This index is in trouble

Stocks gapped lower on yesterday
morning’s open, but a recovery that began at mid-day enabled the
indices to finish with mixed results. The Nasdaq Composite
(
COMP |
Quote |
Chart |
News |
PowerRating) was
showing a loss of 0.8% after the first ninety minutes of trading, but the index
reversed to close 0.3% higher. The other major indices followed a similar
intraday pattern, but both the S&P 500
(
SPX |
Quote |
Chart |
News |
PowerRating) and Dow Jones Industrial
Average
(
DJX |
Quote |
Chart |
News |
PowerRating) were only unchanged by day’s end. The small-cap Russell 2000
and S&P Midcap 400 indices showed relative weakness again, causing each index to
lose 0.1%. The broad market peaked from its late morning reversal around 1:30 pm
EDT, at which point the major indices began to drift modestly lower throughout
the remainder of the session.

Volume spiked higher in both exchanges yesterday, but
divergent price action in the broad market blurred the implication. In the
Nasdaq, the 16% rise in turnover was positive because the index rallied back
from morning losses and closed higher. The Nasdaq therefore had a bullish
“accumulation day.” Volume in the NYSE was a whopping 28% higher than the
previous day’s level, but the S&P 500 was flat. A closer look also shows that
much of yesterday’s higher turnover in the NYSE was due to heavy losses in the
energy and metals-related sectors as opposed to sectors that gained on strong
volume. Regardless, it was nice to see decent volume in the markets, as it was
the first time since August 9 that volume in the NYSE exceeded its 50-day
average. Curiously, volume in the Nasdaq was just below its average level.

As mentioned, yesterday’s action was pretty divergent among
the various industry sectors. Several technology-related sectors performed well,
accounting for the strength in the Nasdaq. The Philadelphia Semiconductor Index
(
SOX |
Quote |
Chart |
News |
PowerRating) zoomed 2.5% higher, while both the Software
(
GSO |
Quote |
Chart |
News |
PowerRating) and Internet
(
GIN |
Quote |
Chart |
News |
PowerRating)
indexes turned in gains as well. We have our eye on a couple of the Software
ETFs for potential long entries (IGV, PSJ, or SWH). In the S&P 500, the Retail
Index
(
RLX |
Quote |
Chart |
News |
PowerRating), which gained 1.8%, was the only non-tech sector that closed at
least one percent higher. Conversely, a handful of industries suffered
considerable losses.

Last Friday’s break of its 200-day moving average weighed
heavily on the Amex Oil Index
(
XOI |
Quote |
Chart |
News |
PowerRating), which fell 2.5% yesterday. The weakness
correspondingly caused the S&P Select Energy SPDR
(
XLE |
Quote |
Chart |
News |
PowerRating) to lose 3.1% as
well. We covered a majority of our XLE short position into the weakness for a
gain of nearly 8% (four points). While it still may test the June low, only two
points lower, we interpreted yesterday’s high selling volume in the sector as a
potential sign of short-term capitulation. XLE, for example, traded at 250% of
its average daily volume.

In addition to oil, the steel and specialty alloy stocks lost
a lot of ground, as did precious metals. The Gold and Silver Index
(
XAU |
Quote |
Chart |
News |
PowerRating)
plummeted 7.0% and finished below its 200-day moving average for the first time
since mid-June of this year. Last week, we attempted to buy a breakout in the
StreetTRACKS Gold Trust
(
GLD |
Quote |
Chart |
News |
PowerRating), but quickly closed the position ahead of its
predetermined stop price when the breakout failed. As yesterday’s action in the
$XAU index demonstrated, failed breakouts above key resistance levels often
reverse in a fast and furious manner. To illustrate this, take a look at the
daily chart of the $XAU index:

Stocks gapped lower on yesterday morning’s open, but a
recovery that began at mid-day enabled the indices to finish with mixed results.
The Nasdaq Composite was showing a loss of 0.8% after the first ninety minutes
of trading, but the index reversed to close 0.3% higher. The other major indices
followed a similar intraday pattern, but both the S&P 500 and Dow Jones
Industrial Average were only unchanged by day’s end. The small-cap Russell 2000
and S&P Midcap 400 indices showed relative weakness again, causing each index to
lose 0.1%. The broad market peaked from its late morning reversal around 1:30 pm
EDT, at which point the major indices began to drift modestly lower throughout
the remainder of the session.

Volume spiked higher in both exchanges yesterday, but
divergent price action in the broad market blurred the implication. In the
Nasdaq, the 16% rise in turnover was positive because the index rallied back
from morning losses and closed higher. The Nasdaq therefore had a bullish
“accumulation day.” Volume in the NYSE was a whopping 28% higher than the
previous day’s level, but the S&P 500 was flat. A closer look also shows that
much of yesterday’s higher turnover in the NYSE was due to heavy losses in the
energy and metals-related sectors as opposed to sectors that gained on strong
volume. Regardless, it was nice to see decent volume in the markets, as it was
the first time since August 9 that volume in the NYSE exceeded its 50-day
average. Curiously, volume in the Nasdaq was just below its average level.

As mentioned, yesterday’s action was pretty divergent among
the various industry sectors. Several technology-related sectors performed well,
accounting for the strength in the Nasdaq. The Philadelphia Semiconductor Index
(
SOX |
Quote |
Chart |
News |
PowerRating) zoomed 2.5% higher, while both the Software
(
GSO |
Quote |
Chart |
News |
PowerRating) and Internet
(
GIN |
Quote |
Chart |
News |
PowerRating)
indexes turned in gains as well. We have our eye on a couple of the Software ETFs for potential long entries (IGV, PSJ, or SWH).
In the S&P 500, the Retail Index
(
RLX |
Quote |
Chart |
News |
PowerRating), which gained 1.8%, was the only non-tech sector that closed at
least one percent higher. Conversely, a handful of industries suffered
considerable losses.

Last Friday’s break of its 200-day moving average weighed
heavily on the Amex Oil Index ($XOI), which fell 2.5% yesterday. The weakness
correspondingly caused the S&P Select Energy SPDR (XLE) to lose 3.1% as well. We
covered a majority of our XLE short position into the weakness for a gain of
nearly 8% (four points). While it still may test the June low, only two points
lower, we interpreted yesterday’s high selling volume in the sector as a
potential sign of short-term capitulation. XLE, for example, traded at 250% of
its average daily volume.

In addition to oil, the steel and specialty alloy stocks lost
a lot of ground, as did precious metals. The Gold and Silver Index ($XAU)
plummeted 7.0% and finished below its 200-day moving average for the first time
since mid-June of this year. Last week, we attempted to buy a breakout in the
StreetTRACKS Gold Trust (GLD), but quickly closed the position ahead of its
predetermined stop price when the breakout failed. As yesterday’s action in the
$XAU index demonstrated, failed breakouts above key resistance levels often
reverse in a fast and furious manner. To illustrate this, take a look at the
daily chart of the $XAU index:

As you can see, the $XAU index broke out above a multi-month
base of consolidation at the 150 price level on September 5. Normally, such
action would represent an ideal entry point to buy stocks in that sector.
However, notice how traders immediately sold into strength of that breakout,
causing the index to fall back down into its prior trading range only two days
later. If you are long when this scenario occurs, your best bet is to quickly
take the small loss and close the position without further thought. If you
don’t, you are likely to be caught in the subsequent free-fall that occurs when
all the bulls who bought the breakout are forced to sell their positions, which
in turn attracts the interest of the short sellers. The failed breakout in XLE
that occurred in early August was another example of how a “buy setup” can
instantly change into a “short selling” setup. The only difference is that XLE
took a few weeks longer to finally collapse than the four days it took GLD (and
the $XAU index).

As for the next failed breakout, we remain focused on the DJ
Utilities Index ($DJU). Since failing to break out to a new all-time high
from a five-week consolidation in the end of August, the $DJU has begun to show
substantial relative weakness. The index has closed lower in each of the past
six sessions, despite several days of gains in the broad market. It closed at
support of its 50-day moving average yesterday, which could easily yield a
short-term bounce, but we think the index is in trouble. As such, we remain
short a full position of the S&P Select Utilities SPDR (XLU), although the
Utilities HOLDR (UTH) is another good option.

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 .

 

As you can see, the $XAU index broke out above a multi-month
base of consolidation at the 150 price level on September 5. Normally, such
action would represent an ideal entry point to buy stocks in that sector.
However, notice how traders immediately sold into strength of that breakout,
causing the index to fall back down into its prior trading range only two days
later. If you are long when this scenario occurs, your best bet is to quickly
take the small loss and close the position without further thought. If you
don’t, you are likely to be caught in the subsequent free-fall that occurs when
all the bulls who bought the breakout are forced to sell their positions, which
in turn attracts the interest of the short sellers. The failed breakout in XLE
that occurred in early August was another example of how a “buy setup” can
instantly change into a “short selling” setup. The only difference is that XLE
took a few weeks longer to finally collapse than the four days it took GLD (and
the $XAU index).

As for the next failed breakout, we remain focused on the DJ
Utilities Index ($DJU). Since failing to break out to a new all-time high
from a five-week consolidation in the end of August, the $DJU has begun to show
substantial relative weakness. The index has closed lower in each of the past
six sessions, despite several days of gains in the broad market. It closed at
support of its 50-day moving average yesterday, which could easily yield a
short-term bounce, but we think the index is in trouble. As such, we remain
short a full position of the S&P Select Utilities SPDR (XLU), although the
Utilities HOLDR (UTH) is another good option.

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 .