Institutional distribution is starting to kick in

The major indices scored their fifth
consecutive day of gains yesterday, as stocks drifted sideways to modestly
higher throughout the session. The S&P 500 gained 0.2%, the Nasdaq
Composite 0.3%, and the Dow Jones Industrial Average 0.4%. Small and mid-cap
stocks took a break from their recent patterns of relative strength. The Russell
2000 Index slipped 0.2%, while the S&P Midcap 400 was unchanged. Though the S&P
and Nasdaq secured another higher close, it was merely a consolidation day. The
broad-based indices digested the prior day’s gains by trading within their
respective ranges of the previous day.

Turnover softened in both exchanges yesterday, breaking the
Nasdaq’s string of bullish “accumulation days” over the past week. In the NYSE,
total volume was 1% lighter than the previous day’s level, while volume in the
Nasdaq declined by 4%. Market internals were positive by only a narrow margin,
especially in the Nasdaq where advancing volume exceeded declining volume by
only 1.1 to 1. The NYSE ratio was positive by 3 to 2.

Remember what we said yesterday morning about seeing positive
money flow and sector rotation into the commodity-related ETFs? Scratch that!
Although starting the day on a positive note, the U.S. Oil Fund (USO) plummeted
3.6% and finished at a historical low yesterday. The StreetTRACKS Gold Trust (GLD)
lost “only” 0.9%, but it was trading higher by nearly the same percentage before
it began to sell off late in the morning. Not surprisingly, this had a very
negative effect on the corresponding sector indices as well. Of the major
industry sectors we monitor on a daily basis, the worst performer yesterday was
the CBOE Gold Index ($GOX), which suffered a 4.0% loss. Trailing closely behind
with a 3.7% loss was the Oil Service Index ($OSX). The drop in the price of
crude oil and the oil service stocks was similar, but the spot gold commodity
showed relative strength by losing much less than the individual gold stocks.

Minor price retracements within the context of an uptrend are
normal, but yesterday’s weakness in the commodities, especially oil, was clearly
the result of institutional distribution. Ironically, the heavy selling hit the
commodities just as we started to become pretty bullish on the sector. As you
might have guessed, the bearish commodities action made for a challenging day.
Three of our five open positions stopped out within several hours of one
another. The DB Commodity Index (DBC), which we bought when it broke out on
November 6, stopped us out after rapidly collapsing below support of its primary
uptrend line. USO, which we re-entered on November 15 after attempting a bullish
reversal, stopped us out as well. Fortunately, however, our protective stop was
placed tightly below the November 14 low. After stopping us out at mid-day, USO
lost 2.4% more in the afternoon, a prime example of the importance of honoring
your stops. The iShares Cohen & Steers Realty Majors (ICF), our only short sale
of the five open positions we had, was the third ETF that hit our stop
yesterday. GLD is still showing a solid profit and is above our stop, but it
demonstrated bearish action by failing to hold above yesterday morning’s break
of its hourly downtrend line. The PowerShares WilderHill Clean Energy (PBW)
retraced a bit, but is still above our entry point.

If you’re new to our daily commentary, this is where you may
be expecting me to shed light on the situation by defending our positions and
explaining on a technical level exactly why we had such a tough day yesterday.
But long-time readers know that we always report the facts rather than spinning
a bunch of fluff or hype. The basic fact is that we were just plain wrong!
As always, we obviously had valid technical reasons for entering each of our ETF
trades, but they simply didn’t work out. Learning to take full responsibility
for both your winning and losing trades, rather than blaming external
influences, is a critical element of becoming a consistently profitable
professional trader.

On the long side, the Semiconductor Index ($SOX) has become
one of the best looking sectors for potential entry. It has been consolidating
nicely since breaking out above its 200-day MA three days ago, so we like the
idea of buying the Semiconductor ETFs on a decent pullback. That being said,
however, we must confess that the market has begun fooling us over the past
several days. Numerous sectors we expected to show strength have suddenly
started to exhibit relative weakness, and vice versa. A good example is how the
strength in the commodities completely disappeared, while the Real Estate Index
($DJR) has retraced 75% of its loss from last week’s breakdown below its uptrend
line. There are other instances as well. For that reason, we have shifted into
SOH (“sitting on hands”) mode, a conservative overall trading approach reserved
for situations like this that occur several times per year. For the time being,
we are totally content with merely managing our remaining positions, but sitting
on the sidelines with regard to new trade entries. When most of the industry
sectors stare following through again, we will be ready to attack, but cash is
king until the waters look safer.

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 .