Are you long BBH and SMH? I am and here’s where they could go next…

Throughout most of Wednesday, it appeared the broad
market was poised to register another choppy and indecisive session,
but a high volume rally during the final ninety minutes of the day caused the
major indices to surge sharply higher. Small-cap stocks shook off their recent
relative weakness and led the major indices higher. The Russell 2000 Index
(
RUT |
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PowerRating)
rocketed 1.9% higher yesterday, its largest single day gain in nearly two
months. The momentum in the small caps helped drive both the S&P 500
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and Nasdaq Composite
(
COMP |
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PowerRating) to equally solid gains of 1.0%. The Dow Jones
Industrials, as we have recently become accustomed to, again showed relative
weakness, but still managed to post a 0.7% gain. Completing the picture, the S&P
400 Midcap Index
(
MDY |
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PowerRating) also turned in a strong performance by cruising 1.6%
higher. As such, our short position in MDY stopped out when it crossed above its
20-day MA, but the current gain from yesterday’s long entry in BBH
(
BBH |
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easily made up for the loss. As of the close, our new BBH position was showing
an unrealized gain of nearly 3 points. Regular subscribers should note the
updated BBH stop price in the position summary below.

The most important factor of yesterday’s rally is that volume in both
exchanges spiked significantly higher, which confirms institutions were behind
the buying. Total volume in the NYSE was 23% higher than the previous day, while
volume in the Nasdaq increased by 15%. Considering that NYSE volume also
increased by more than 20% in Tuesday’s down day, it was even more impressive
that volume surpassed that level by 23% more. Turnover in both exchanges came in
well above 50-day average levels, and it was the highest volume day in the NYSE
since June 24. The solid, broad-based gains on higher volume gave the major
indices a bullish "accumulation day," the first we have seen in quite a while.
Nevertheless, don’t forget that both the NYSE and Nasdaq have had five days of
higher volume selling ("distribution days") within the past month as well.
Yesterday’s action was certainly positive and long setups are beginning to
re-appear, but caution is still in order on the long side of the market. One
good reason, for example, is that the Dow Jones is still trading below its
200-day moving average.

Because the Biotech Index
(
BTK |
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PowerRating) had been showing relative strength by not
selling off sharply when the broad market did over the past three weeks, it was
not surprising that it was also the first index to rally and lead the Nasdaq
higher yesterday. The Nasdaq gained 1%, but the Biotech Index ($BTK) more than
doubled that gain and posted a 2.6% increase yesterday. The other Nasdaq sector
that had been showing relative strength lately, the Semiconductor Index
(
SOX |
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gained 1.1%. Rather than outperforming the Nasdaq as one might have expected, it
merely kept pace with the index instead. Compare the performance of BBH (Biotech
HOLDR) and
(
SMH |
Quote |
Chart |
News |
PowerRating) (Semiconductor HOLDR) throughout the past year on the
weekly charts below:

Comparing the charts, notice how SMH had been trending modestly lower
throughout the past four weeks, but BBH just went sideways during that same
time. Such action confirms the relative strength in BBH, which is probably the
better play of the two. SMH could take off from here as well, but there is more
overhead supply from the prior four weeks to contend with. Also, even if SMH
rallies above its August 2 high, it will only be at a new 52-week high.
Conversely, BBH is only 0.5% away from setting a fresh four-year high. Several
individual stocks within the index, such as DNA and CELG, already closed
yesterday at new all-time highs (we are long DNA per The MTG Stalk Sheet).
As you probably know, new highs are among the best trades to swing long. Why?
Simply because nobody is selling in an attempt to "just break even" if they got
stuck at a higher price before the stock or ETF went lower. Anyone who wanted
out of BBH has already sold within the past four years. Simply put, sellers from
prior recent price levels is what creates horizontal price resistance levels.
Human nature causes many people to mistakenly look to buy new lows and sell new
highs, but that is usually a costly mistake. New highs typically continue go
much higher simply because there are more buyers than sellers. Understanding the
psychology behind this is key.

From a technical basis, the Nasdaq recovered more than the other major
indices yesterday because it is the only one that is back above resistance of
both its 20 and 50-day moving averages. However, we cannot be complacent on the
long side because the index also closed right at resistance of its 38.2%
Fibonacci retracement
level. When a downtrending stock or index bounces, the 38.2%, 50%, and 61.8%
retracement levels typically act as key resistance points. It is not until
crossing above the 61.8% retracement that odds favor a complete reversal of the
downtrend. Therefore, stay alert as the Nasdaq tests these three main Fibonacci
resistance levels overhead. Support should now be found in the 2,135 to 2,140
level, near the 50-day moving average. The Fibo retracement levels are shown on
the daily chart of the Nasdaq below. We removed the moving averages so you can
more easily see the Fibo price levels:

The S&P 500 managed to close only half a point above its 50-day moving
average, which is not enough to really confirm it has reclaimed it. Resistance
of the 20-day MA is also a factor to watch going into today, as it is only one
point above yesterday’s close. It seems we will need some follow through in the
form of decent volume in order to push the S&P clearly back above these moving
averages. Short-term support on the S&P is at the 1,210 to 1,212 level (prior
resistance of hourly downtrend line). Because the S&P is also attempting to
recover from a month-long downtrend, Fibonacci analysis is useful with this
index as well. You may wish to make a note of the three main Fibonacci
retracement levels, as illustrated on the S&P chart below:

Looking at the chart above, notice how the August 22 high (circled in blue)
perfectly correlates to the 61.8% retracement. Interestingly, it is a common
occurrence for prior highs to match up with pivotal Fibo levels as well. When
this happens, it adds further validity to the resistance level due to the
convergence that occurs.

The Dow Jones is still below even its first 38.2% Fibonacci retracement and
also remains approximately 0.5% below resistance of its 20, 50, and 200-day
moving averages which have all converged together. While the Nasdaq and Small
Caps may be trying to recover, the Dow is acting like an anchor. When the major
indices begin to diverge away from each other, it creates choppy and erratic
market conditions rather than smooth trends. Therefore, for the sake of all
swing traders, we need to either see the Dow play "catch up" or for the Nasdaq
to fall back down. Either one is fine with us because we trade both sides of the
market and any trend is better than the chop and indecision that has recently
been plaguing the market.

Open ETF positions:

Long BBH, short ICF (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
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 .