Divergence In SPY and QQQQ

The major indices followed up the
previous day’s losses with a large opening gap yesterday morning, but traders
immediately sold into strength, causing stocks to slide into negative territory
within the first hour of trading. After trading sideways for several
hours, another wave of selling hit the market in the early afternoon, but a
bounce around 2:30 pm EDT lifted stocks off their intraday lows. Results into
the close were mixed. The Nasdaq Composite fell 0.3%, but the S&P 500 managed a
0.1% gain. The Dow finally probed above the 12,000 level intraday, but closed
just below it. The blue-chip index finished 0.4% higher. Both the small-cap
Russell 2000 and S&P Midcap 400 declined 0.2%.

Total volume in the NYSE increased by 7% yesterday, but
turnover in the Nasdaq was 1% lighter than the previous day’s level. The small
drop in volume prevented the Nasdaq from having its second straight
“distribution day.” Despite the S&P and Dow both closing higher, declining
volume in the NYSE marginally exceeded advancing volume. In the Nasdaq,
declining volume exceeded advancing volume by a margin of just over 3 to 2.

There was a huge divergence between the S&P and Nasdaq that
was not readily apparent simply by comparing the closing prices of the major
indices. This digression was clearly apparent with the market’s opening gap, and
it continued throughout the entire session. To illustrate this, let’s compare
the intraday charts of the S&P 500 SPDR (SPY) and the Nasdaq 100 Index Tracking
Stock (QQQQ). First is the chart of SPY:

Looking at the chart above, notice how SPY gapped open above
not only the previous day’s high, but above the October 16 high. On the open,
SPY was looking great because it had completely blown off the previous day’s
weakness and was actually trading at a new multi-year high. But the gap quickly
faded, causing SPY to trade near the flat line for most of the session before
finishing fractionally higher. Now, notice the major relative weakness that
plagued the Nasdaq, as represented by QQQQ:

Unlike SPY, which gapped open well above the October 16 high,
QQQQ barely opened above the previous day’s high. Then, when traders sold into
strength of the opening gap, it caused QQQQ to drop all the way down to test
support of its previous day’s low. Comparatively, notice how SPY found support
near the top of its previous day’s range. As you can see, the relative
weakness remained into the close. QQQQ closed near its prior day’s low, while
SPY closed near its prior day’s high. If you followed yesterday’s action in the
Semiconductor Index ($SOX), you would know the reason for this huge divergence
between the indices. Check out the intraday chart of the $SOX:

Not only did the $SOX not gap above the previous day’s high,
but it actually gapped down to open near the previous day’s low. Fifteen
minutes later, it entered into the steady downtrend that pulled the entire
market with it. The index eventually finished with a 2.8% loss. The reason we
showed you these three charts is to clearly illustrate the importance of the
$SOX index with regard to determining the direction of the entire broad market.
We talk about the $SOX index all the time because it is so heavily weighted
within the Nasdaq. As the $SOX goes, the Nasdaq goes, which in turn leads the
S&P and Dow. The above charts are a great example of this. When the $SOX starts
a trading day so weak, it should always serve as a warning sign for any new long
entries that session.

After falling 5.3% over the past two days, the $SOX now sits
at support of its 50-day moving average. Yesterday, we illustrated the major
resistance of its 200-day MA and prior uptrend line, but support in the $SOX
should be found at its 50-day moving average, half a percent below
yesterday’s closing price. The S&P and Dow are doing their best to hold near
their highs, but the $SOX could throw a wrench in the works if its relative
weakness continues. A number of major tech companies released earnings after the
close yesterday as well, so let’s see how the market digests these results. When
the indices are out of sync with each other, as they were yesterday, it often
leads to choppy and erratic trading action, so beware of aggressively entering
new positions on either side of the market right now.

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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 .