The SOX is key to Nasdaq’s Next Move

Stocks moved modestly higher in the
first hour of yesterday’s session, then drifted sideways, in a narrow range,
throughout the remainder of the day. All the major indices finished
higher, but weakness in the tech arena caused the Nasdaq to lag. Both the S&P
500 and Dow Jones Industrial Average gained 0.4%, as the Nasdaq Composite,
small-cap Russell 2000, and S&P Midcap 400 indices each advanced 0.2%. After the
opening rally subsided, the subsequent intraday trading range became rather
tight. Still, the S&P 500 finished near its best level of the day and closed at
another new six-year high. The Dow remained stuck at resistance of its prior
uptrend line that we illustrated in yesterday’s newsletter.

Total volume in the NYSE increased by 10% yesterday, enabling
the S&P to register an “accumulation day,” but turnover was still below its
50-day average level. In the Nasdaq, volume was only 1% higher than the previous
day’s level. As long as stocks remain in an overall trend of declining volume
below average levels, extra caution should be taken when entering new long
positions. It only takes a one day spike in selling volume to wipe out many days
of light volume gains, which is what occurred on November 27. Market internals
were mixed. Advancing volume in the NYSE exceeded declining volume by a margin
of 1.9 to 1, while the Nasdaq volume ratio was flat.

As always, one major factor weighing on whether the Nasdaq
breaks out to a new high or forms a lower high and reverses is the direction of
the Semiconductor Index ($SOX). Last week, the $SOX fell below the low of its
prior consolidation, but bounced off major support of its 200-day moving
average. Just as the 200-day MA acted as a brick wall that stopped the rally
attempt on October 16, it did exactly the opposite on December 1. For
educational purposes, this is a great example of how a prior resistance level
becomes the new support level after the resistance is broken. It also shows how
the 200-day MA nearly always triggers a bounce when acting both as either
support or resistance:

As you can see, the $SOX is now trapped in “no man’s land”.
The 200-day MA, as well as the rising 50-day MA, are both acting as support from
below, but resistance from the high of the prior consolidation is overhead. This
“tug-of-war” could easily keep the $SOX trapped in a range over the next few
weeks, which would keep the Nasdaq volatility in check as well. However, in the
event that the $SOX manages to break out to the upside, it’s good to have a plan
of action. The Semiconductor HOLDR
(
SMH |
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PowerRating) and iShares Semiconductor
(
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are both following a similar pattern to the $SOX index itself, but one ETF
showing relative strength to the index is the PowerShares Semiconductor
(
PSI |
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Unlike the $SOX, notice that PSI closed yesterday right at the
high of last month’s consolidation. Its relative strength to the $SOX index
means it should be the top performing ETF in that sector if the semis
break out. The buy trigger in PSI is above horizontal price resistance at 18,
but buying it without the $SOX first proving it can break out above its recent
consolidation is a risky proposition.

Regarding the broad market, there’s not much new to say other
than it remains rather resilient. All the major indices continue to grind
higher, although the Dow is still in dangerous territory, right at resistance of
it its prior uptrend line. The recovery from the November 27 selloff has lacked
overall conviction, but being short is pretty tough as well. For that reason, we
remain in SOH mode (“sitting on hands”) with regard to any ETFs that are
closely correlated to the broad market. International, commodities, and currency
ETFs are good places to look for non-correlated ETFs. When the market begins
giving us clear signals that are all in line, we will be ready for new trade
entries in whichever direction it goes.

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 .