One sector to buy — and one you should exit quickly

The stock markets followed up
Wednesday afternoon’s bullish reversal with a choppy session Thursday
that left the major indices with mixed results near unchanged levels. The S&P
500 eked out a 0.1% gain, but both the Nasdaq Composite
(
COMP |
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PowerRating) and Dow
Jones Industrials
(
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PowerRating) lost 0.2%. The Russell 2000 Index
(
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0.3%, indicating that small caps again led the broad market. The S&P 400 Midcap
Index
(
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PowerRating), however, was unchanged. Each of the major indices closed near
the middle of their intraday ranges, a typical sign of overall indecision.

Total market volume in the NYSE declined by 6% Thursday, while
volume in the Nasdaq was 3% lighter than the previous day. Although turnover was
lower, volume levels in both exchanges still came in above average levels
because the prior day’s volume had spiked so high. Yesterday was technically not
a "distribution day," but we view the higher than average volume as a negative.
Trading activity should usually decline during a session of consolidation that
followed a high volume bullish reversal day. If volume levels remain nearly the
same but no upward price movement occurs, it signals "churning," which often
disguises institutional selling into strength.

Thursday’s industry sector performance was interesting. The
Gold Index ($GOX) rocketed 4% higher on Thursday, as a handful of gold stocks
like
(
RGLD |
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PowerRating) and
(
GG |
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PowerRating) broke out to new 52-week highs.
(
GLD |
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PowerRating) (StreetTRACKS
Gold Trust), which we targeted for long entry a few weeks ago but never entered,
is now back on our radar for long entry. Subscribers can see details of that
trade setup on "Today’s Watchlist" below. The Oil Index
(
XOI |
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PowerRating) also spurted
another 3.6% higher and closed at a fresh all-time high for the second day in a
row. Although oil-related stocks technically have been very strong as of late,
we have intentionally avoided trading in
(
OIH |
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PowerRating) (Oil Service HOLDR) simply
because that sector is now being driven largely by news, particularly
speculation on the effects of Hurricane Katrina. The DJ Utilities Average
(
DJU |
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PowerRating)
similarly cruised 2.1% higher. On the downside, the Airline Index ($XAL)
plummeted 5.8%, a typical inverse reaction to upward movements in the Oil Index.
The Retail Index
(
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PowerRating) lost 1.1%, due largely to weakness in the apparel
retailers.
(
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PowerRating) (Retail HOLDR), which we shorted and covered for a nice
profit last week, is now firmly below its 200-day moving average.

In Thursday’s Wagner Daily, we analyzed and compared
the relative strength of the Biotech versus the Semiconductor indexes and came
to the conclusion that buying
(
BBH |
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(
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PowerRating) (Semiconductor HOLDR). Given that BBH gained 1.1% yesterday
while SMH lost 1.1%, it seems our analysis may be correct. Since BBH is
now showing an unrealized gain of more than 5 points since our initial long
entry two days ago, it gives us a nice profit buffer to trail a loose stop. We
looked at the longer-term weekly charts of both BBH and SMH yesterday that
showed how each one had come into support of its weekly uptrend line, but the
shorter-term daily charts show a big difference in their recent relative
strength:

As you can see, BBH is now free of overhead supply and
resistance because it broke out and closed at a new 4-year high yesterday. SMH,
on the other hand, failed to break out above resistance of its multi-week range,
just above the $37 level. It closed a few cents below its 20-day moving average
and only 24 cents above its 50-day MA. Within the past week, SMH bounced off its
50-day MA on three separate days, but it failed to gain any ground after doing
so. Therefore, if it doesn’t break out within the next few days, it could easily
break below its 50-day MA. Because the Semis are so heavily weighted, weakness
in that sector would probably weigh heavily on the Nasdaq. It would even make it
more difficult for the Biotechs to gain ground, although they probably would not
drop much. SMH is holding the consolidation and could still take off, but, if
you’re long, be sure to exit quickly if SMH closes below the 50-day MA by more
than a few cents. Even if SMH breaks out above the $37 area, there is still
resistance all the way up to the prior high of $38.32.

Because the major indices each closed near unchanged levels
and in the middle of their intraday ranges yesterday, the technical picture for
the broad market has not changed much since yesterday’s analysis. The key thing
to watch is resistance of the Fibonacci retracement levels we pointed out in
yesterday’s Wagner Daily. Since the markets are closed for Labor Day
holiday on Monday, expect volume to be light and trading activity to be
lethargic and choppy today. Many traders will probably head out at mid-day to
begin their long weekends early, so it’s probably not going to be the most ideal
session for aggressively entering a bunch of new trades.

Note that the U.S. equities markets will be closed on Monday,
September 5 for the Labor Day holiday. As such, both The Wagner Daily and
MTG Stalk Sheet will not be published that day. However, regular
publication will resume on Tuesday, September 6. Enjoy your holiday weekend.

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 .