Stalking a setup in the QQQQ

Stocks oscillated in a narrow,
sideways range last Friday before finishing the session modestly higher.
The S&P 500 rose 0.2% and the Nasdaq Composite gained 0.6%, but the Dow
Jones Industrial Average was unchanged. The small-cap Russell 2000 Index
performed well and registered a 0.9% gain, while the S&P Midcap 400 closed 0.7%
higher. Of the major indices, the Nasdaq showed the most relative strength last
week by rallying 2.5%. The S&P 500 gained 1.2% and the Dow Jones 1%.

Turnover fell off dramatically last Friday, resulting in the
lackluster performance and tight range of stocks. In the Nasdaq, total volume
declined by 29%, while volume in the NYSE was 23% below the previous day’s
level. It was the lightest volume in weeks and was well below average levels in
both exchanges. Market internals were marginally positive. In both the NYSE and
Nasdaq, advancing volume exceeded declining volume by a ratio of approximately
1.2 to 1.

On a technical level, last Friday’s action did little to
change the overall picture. As discussed in the November 10 issue of
The
Wagner Daily, both the S&P and Nasdaq are still at pivotal “make it or
break it” levels of either breaking out to new highs or falling below support of
the primary uptrend lines. The hourly chart of the Nasdaq shows that the right
shoulder of a bearish “head and shoulders” pattern formed on Friday. The Nasdaq
100 Tracking Stock (QQQQ) has formed the same pattern as well:

On the chart above, the dashed horizontal line marks the
“neckline” of the pattern. A break below that level in either QQQQ or the Nasdaq
Composite (the November 9 low) would probably cause the indices to fall to their
November 3 lows. Conversely, a rally above the top of the “head” would
constitute a failed head and shoulders pattern. When this occurs, it is very
bullish and usually results in a rapid move higher from the bears who sold short
on the right shoulder. Be prepared either way, as we should see resolution
within the next day or two.

There’s not much new to report in the industry sector action,
but we will be watching to see which ones show the most relative strength and
weakness in the event of a breakdown. Obviously, those with the most relative
weakness to the S&P are the ones we will want to short with the proper entry
points. Those with relative strength will be the first sectors we will look to
buy when the market recovers. In the event of a breakout to new highs, we don’t
recommend being too aggressive with new positions because the four-month rally
has occurred without yet having a significant correction.

Open ETF positions:

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 .