3 ETFs I’m Shorting…And Another Waiting To Be Triggered

A break of the Nasdaq’s weekly
uptrend line sparked a broad-based, high volume
selloff that hit nearly every industry sector. The major indices began the
session with an opening gap down, trended steadily lower throughout the entire
day, and closed at their intraday lows. The Nasdaq Composite plummeted 1.4%
yesterday, its biggest one-day decline since its 1.5% drop on April 22. The S&P
500 and Dow Jones Industrial Average suffered similar losses and closed lower by
1.2% and 1.1% respectively. Even the mid and small-cap stock indices, both of
which have been showing relative strength to the S&P and Nasdaq for months,
sustained sizable losses. The S&P 400 dropped 1.4%, while the Russell 2000 Index
shed 1.7%.

Yesterday’s total market volume increased by 14% in the NYSE
and 12% in the Nasdaq. The rise in the broad market’s volume levels, combined
with the losses, caused both the S&P and Nasdaq to register another bearish
"distribution day" that clearly indicated institutional selling. Market
internals were extremely negative, as declining volume exceeded advancing volume
in the NYSE by a whopping margin of 5.3 to 1! The Nasdaq was negative by a ratio
of 2.7 to 1. The last time the NYSE adv/dec volume ratio was negative by more
than 5 to 1 was back on April 15, a day in which the S&P 500 fell 1.6%.

Each of the Nasdaq’s three "down" days within the past five
days have been distribution days, but careful attention to our daily volume
analysis of the broad market should have prepared you for a possible selloff. In
the week preceding yesterday, price action itself looked okay in the Nasdaq, but
we have been warning that the price to volume relationship of the broad market
actually turned negative five days ago. Because volume is a leading
indicator that shows what is happening beneath the surface, you will often see
bearish signs such as higher volume selling ("distribution") and lighter volume
rallies at least one to two weeks before the price action becomes bearish.
This is why we focus so much on the market’s volume every day.

As the market internals indicated, yesterday’s selling was
broad-based and aggressive, leaving essentially nowhere to hide on the long side
of the stock markets. The Airline Index ($XAL), which rallied 3.4%, was one
exception. The Gold Index ($GOX) also closed higher, but only fractionally.
Otherwise, every other major industry sector we follow closed in the red.
Sectors ranging from Oil to Internets, Home Construction to Computer Hardware,
and Utilities to Transportation all closed with losses of 1.3% or greater. Even
the Semiconductors ($SOX) and Biotechs ($BTK), two industries that were formerly
showing relative strength, lost 2.0% and 1.7% respectively. Of particular
interest to us was yesterday’s 2.6% drop in the Retail Index ($RLX).

Lowered sales guidance numbers from Wal-Mart and a handful of
other retailers triggered a sharp drop in the $RLX, but this was to our delight
because it also caused RTH (Retail HOLDR), which we are short, to fall nearly 3
points and close below its 50-day moving average. Additional weakness in the
apparel retailers also enabled the
MTG Stalk Sheet’s
short setup in BEBE to trigger and hit its downside price target in the
same day. RTH, which we shorted in the
August 5 issue
of The Wagner Daily, is now on its way to our new downside price
target of the $95.20 area. As subscribers will recall, we shorted RTH after it
closed below support of its 3-month uptrend line on August 4. It subsequently
traded in a choppy range in the seven days that followed, but fell below the
trading range and support of its 50-day moving average yesterday. The daily
chart of RTH below illustrates the initial break of trendline support on August
4, as well as yesterday’s drop below the 50-day moving average:

Just as quickly as the Nasdaq Composite bounced off support of
its three and half month uptrend line on Monday, it collapsed below it
yesterday. This, however, should not have been surprising given the combination
of the previous day’s weak, low-volume bounce and the lack of confirmation by
the S&P and Dow. Remember that a prior support level becomes the new resistance
level after the support level is broken. Therefore, expect the Nasdaq to now
find resistance at its prior uptrend line, currently near the 2,150 level. Next
support on the Nasdaq is at the 50-day moving average of 2,126. Because the
Nasdaq is still 11 points above its 50-day moving average, it remains tricky to
attempt shorting in the tech and biotech-related stocks and ETFs at current
levels.

If looking for a short in the broad market ETFs, consider one
that has fallen below its key moving averages, as that will provide more
overhead resistance in the event of a rally attempt. We would avoid trading in
QQQQ (Nasdaq 100 Index) right now because it is in "no-man’s land," trapped
between key support and resistance levels. DIA, however, is looking like one of
the better broad-based ETF shorts because the Dow Jones closed below support of
both its 50 and 200-day moving averages yesterday. The Dow has also been the
biggest laggard of the major indices during the broad market’s most recent
rally. Our model account is currently short both UTH and RTH, two sector ETFs
that tend to move with the Dow, but you may consider shorting DIA as well. The
daily chart below shows how DIA closed right at support of its prior low and
its 200-day moving average at the 105.28 level. A drop of at least 15 cents
below that level would be an ideal entry point for a break of support in DIA:

As for SPY (S&P 500), it is still holding above support of
both its weekly uptrend line and its 50-day MA, but we would consider shorting
it if it breaks the 50-day MA and fails a subsequent bounce. Overall,
yesterday’s action has changed our short-term bias from neutral to bearish, but
the intermediate-term uptrends in most of the indices remain intact (at least
for now). Most importantly, be sure to honor your stops on all positions,
regardless of whether you are net long or short. Trends can be erratic and
choppy during the light-volume "summer doldrums," so stay alert and don’t
overtrade!

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 .