Watch the SOX for follow through

Stocks gapped down on the open last
Friday morning, but recovered at mid-day to finish the day near unchanged
levels. The S&P 500 eked out a 0.1% gain, but the Nasdaq Composite
was lower by the same percentage. Blue chips showed the most relative strength,
enabling the Dow Jones Industrial Average to advance 0.3%. The S&P Midcap 400
ticked 0.1% lower, while the small-cap Russell 2000 fell 0.3%. Although the
broad market closed near the flat line, each of the major indices continued to
show resiliency by bouncing back from early losses to finish at their intraday
highs. Friday’s mixed session capped a strong week of broad-based gains. The
Nasdaq gained 2.3%, the S&P 500 1.5%, and the Dow 1.9%. All three indices posted
either record or fresh multi-year highs.

Total volume in the NYSE ticked 0.1% higher, but turnover in
the Nasdaq was 15% lower than the previous day’s level. The higher volume gain
in the S&P technically gave the index another bullish "accumulation day," but
both the percentage gain and uptick in volume were marginal. The drop in the
Nasdaq was equally positive because the index closed with a small loss. Despite
higher prices in the S&P and Dow, declining volume in the NYSE exceeded
advancing volume by a margin of 1.3 to 1. The Nasdaq internals were negative by
8 to 1.

On a technical level, the most notable thing that happened
last week was the breakout in the Semiconductor Index ($SOX). As noted in the
November 15 issue of
The
Wagner Daily, the $SOX broke out to close above its 200-day moving
average for the first time since May 11 of this year. Over the three subsequent
days that followed, the index digested its gain by trading in a tight, sideways
pattern of consolidation:

If the broad market strength is to continue, we should see
follow-through of another leg up in the $SOX within the next several days. SMH,
IGW, PSI, and XSD are the ticker symbols of all the ETFs that are tied to the
Semiconductor sector. They have each shown similar price action since the $SOX
breakout on November 14, but remember that XSD has shown the most
intermediate-term relative strength. It is the only semiconductor ETF that is
already trading above its October 16 high. The safest entry point to buy any of
the semiconductor ETFs would be above their respective highs of the past three
days.

Of the major industry sectors that are showing strength, the
$SOX is one of the least extended and therefore offers the best risk/reward
ratio for potential entry. However, our concern is that the strength in the $SOX
may be out of sync with the broad market that has already made a very
substantial move in recent weeks. The S&P 500, for example, has closed higher in
9 of the last 10 sessions. By entering any new positions at current levels, the
risk is much greater because the major indices have again become extended away
from their 20-day moving averages that act as solid support. If the overall
market moves higher without taking a rest, the Semis will probably lead the way,
but consider reducing your share size to decrease your risk. As for us, we
remain in "SOH mode" (sitting on hands), managing existing positions and
stalking for the next solid opportunity.

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 .