NASDAQ Starts 2007 Off At Critical Level

Despite preceding a rare four-day
holiday weekend that included Tuesday’s closure in honor of the passing of
President Ford, last Friday’s session was marked by a decent amount of
volatility. After rallying higher in the first hour, stocks drifted
back down to the flat line through mid-day, then sold off in the final trading
hour of 2006. Both the S&P 500 and S&P Midcap 400 indices lost 0.5%, while the
Nasdaq Composite declined 0.4%. The blue chip Dow Jones Industrials fell only
0.3%, but the small-cap Russell 2000 shed 0.9%. Each of the major indices
finished near the bottom of their intraday ranges.

Turnover picked up in both exchanges last Friday, but remained
well below average levels. Total volume in the NYSE increased by 13%, while
volume in the Nasdaq was 9% higher than the previous day’s level. The losses on
higher volume caused both the S&P and Nasdaq to register bearish “distribution
days.” However, it was the seventh straight session in which volume in both
exchanges was lower than 50-day average levels. Obviously, a lack of
institutional participation is normal in the week between Christmas and New
Year’s Day. Now that the holiday season has passed, volume should return to
average levels in the coming days. Pay close attention to the relationship
between the stock market’s price action and volume increases in order to
determine what institutional traders are doing beneath the surface. The action
in the first week of the new year is likely to set the tone for at least the
rest of the month.

Since you’ve probably already been inundated with stock market
recaps for 2006, we won’t bore you with yet another rundown of how the major
indices performed last year. Instead, we’ll give you a fresh, forward-looking
technical outlook of the S&P, Nasdaq, and Dow that can assist you with your
trading decisions in the coming weeks. Let’s begin by analyzing the daily chart
of the benchmark S&P 500:

The S&P 500 is entering the new year less than one percent
below its 52-week high. It is also less than nine percent below its all-time
high that was set back in March of 2000. But although its long-term monthly
chart remains in a healthy uptrend, the daily chart shows the S&P is in danger
of breaking its six-month primary uptrend line (the dashed blue line). After
correcting down to support of its 20-day moving average on December 22, the
index quickly rallied back to test its prior high, but ran out of gas and headed
back down on December 28 and 29. This has created a “lower high” that is marked
by the high of December 27. Going into this week, that 1,427 price level is a
clear area of price resistance to pay attention to. Conversely, pivotal support
of its primary uptrend line (and the 20-day MA) is just below last Friday’s
close. If the S&P breaks below that level and closes below the December
22 low of 1,410, it will form a “lower low” as well. If that occurs, the index
will likely enter an intermediate-term correction that will at least lead to a
test of its 50-day MA. Therefore, caution is required for all new long entries
unless the S&P moves back above the 1,427 resistance. Next, take a look
at the daily chart of the Nasdaq Composite:

It only takes a quick glance to see that the Nasdaq has been
showing much more relative weakness than the S&P. Over the past seven weeks, the
S&P has been moving steadily higher, but the Nasdaq has been stuck in a choppy,
sideways range. In actual performance terms, the S&P has gained 1.2% since the
week ending November 17, but the Nasdaq has lost the same percentage. On
a technical level, the Nasdaq has already broken support of its six-month
uptrend line and formed a double top in mid-December (the red horizontal line).
Since then, the index has already tested support of its 50-day MA and has been
consolidating near the low of its seven-week range. It attempted to pop back
above its 20-day MA last Friday morning, but the bears took control and caused
the Nasdaq to finish at its intraday low and just above its 50-day MA. Going
into today, last Friday’s high of 2,437 is the key resistance level traders will
be focused on. An inability to quickly recover above that level could trigger a
wave of selling that would lead to a confirmed break of its 50-day MA. It’s
positive that the index bounced off its 50-day Ma last week, but negative that
it drifted back down to that level only three days later. Therefore, the Nasdaq
is entering the new year at a “make it or break it” level that will determine
its intermediate-term direction.

Curiously, the Dow has been showing the most relative strength
of the three major market indices. It finished 2006 only 0.4% off both its
52-week and its all-time high. It is also holding firm near the upper end
of its recent trading range and is not yet in danger of breaking its primary
uptrend line. If the Nasdaq and/or S&P break down in the coming days, it will
certainly weigh on the Dow. However, the blue chip index should also be the
first to break out to a new high if trader return to the market in a bullish
mood.

Presently, we still have three open ETF positions:
StreetTRACKS Gold Trust
(
GLD |
Quote |
Chart |
News |
PowerRating), UltraShort QQQ ProShares
(
QID |
Quote |
Chart |
News |
PowerRating), and
UltraShort S&P Midcap ProShares
(
MZZ |
Quote |
Chart |
News |
PowerRating). All three are long positions, but QID
and MZZ are bearish positions that are inversely correlated to the movement of
the Nasdaq 100 and S&P Midcap 400 indices. So far, each position is showing an
unrealized gain, but we will be closely analyzing the market internals to
determine whether to lock in our gains on QID and MZZ, or whether to continue
trailing our stops higher if the Nasdaq remains weak. GLD is not directly
correlated to the broad market, but it continues to act well. We’ll return to
analysis on specific industry sectors and ETFs as the market shows its hand in
the coming days.

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 .