SOX Leads Market Decline
A nearly 4% plunge in the Semiconductor Index ($SOX) yesterday led to a sharp
drop in the Nasdaq that followed the previous day’s weakness. The Nasdaq
Composite gapped down on the open, trended steadily lower throughout the day,
then finished near its intraday low and with a 1.5% loss. The small-cap Russell
2000 similarly declined 1.3%, but the S&P and Dow showed firm resilience for
the second consecutive day. The S&P 500 fell 0.3%, while the Dow Jones
Industrial Average lost only 0.1%. The S&P Midcap 400 was lower by 0.9%.
Although the S&P 500 lost only 0.3%, a 6% volume increase in the NYSE
generated a bearish “distribution day” for the S&P yesterday. Turnover in
the Nasdaq was also 6% higher than the previous day’s level, causing the Nasdaq
to register its second straight “distribution day.” Not surprisingly, market
internals in the Nasdaq were firmly negative as well. Declining volume in the
Nasdaq trounced advancing volume by a margin of more than 7 to 1. The NYSE ratio
was only negative by 1.2 to 1.
Yesterday was the Nasdaq’s third day of institutional selling within the past
four weeks, which should serve as a warning to astute traders. As mentioned
yesterday, uptrends can reverse in a fast and furious manner when an index sees
four or more “distribution days” within a one-month period. Remember that
institutional trading accounts for approximately two-thirds of the stock
market’s volume on any given day. Therefore, the market will always follow the
trend of institutional trading activity. That’s why we pay so much attention to
the days in which the market rises or falls on higher volume. “Accumulation
days” and “distribution days” are the footprints of institutional activity.
In yesterday’s target=_blank>The Wagner Daily, we explained why a break below
Wednesday’s low in the $SOX would likely cause the index to rapidly drop down to
its 200-day moving average. That is exactly what happened yesterday, but the
collapse was even faster and more far reaching than we expected. The $SOX opened
just below the previous day’s low, then plummeted down to its 200-day moving
average within the first thirty minutes. By day’s end, the $SOX had shed 3.9%
and closed well below its 200-day moving average. From December 1 through
January 4, the $SOX tested and bounced off support of its 200-day MA in
seven different sessions. The numerous bounces off its support
demonstrated the importance of the 200-day MA as a pivotal support/resistance
level, but each subsequent test increased the likelihood of an eventual
breakdown.
When the $SOX broke out above its downtrend line on January 10, many traders
(including yours truly) bought the semiconductors in anticipation of further
upside. But a negative reaction to Intel’s earnings report three days later
killed the technical setup. This caused the bulls to be trapped, as traders who
bought the strength were forced to sell a few days later. The resulting failed
breakout from this selling attracted the attention of the short sellers, who
further accelerated the decline. When it became apparent the $SOX was finally
going to break support of its 200-day MA yesterday, the last batch of sellers
was the the people who have been hanging on to their positions only because the
$SOX was holding above its 200-MA. When it became apparent that a breakdown was
imminent, those traders and investors “threw in the towel” as well. Fortunately,
we realized only a small loss in our SMH position because we sold half of the
position into strength on January 17, immediately after the negative Intel
reaction, then dumped the rest on yesterday’s open. Looking at the daily chart
below, notice how rapidly the $SOX came unglued after failing to hold the low of
its January 10 breakout:
Remember that technical analysis is nothing more than a way of charting human
psychology and emotions. If you continually think about the reasons that traders
are inclined to buy and sell, namely fear and greed, then you will understand
why support and resistance levels work as well as they do. This is the reason
why we explained the human factors that led to a breakdown in the $SOX, rather
than just showing you the chart and telling you it lost support.
Needless to say, the Nasdaq’s valiant start to the new year is now in
jeopardy. The index closed well below the 2,470 support level that we
illustrated yesterday, and is once again in danger of breaking below its 50-day
MA. The Nasdaq Composite closed only 11 points above its 50-day MA, so keep an
eye on that important level today. Downward momentum is likely to be substantial
if the index breaks below that level today. So far, the Nasdaq is positioned for
a classic failed breakout to a new high. Obviously, the S&P and Dow are
holding up much better, but a breakdown in the Nasdaq would inevitably become a
major drag on the other indices as well. Remember that the Nasdaq was the only
one of the major indices that had broken out to a new six-year high, but now all
the indices are back below their December highs (January 3 high for the Dow).
The Russell 2000 also closed below its 50-day MA yesterday, which is a negative
sign for the broad market as well.
If you’ve been heeding our warnings against aggressively trading during
earnings season, you have probably averted substantial losses. But if you are
still fully positioned, now is not the time to be a hero. Continue to
tread lightly over the next few weeks because a shaky market is more susceptible
to news, and there is plenty of that on tap!
Open ETF positions:
Short FXI, EEM
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Deron Wagner is the head trader of Morpheus Capital Hedge Fund
and founder of Morpheus Trading Group (href=”https://morpheustrading.com”>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 href=”https://morpheustrading.com”>morpheustrading.com or send an e-mail to
deron@morpheustrading.com .