What This Reliable Indicator Says About The Probable Direction Of The Market

The major indices wrapped up a choppy and
indeterminate week with a day of broad-based losses
last Friday. A negative earnings report from Dell Computer
(
DELL |
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PowerRating) caused
the Nasdaq
(
COMP |
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PowerRating) to gap down 0.7% and drift lower to a 1.3% loss at
mid-day, but the index recovered in the afternoon and finished the session near
its intraday high and with a 0.8% loss. The S&P 500
(
SPX |
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Chart |
News |
PowerRating) showed more
relative strength than the Nasdaq in the morning, but the index closed 0.6%
lower and in the bottom third of the day’s range. The Dow Jones Industrial
Average
(
DJX |
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Chart |
News |
PowerRating) followed a similar pattern and posted a 0.8% loss. Small caps
continued their correction that began two weeks ago, as the Russell 2000 Index
shed 1.0%. The S&P 400 Mid-Cap Index, however, held up well and lost only 0.2%.

Total volume in the NYSE declined by 8%, which prevented the
S&P and Dow from registering a "distribution day." But turnover in the Nasdaq
conversely rose 4% higher than the previous day’s level. The increase in volume,
combined with its 0.8% loss, gave the Nasdaq its second "distribution day"
within the past week. Internals were also bearish, as the Nasdaq’s declining
volume exceeded advancing volume by a margin of 2.5 to 1. The NYSE was similarly
negative with a 2.3 to 1 ratio. Prior to August 10, most of the Nasdaq’s "up"
days were occurring on higher volume, while all but one "down" day in the prior
four weeks were on lighter volume. Such action indicated a healthy market, but
the picture began to change last Wednesday. The last three sessions have
consisted of two days of higher volume selling ("distribution") and one "up" day
that occurred on lighter volume. This recent change to a negative price to
volume relationship in the Nasdaq serves as a caution sign to astute traders who
understand that volume is one indicator that never lies.

Since closing the month of July at a fresh 4-year high, the
Nasdaq has had two straight weeks of losses, but the positive is that the index
has come into support of its weekly uptrend line. The chart of the Nasdaq below
shows how the index finished last week just above the lower channel support of
its uptrend (the ascending blue line) that has been in place since the low of
April:

Because the above uptrend line has been in place for the past
three and a half months, we must assume the uptrend will remain intact until the
Nasdaq proves otherwise. As such, it seems likely the Nasdaq will bounce off
support of its uptrend line in the coming week. But even if the index breaks its
uptrend line, support of the 50-day moving average is just below (at the 2,123
level). The Semiconductor Index
(
SOX |
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Chart |
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PowerRating)) has also shown great relative
strength during the broad market’s recent correction and should be among the
first sectors to rally when the Nasdaq does. We closed the rest of our long
position in SMH (Semiconductor HOLDR)
(
SMH |
Quote |
Chart |
News |
PowerRating) for a 7% profit when it broke
short-term support on August 4, but we are looking for a possible re-entry point
in the coming week. As you can see on the chart below, the 50-day moving average
has converged with the daily uptrend line of SMH. This convergence should
provide strong support to enable a continuation of the current uptrend:

While the Nasdaq and $SOX charts look bullish in the
short-term, the daily charts of both the S&P 500 and Dow Jones show a lot of
recent indecision. Despite gains of 0.3% in both indices last week, it was a
major "chop fest" in the S&P and Dow. Notice the wild swings in both directions
on the hourly chart of the S&P below:

As long as the erratic and choppy action continues in the S&P
and Dow, we would advise against trading SPY or DIA. Be careful because it is
easy to overtrade a sideways, range-bound market. As beginning traders quickly
learn, doing so is never a good idea! Going into the new week, we are taking a
neutral stance on the broad market’s short-term direction. Our focus is
therefore on managing existing positions for maximum profitability rather than
aggressively entering new positions. Patient and disciplined traders are always
rewarded in the long-term, so take it easy until the market gives us clear
signals of its next direction.

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 .