Bearish Pattern in IYT Signals Lower Prices

Stocks trended lower ahead of
yesterday afternoon’s decision on interest rates, but a subsequent lack of any
surprises from the Fed enabled the broad market to recover off its lows.
Still, each of the major indices closed in the red. Both the S&P 500 and Dow
Jones Industrial Average lost 0.1%, but the Nasdaq Composite showed relative
weakness by falling 0.5%. The S&P Midcap 400 Index also slid 0.5%, while the
small-cap Russell 2000 declined 0.6%. The S&P and Dow finished in the upper
third of their intraday ranges, but the Nasdaq closed just below the middle of
its range. The price divergence between the major indices confirms what we
illustrated in yesterday’s newsletter, regarding the Nasdaq showing more
relative weakness than the S&P 500.

Turnover rose across the board yesterday, causing the Nasdaq
to register a bearish “distribution day.” The minor loss in the S&P was not
significant enough to confirm institutional selling. Total volume in the NYSE
swelled 17% above the previous day’s level, while the Nasdaq volume increased by
6%. Despite the “distribution day” in the Nasdaq, the NYSE volume remained below
its 50-day average level for the seventh consecutive session. In the Nasdaq, it
was the third day of higher volume selling within the past four weeks. It’s
normal to expect occasional bouts of institutional selling in a healthy market,
but caution is required when the count exceeds more than three “distribution days”
within a month. A concentrated analysis of the market’s daily price to volume
ratios enables one to see what is happening “under the hood” rather than merely
assessing the obvious price action. We discuss changes in the market’s volume on
a daily basis because volume spikes are the hallmark of professional buying on
the “up” days, and selling by hedge funds, mutual funds, and other institutions
on the “down” days.

While most industry sectors closed in the red, the Banking
Index ($BKX) reacted favorably to yesterday afternoon’s Fed announcement. The $BKX
followed through on Monday’s breakout to a new record high, which we illustrated
in the December 12 issue of

The Wagner Daily.
The DJ Utilities Index ($DJU) also built on the previous day’s gain. Conversely,
the Dow Jones Transportation Average ($DJT) was among the weakest sectors
yesterday. The $DJT not only lost 1.2%, but it also broke a key support level
and is now positioned for further downside. As for ETFs, the iShares
Transportation
(
IYT |
Quote |
Chart |
News |
PowerRating) has a nearly identical chart pattern as the $DJT index.
As you can see on the chart below, IYT is in the process of following through on
a bearish “head
and shoulders” chart pattern:

Not only did IYT break down below support of its ascending
neckline yesterday, but the selloff also coincided with a break below the 50-day
MA. From here, we should expect IYT to at least drop to support of its
200-day MA within the next several days. However, the projected price target
from the top of the head down to the neckline puts IYT at a downside price
target of just below the $81 level. We sent an intraday e-mail alert to
subscribers yesterday, informing them we were initiating a new short position in
IYT after it broke below its 50-day MA. The U.S. Oil Fund
(
USO |
Quote |
Chart |
News |
PowerRating) failed to
follow through on its “bull flag” chart pattern, so we stopped out of it
yesterday. But the new IYT position is already showing a small profit and looks
promising. The UltraShort QQQQ ProShares
(
QID |
Quote |
Chart |
News |
PowerRating) also moved in our favor
yesterday.

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 .