Identify new trading opportunities–try this

The Dow Jones’ recent relative
strength enabled the index to break out of its range and leap 1.3%
Tuesday, pulling the other broad-based indices along with it. The small-cap
Russell 2000 woke up and advanced 1.3% as well. Both the S&P 500
(
SPX |
Quote |
Chart |
News |
PowerRating) and
Nasdaq Composite
(
COMP |
Quote |
Chart |
News |
PowerRating) gained exactly 1%, while the mid-cap S&P 400 closed
0.8% higher. Due to support of the 50-day moving average, we tightened our stop
in the MDY short position yesterday, which was subsequently hit later in the
session. This enabled us to lock in a 2-point gain on the MDY short.

Confirming Tuesday’s gains was higher volume in both
exchanges. Total volume in the NYSE surged 30% higher, while volume in the
Nasdaq was 10% higher than the previous day’s level. This caused both the S&P
and Nasdaq to register a bullish “accumulation day” yesterday. However, despite
the ten percent increase in Nasdaq volume, turnover in that exchange still came
in below its 50-day average level. This is because the previous day’s volume was
the lightest of the year. Market internals were positive overall, as advancing
volume exceeded declining volume by a ratio of 5 to 2 in both exchanges.

Looking at individual sector action, it was interesting to
note yesterday’s inverse relationship between the DJ Transportation Average
(
DJT |
Quote |
Chart |
News |
PowerRating)
and the Oil Service Index
(
OSX |
Quote |
Chart |
News |
PowerRating)). Of the major sectors we follow, $DJT was
the highest percentage gainer yesterday, posting a 2.6% gain. The $DJT also
closed at a fresh all-time high! Conversely, the $OSX plummeted 2.8% and
was the worst performing sector. $OSX closed below its 50-day moving average for
the first time since November 15, 2005.
(
OIH |
Quote |
Chart |
News |
PowerRating) (Oil Service HOLDR) followed
suit and has now fully completed its predicted 7% drop from the head and
shoulders pattern that we shorted on February 3. Due to support of the 50-day
MA, we made the decision to cover OIH and locked in the cool 10-point profit on
February 10. Still, it is interesting to see that OIH only bounced off its 50-MA
for one day before following-through to the downside.

The point in comparing yesterday’s performance of the
Transports and Oil Service is that you can often identify new trading
opportunities by learning the inverse relationships between sectors. In this
case, consider that lower crude oil prices typically enable transportation
companies to be more profitable. Therefore, we saw a rise in transportation
stocks while oil service stocks sold off. There are other inverse sector
relationships that often go hand-in-hand as well. After you learn to spot these
inverse relationships, you can find ideal trading opportunities through buying
one sector ETF while shorting the other. I will be speaking more about this on
June 10, at the

upcoming Traders’ Expo in Ft. Lauderdale, Florida.

Of the other sector ETFs we have discussed over the past
several days, FXI (Xinhua China 25 Index) broke out above its daily downtrend
line yesterday and closed only 10 cents below its record high. However, we made
a judgement call to not buy it yesterday because much of the gain was the
result of an opening gap up. As such, our initial risk/reward ratio on the setup
was negatively skewed. Ideally, we would like to see FXI trade sideways for a
week or so before breaking out to new highs. If it does so, the breakout to a
new high would be buyable, despite passing on the original intended entry over
the downtrend line yesterday.

(
GLD |
Quote |
Chart |
News |
PowerRating) (Gold Trust), which we analyzed yesterday, showed
strength just above its 50-day MA and gained 1.3%. However, we anticipate
another leg down on the daily chart before it stabilized and resumes its strong
weekly uptrend. This is because it did not yet have a probe below the 50-day
moving average to trigger stops and shakeout the “weak hands.” After it does,
the first subsequent rally above its hourly downtrend line would be buyable.

As for the broad market, the thing that concerns us the most
is that the Dow is the only major index that has a decent looking daily chart.
Although the Dow closed only 15 points below its 5-year high, the S&P 500,
Nasdaq Composite, Russell 2000, and S&P 400 each remain firmly below their
downtrend lines that have been in place since the mid-January highs. We have
illustrated resistance of these downtrend lines on the daily charts of those
four indices below:

 

As the charts above clearly indicate, we are certainly not
“out of the woods” just because of yesterday’s rally. More importantly, a lot of
technical damage has been done to leading stocks and it will take them at least
several weeks, and probably more, to recover. Rather than looking for new stocks
and ETFs to buy, we are viewing the current bounce as a chance to sell short
weak stocks and ETFs into strength. Only if the major indices begin to break out
above their daily downtrend lines will our bias change.