How The Past 5 Days Tell You It’s A Healthy Market

Like the previous day, the major
indices began the day with an opening gap up,
but this time the gains remained intact. The broad market traded in a narrow,
sideways range throughout the first half of the day, then exhibited the usual
post-Fed volatility and indecision after the announcement of a (widely expected)
quarter-point increase in the Federal Funds rate. Buying in the Pharmaceutical
stocks enabled the Dow Jones Industrial Average to exhibit rare relative
strength and gain 0.7% yesterday. The S&P 500 also moved 0.7% higher, while the
Nasdaq Composite recovered 0.5% of its recent losses. Many small and mid-cap
stocks showed relative weakness, as they continued to correct from their recent
record high prices. The S&P 400 bounced 0.4%, but the Russell 2000 managed only
a 0.1% gain.

After three straight days of declining volume, yesterday saw
an uptick in turnover. Total volume in the NYSE increased by 16%, while volume
in the Nasdaq came in 1% higher than the previous day’s level. Internals were
bullish, as advancing volume in the NYSE exceeded declining volume by a margin
of 2.2 to 1. The Nasdaq internals were positive by a similar margin. Although
the percentage increases in yesterday’s volume levels were relatively small, it
was technically a bullish “accumulation day” nevertheless. The S&P 500 and Dow
Jones have closed lower in three of the past five sessions, but both of the “up”
days were on higher volume, while the three “down” days were on declining
volume. Higher volume on a majority of the “up” days and lighter volume on the
“down” days is exactly what you should see in a healthy market, regardless of
normal price corrections along the way.

Yesterday’s industry sector performance was mixed, as none of
the major sectors we follow closed higher or lower by more than 1.3%. As
expected, relative strength in the Semiconductor Index ($SOX) enabled the sector
to easily gain 1.2%, despite only a 0.5% gain in the Nasdaq Composite. Both the
Retail ($RLX) and Home Construction ($DJUSHB) indexes also bounced about 1%
yesterday, but this was to be expected considering that $RLX dropped 4% and $DJUSHB
plummeted 10% throughout the prior four days. Because their retracements were
minor and on light volume, we continue to expect lower prices on both sectors in
the short-term.

The DJ Utilities Average ($DJU) similarly gained 1.1%
yesterday, but remains below resistance of its prior intermediate-term uptrend
line that was broken the previous day. We like the idea of shorting XLU or UTH
into yesterday’s bounce, but such a trade would need to have a short-term time
horizon because both ETFs have support of their long-term, monthly uptrend lines
just below current levels. The longer a trendline has been intact, the more
significant the trend becomes. Therefore, an uptrend that has been in place for
several years is more powerful than a trend that has only been in place for a
few months. The first graphic below shows a break of trendline support on the
daily chart of XLU (S&P Utilities SPDR), but the longer-term monthly chart below
it shows the primary trend is still intact:

When two charts of the same stock present conflicting signals
on different time frames, remember that the longer-term chart is always more
powerful. This, of course, does not mean you could not profit from a short in
XLU at this time, but it simply means you would need to keep a tight stop and be
quick about taking profits due to support of the multi-year uptrend line just
below. A safer way to play this would be to wait for a potential break of the
monthly uptrend line, then short the first subsequent bounce into that
trendline. We will be stalking XLU over the next few weeks for the opportunity
to do so.

Taking an updated look at the major indices, it’s positive to
see that the S&P 500 has held above support of its prior high at the 1,220
level. However, the index closed yesterday just below resistance of its 20-day
moving average at the 1,232 level. As long as the S&P holds above that 1,220
support level, the daily chart remains healthy, but a break below that level
will cause a test of the 50-day moving average at 1,214. The next several days
will likely determine the direction of the S&P throughout the remainder of the
month. A rally back up to last week’s highs would set a bullish tone, but a
break down to the 50-day moving average would create enough overhead supply to
cause choppy conditions through month-end. The blue horizontal line on the daily
chart below illustrates the short-term support level. We have also circled the
resistance levels as well:

The Nasdaq Composite daily chart looks even better, as the
index is (thus far) holding well above its 50-day moving average and daily
uptrend lines. A sideways consolidation seems more likely than a significant
retracement in the Nasdaq, but a rally back above the 2,190 level could easily
negate any further correction at all. As for the Dow Jones, it continues to be a
choppy, sloppy mess that is stuck in the middle of a multi-month range and its
20 and 50-day moving averages. We continue to advise against trading DIA unless
you are only daytrading it.

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 .