Watch For Setups In The Stocks Of These 7 Sectors

Mirroring the previous day’s
performance, stocks modestly attempted to rebound at mid-day,
but the broad market succumbed to selling in the afternoon. The Dow Jones
Industrial Average
(
DJX |
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SPX |
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0.1% and the Nasdaq Composite Index
(
COMP |
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Nasdaq closed lower by the same percentage they gained the prior day. The S&P
400 Mid-Cap Index
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MDY |
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RUT |
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shed 0.6%. Every industry sector we regularly follow closed within 1% of
unchanged, though a majority of sectors closed in the red. Overall, it was a
choppy, narrow-range day that was rather quiet.

As is typical of lethargic, uneventful days, volume declined
in both exchanges declined yesterday. Total volume in the NYSE was 4% lower,
while volume in the Nasdaq came in 9% lighter than the previous day’s level.
Most market internals were bearish. Declining volume in the Nasdaq exceeded
advancing volume by a ratio of 2.1 to 1, while the NYSE was negative by 1.8 to
1. As we remain in the "summer doldrums" and many traders are on vacation,
turnover in both exchanges once again came in below average. Volume in the
Nasdaq has been lighter than its 50-day average level in ten of the past eleven
sessions. We don’t expect major increases in volume for the next two weeks, at
least until after the Labor Day holiday passes on September 5.

For the second consecutive day, the S&P 500 clung to support
of its 50-day moving average, but could not muster up enough strength to bounce
off of it. The index also closed in the middle of yesterday’s narrow range,
which resulted in a

"doji star" candlestick formation being formed at its 50-day moving average.
A "doji star" indicates indecision and sometimes precedes a trend
reversal. Looking at the chart below, also notice how yesterday’s low in the S&P
corresponded with support of its primary uptrend line (the blue line):

Like the S&P 500 Index, the Semiconductor HOLDR
(
SMH |
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closed at support of its primary uptrend line, which has been in place since the
low of April 29. It also is holding above its 50-day MA, which is 34 cents below
yesterday’s closing price. The blue ascending line on the weekly chart below
marks support of the primary uptrend:

Also hovering near a pivotal area of support is the Dow Jones
Industrial Average, which has tested support of both its 50 and 200-day moving
averages in each of the past three days. The 50-day MA is closely watched by
institutions as an indicator of intermediate-term health of an index, but the
200-day MA is even more important because it tells institutions on which side of
an index to be positioned in the long-term. Because the financial media
so frequently discusses the performance of the Dow, its direction and trend is a
powerful "psychological" indicator for the health of the overall broad market.
This is so regardless of the fact that the index is comprised of only thirty
stocks. Needless to say, watch for a possible break of the three-day low in the
Dow, which could trigger rapid selling across the board:

The Nasdaq Composite remains below resistance of its prior
uptrend line, which it fell below on August 16, but the index is still six
points above support of its 50-day moving average. Any rally attempt in the
Nasdaq will be met with resistance of the prior uptrend line near the 2,160
area. However, the 50-day MA is likely to prevent the index from falling much
lower, at least in the short-term.

As the charts above illustrate, the broad market is at a
pivotal area of support that could result in big moves in either direction.
Given the light overall volume in the markets, it’s quite difficult to predict
whether the indices will bounce off these key support levels and rally back to
their highs, or if they will break support and slide further in the coming
weeks. We are currently positioned mostly on the short side of the market, but
are prepared to quickly cover our short positions and initiate new long entries
if the indices reverse off support. If you’re currently positioned mostly in
cash, it is a good idea to have a watchlist of stocks and ETFs you are stalking
for potential entry on both sides of the market. For long positions, consider
the sector ETFs with the most relative strength: Biotech
(
BBH |
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Semiconductors
(
SMH |
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PowerRating), and Gold
(
GLD |
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PowerRating). For short ideas, we like the
following sectors: Retail
(
RTH |
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PowerRating), Utilities
(
UTH |
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PowerRating), REITS
(
IYR |
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PowerRating), Home
Construction (no ETF), and the DJ Industrials
(
DIA |
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PowerRating). Above all, don’t try to
predict where the markets will go from here. Rather,
trade what you see, not what you think!

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 .