Tech Takes the Lead

The major indices diverged sharply
yesterday, as strength in techs lifted the Nasdaq to a solid gain, but all the
other indices lagged behind. After shaking off initial weakness in
the first hour of trading, the Nasdaq Composite trended steadily higher before
finishing at with a 1.3% gain. The S&P 500 and Dow Jones Industrial Average
showed substantial relative weakness, as both indices edged only 0.1% higher.
Even the small and mid-cap stocks, which typically lead the Nasdaq on positive
days, both had trouble getting in gear. The Russell 2000 advanced 0.3%, while
the S&P Midcap 400 gained only 0.2%. Stocks closed only slightly off their
highs, enabling the major indices to close in the upper third of their intraday
ranges.

Total volume in the NYSE declined by 16%, while volume in the
Nasdaq was 12% below the previous day’s level. The lower turnover prevented the
Nasdaq from registering a bullish “accumulation day,” but it is positive that
volume still came in above its 50-day average level. In the Nasdaq, advancing
volume exceeded declining volume by a healthy margin of 3 to 1. However, the
NYSE ratio was actually negative by 1.3 to 1.

Yesterday’s divergence in the stock market was rather
interesting because the buying was primarily confined to tech-related sectors
such as Semiconductors, Software, and Internets. One probable cause for the
sudden strength was that the Semiconductor Index ($SOX) once again tested and
bounced off support of its 200-day moving average. Several times throughout last
month, we pointed out the close proximity of the $SOX to its 200-day MA, as the
moving average is generally regarded as a sign of long-term strength or weakness
in a stock or index. Amazingly, the 200-MA continues to provide rock solid
support, enabling the $SOX to bounce every time it drifts back down to touch it.
Since the beginning of December, the $SOX has touched support of its 200-MA on
numerous occasions, but each time has led to a subsequent bounce. This is a
great example of the power of the 200-day moving average:

Because the $SOX is so heavily weighted within the Nasdaq, it
is bullish for the entire market that the index refuses to break below its
200-day MA. However, the problem is that every bullish reversal attempt over the
past month has gone nowhere. On the last attempt, the 20-day MA acted as
resistance that stalled out the rally attempt on December 18. Now, that day’s
high has become a resistance level the $SOX needs to get above. But until that
happens, there is no reason to get excited. Even if it does, the index still
must contend with overhead supply all the way up to its high, around the 492
level. For that reason, we recommend that you have a short-term, momentum-driven
time frame on any tech-related stocks or ETFs you may buy.

The Internet Index ($GIN) has a cleaner chart pattern than the
choppy $SOX. On January 3, the $GIN dropped to test support of only its 50-day
MA, as the index remains well above its 200-day MA. Since it was the index’s
first test of the 50-day MA since the current uptrend began in July, the $GIN
easily bounced off its support. One more strong day of buying could push the
index back to test its 52-week high:

Of all the tech-related ETFs, the Software HOLDR
(
SWH |
Quote |
Chart |
News |
PowerRating) is
perhaps the only one that is setting up for a potential buy entry on a breakout.
For the past three months, SWH has been consolidating near its 52-week high in a
relatively narrow, sideways range. The longer a base of consolidation, the more
likely that a subsequent breakout will remain intact and move higher. For that
reason, we plan to buy a small position of SWH if it breaks out above the
range. Looking at the chart below, notice how it closed yesterday less than 25
cents below resistance of the high of its consolidation. The increasing volume
is also a good sign:

Although the tech sectors showed encouraging signs of life
yesterday, the lack of follow-through in the other industry sectors is
concerning. Tech could single-handedly lead the Nasdaq higher for a
while, but the stock market always trends more smoothly when rallies are
broad-based. A lack of participation by other key sectors such as Financial and
Retail increases the odds that strong tech stocks will fail their breakouts.
Conversely, strength in tech makes it difficult to be short the weak sectors as
well. Unfortunately, the divergence within the broad market increases the
likelihood of the major indices staying stuck in choppy, sloppy sideways range
for a longer period of time. As trend traders, choppy and erratic markets are
not our friends. Until the market makes a decisive move out of the range,
protect yourself by trading with reduced share size and a minimal number of
positions.

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 .