Nasdaq and Russell Showing Bearish Setups

Downward momentum from Monday’s
selloff triggered an opening gap lower yesterday morning, but each of the major
indices except the Nasdaq reversed to close marginally higher. The
S&P 500 recovered from a 0.5% opening loss and finished with a gain of 0.2%. The
Dow Jones Industrial Average also advanced 0.2%, but the Nasdaq Composite
continued its recent pattern of negative divergence by losing 0.3%. The
small-cap Russell 2000 was unchanged and the S&P Midcap 400 managed to close
0.1% higher. The broad market descended from its high in the final thirty
minutes of trading, but each of the indices still closed in the upper third of
their intraday ranges.

Turnover rose across the board. Total volume in the NYSE was
5% higher than the previous day’s level, while the Nasdaq’s volume increased by
4%. Volume in both exchanges returned to above their 50-day average levels for a
change. The Nasdaq’s loss on higher volume was technically a bearish
“distribution day,” but the bullish intraday pattern, small percentage loss, and
minimal volume increase prevent us from making a definitive declaration of such.
Mixed market internals confirmed the tug-of-war in the broad market. In the
NYSE, advancing volume exceeded declining volume by nearly 3 to 2. The Nasdaq
ratio, however, was negative by the same margin.

As expected, the streetTRACKS Gold Trust
(
GLD |
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PowerRating) bounced off
the triple convergence of support that we discussed in yesterday’s newsletter,
gaining 1.2% in the process. Individual gold mining stocks led the recovery in
the spot gold commodity, enabling the CBOE Gold Index ($GOX) to zoom 2.8%
higher. We bought GLD when it opened above the previous day’s high and the
position is now showing a gain. The Market Vectors Gold Miners
(
GDX |
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PowerRating) rallied
the same percentage as the $GOX index and, more importantly, closed above
resistance of its hourly downtrend line. This increases the odds that it will
resume its primary uptrend by moving back to its December 5 high. We liked GDX
for potential long entry as well, but bought GLD instead because the triple
convergence of support made for a lower risk entry point. We have illustrated
the trendline break of resistance on the hourly chart below:

The most notable technical event that occurred yesterday was
the Nasdaq’s break of its daily uptrend line that began with the lows of August
2006. Last week, the index tested support of its primary uptrend line on several
occasions, but recovered to close at or above it each time. As the daily chart
below illustrates, this time was different. Notice how the Nasdaq made a
definitive break below trendline support yesterday:

With the Nasdaq below its trendline support, the next obvious
downside target would be its 50-day MA at the 2,397 area. We feel odds are
pretty good that the index at least touches its 50-day MA in the coming days,
though it’s more difficult to predict whether or not it will close below it.
Conversely, new overhead resistance should now be found at the prior uptrend
line.

Another important occurrence was yesterday’s test of 50-day
moving average support for the Russell 2000 Index. Of all the major market
indexes we follow, this is the first one that has already fallen to test support
of this pivotal level. But even though it touched its 50-MA yesterday morning,
it’s positive that the index bounced off support to close firmly above it:

If the Russell 2000 holds above its 50-day MA for the next
week, it could begin to form a new base from which to rally, but a firm close
below the 50-MA would be an ominous sign for the entire market. Curiously, both
the S&P and Dow are continuing to ignore the weakness in the Nasdaq, Russell,
and S&P Midcap indices. It seems that indecision is the name of the game right
now, which is never fun for trend traders.

As for our open positions, we now have four of them. The short
position in the iShares DJ Transportation
(
IYT |
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PowerRating) is showing a gain of more
than one point and continuing to show relative weakness to the broad market. We
also remain long the UltraShort QQQQ ProShares
(
QID |
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PowerRating), the ETF that is
inversely correlated to the Nasdaq 100 Index. The position is hanging out near
our original entry point, but we still like the setup and feel it has good
potential to surge higher. A move below yesterday’s low in the Nasdaq would
likely trigger a nice surge in the price of QID. Yesterday, we added two new
positions. The first was our long entry in GLD and the second was a new long
position in the UltraShort Midcap ProShares
(
MZZ |
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PowerRating), which is also showing a
bearish pattern like the Nasdaq.

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 .