dec volume ratio higher than 2 to 1 is considered
firmly bullish.

Yesterday’s gains in the S&P 500 finally pushed the index
above its downtrend line that we have discussed over the past several days. It
also closed just over its prior high from January 30. If it holds the breakout,
it will only take a rally of five more points to push the S&P to a new
multi-year high:

Being that the S&P closed above its prior high of the former
downtrend, but just below its 52-week high, trading could become a bit erratic
and choppy over the next week. This is further compounded by the fact that the
Nasdaq Composite is still below its daily downtrend line.

What we find interesting about this market is that there
appears to be a “changing of the guards” taking place. The Dow Jones, for years
a laggard that many people stopped paying attention to, has suddenly been
showing relative strength and leading the broad market higher. Conversely, the
Nasdaq has been drifting along with little enthusiasm. Below are daily charts of
the Dow Jones and Nasdaq Composite that illustrate this divergence:

Most likely, the Dow is seeing strength simply due to normal
institutional sector rotation, but the reason is irrelevant. What is relevant is
knowing which of the broad-based ETFs offer the best odds of profitability both
on the long and short side of the markets. On the long side, DIA and SPY
obviously have the least amount of overhead resistance. QQQQ and MDY have the
most resistance. In fact, MDY appears to be completing the right shoulder of a
bearish

“head and shoulders” pattern, just as OIH did before it dropped more than
10% in just one week. Needless to say, we typically have a high degree of
success with shorting clearly defined head and shoulders chart patterns, but the
divergence between the major indices may cause MDY to become whippy. Therefore,
while we still may short MDY if it begins to roll over, reduced share size and
close adherence to our stops is key. If the S&P holds above its prior high
through today, we’ll begin to look at new long setups in strong sectors next
week. GLD (Gold Trust) is one such ETF that may provide us with a nice entry off
support of its 50-day moving average.

NOTE: The U.S. stock markets will be closed on Monday,
February 20 in honor of Washington’s Birthday holiday. As such, The Wagner
Daily will not be published that day. Regular publication will resume on
Tuesday, February 21. Enjoy the day off!