Look For Quality Trade Setups In This Sector

A negative earnings report from semiconductor company Analog Devices
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caused the broad market to open lower yesterday morning, but the major indices
recovered to close near unchanged levels. The Nasdaq Composite
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began the day showing a loss of 0.4%, but the index showed resiliency and
grinded its way higher to close with a loss of less than 0.1%. Both the S&P 500
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similar intraday fashion, but late afternoon strength enabled each index to
close in positive territory with matching gains of 0.1%. Small and mid-cap
stocks, which have outperformed the major indices for the past several months,
showed signs of selling into strength. The Russell 2000 Small Cap Index lost
0.7%, while the S&P 400 Mid-Cap Index gave up 0.3%.

Total market volume in the NYSE increased by 4% yesterday, while volume in
the Nasdaq eked out a 2% increase over the previous day’s level. Technically,
the 0.1% loss in the Nasdaq combined with the 2% increase in volume made
yesterday a bearish "distribution day" in the index, but with such a fractional
loss and modest volume increase, the session did not have the feeling of
institutional selling. Conversely, the S&P and Dow technically had a bullish
"accumulation day," but it would be misleading to call it that because declining
volume nominally exceeded advancing volume levels. Overall, it was simply a
quiet day of consolidation, precisely what you want to see following the
market’s recent gains.

Nearly every major industry sector closed within one percent of unchanged
yesterday, but one notable exception was the Philly Gold and Silver Index
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which surged 4% higher. We have been stalking the $XAU index (behind the scenes)
for the past several weeks, waiting for a breakout above its weekly downtrend
line. After consolidating in a narrow, sideways range for the past six weeks,
the index finally broke out yesterday. The 4% gain enabled the index to close
above resistance of its weekly downtrend line, which had been in place since the
high of November 2004. At the same time, the index also broke out and closed
above its 200-day moving average. The weekly chart of $XAU below illustrates the
break above the 9-month downtrend line. Also notice how the 200-week MA (the
orange line) acted perfectly as support:

Taking a look at the shorter-term daily chart, you can see the bullish
consolidation and subsequent breakout above the 200-day moving average:

Because both the daily and weekly charts are confirming a breakout in the
Gold and Silver Index, we feel the sector now provides some quality trade setups
for both short and intermediate-term traders. GLD
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is directly related to the $XAU index, but note that GLD mirrors the price of
the Spot Gold commodity, whereas the $XAU index consists of individual gold and
silver mining stocks. Therefore, buying GLD is not the same as buying individual
stocks in the $XAU index. There usually is a price correlation between
the price of Spot Gold and the gold mining stocks, but right now it appears that
the individual gold and mining stocks are actually breaking out ahead of the
price of Spot Gold. As such, you may wish to consider creating your own
"synthetic ETF" by buying a small basket of leading stocks within the Gold and
Silver Index. A few mining stocks with bullish looking charts are RGLD
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GOLD
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Yesterday was basically a consolidation day for the major indices, so the
short-term support and resistance levels of the major indices haven’t changed.
The S&P 500 closed right at last week’s resistance of the 1,245 level, so it
would only take a gain of a few points to push the index above those intraday
highs. Support should be found near the August 2 low of 1,235, then the 20-day
moving average at 1,228. In the Nasdaq Composite, minor price resistance is at
the 2,220 level, just three points above yesterday’s closing price. Support is
in the range of 2,190 to 2,195. The Dow Jones continues to be a choppy, sloppy
mess on the daily chart, so it is best left alone. Nevertheless, the index
closed less than twenty points away from a breakout of its three-week range.

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.