This ETF has a bearish pattern

The broad market corrected from its
recent gains yesterday, as stocks sold off sharply across the board.
The major indices gapped down on the open, then trended lower throughout the
session. The Nasdaq Composite
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PowerRating) fell 1.7%, the S&P 500
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1.0%, and the Dow Jones Industrial Average
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see on “down” days in the market, the small-cap Russell 2000 showed the most
relative weakness by closing 2.1% lower. The S&P Midcap 400 Index declined 1.7%.
Each of the indices finished near their intraday lows, pointing to potential
downward momentum into today’s open.

Total volume in the NYSE rose by 8%, while volume in the
Nasdaq was 3% higher than the previous day’s level. The broad-based losses on
higher volume caused bearish “distribution days” to register for both the S&P
500 and Nasdaq Composite. However, the increase in volume was not too
significant, especially considering the large percentage losses in the market.
On August 31, the major indices technically sustained a “distribution day,”
despite minimal price losses. As you may recall, we classified that session as
bearish “churning” action. Other than that session, August 9 was the last time
both exchanges sold off on higher volume. Firmly negative market internals
confirmed yesterday’s bearish price action. In the NYSE, declining volume
exceeded advancing volume by a margin of 5 to 1. The Nasdaq ratio was negative
by nearly 7 to 1.

In the August 31 issue of

The Wagner Daily,
we pointed out the bearish pattern that was developing in the S&P Select Energy
SPDR
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PowerRating), which is largely tied to the movement of oil stocks. As you
might recall, we liked the break of the 50-day moving average that also
corresponded to a breakdown below support of its two-month uptrend line. After
breaking this dual area of support, XLE bounced higher on September 1 and 5, but
the 50-day moving average acted perfectly as resistance that triggered a large
selloff yesterday. This is a great educational example of the most basic tenet
of technical analysis — prior support becomes the new resistance after the
support is broken. We have illustrated this on the daily chart of XLE below:

Yesterday’s pattern in XLE was rather bearish, as it gapped
open near the bottom of the previous session’s “up” day, then sold off sharply
to close below the lows of the prior three days. Because it finished beneath the
August 31 low, odds are pretty good that we will now see further downside.
Support of the 200-day moving average below may provide an excuse for another
short-term bounce, but an eventual re-test of the June low is feasible. Though
not an “official” play, we remain short XLE in the Morpheus Capital hedge fund
from a price of 56.48. Since it broke support of the August 31 low, we are now
trailing our stop lower, to near break-even and just above the September 6 high.

The loss in the S&P 500 yesterday caused the index to close
right at support of its eight-week uptrend line:

As with all trendlines, we must assume that the current
uptrend in the S&P will remain intact until the index proves otherwise. An
intraday probe below support is highly likely, but the important point is
whether or not it closes below the trendline. Even a one-day close below
the trendline would not confirm the break of support, but it would clearly serve
as a warning sign to the bulls. Now is the time to tighten your stops on all
long positions and begin making a new watchlist of short setups.. If the S&P
breaks its uptrend line, the first bounce that occurs after the trendline break
would provide the ideal entry point on the short side. Waiting for that
retracement into resistance is much safer than selling short the actual
breakdown. The XLE chart above is a clear example of this.

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 .