What triggered yesterday’s avalanche? Read on…

Early gains in the Semiconductor
Index
(
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sparked a late morning rally in the Nasdaq
, but
pivotal resistance levels on several of the major indices triggered
institutional sell programs in the afternoon. The end result was a smattering of
bearish reversals with broad-based losses on higher volume. At mid-day, the
Nasdaq Composite
(
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was showing a 0.8% gain, but the index finished the
day 0.9% lower. Equally negative was the performance in the $SOX index,
which saw its 2.4% intraday gain transform into a 0.2% loss. Although it briefly
traded at a new all-time high on an intraday basis, the small-cap Russell 2000
later plummeted to a 1.3% loss. The S&P 500
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fell 0.6%, the S&P Midcap
400 shed 0.9%, and the Dow Jones Industrial Average
(
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  lost 0.4%.
Each of the major indices closed at their intraday lows, positioning stocks for
further downside momentum into today’s open.

Confirming yesterday’s bearish reversals was an increase in
total market volume in both exchanges. Volume in the NYSE increased by 11%,
while volume in the Nasdaq rose 21% above the previous day’s level. The losses
on higher volume caused both the S&P and Nasdaq to register a confirmed
“distribution day” that was indicative of institutional selling. It was the
fourth “distribution day” within the past four weeks, which is always a warning
sign to the bulls. As for internals, declining volume exceeded advancing volume
by nearly 3 to 1 in the NYSE and 2 to 1 in the Nasdaq. Although the ratio in the
Nasdaq was not horrible, it is important to note that the ratio was positive
by nearly 4 to 1 before the afternoon reversal.

If you are wondering what caused the sudden change of
sentiment that triggered yesterday afternoon’s avalanche, one of the biggest
contributing factors was that several of the major indices ran into very pivotal
resistance levels of their previous highs. Most interesting was the Nasdaq
Composite, which collapsed after failing to break through resistance of its
5-year high that was set on January 11 of this year. That level of 2,332.9 has
clearly become a “line in the sand.” Looking at the daily chart below, notice
how the Nasdaq rallied exactly up to resistance of its prior 5-year high
before it fell apart in the afternoon:



Curiously, the Dow Jones Industrial Average also reversed
after running into resistance of its 5-year high yesterday. This is illustrated
on the long-term monthly chart below:



At its intraday high, the S&P 500 had probed above the high of
its three-day range of consolidation, but the index finished the session all the
way back down at its prior breakout level. As you may recall, 1,295 represented
resistance of the S&P’s prior high that it broke out above on March 14.
Yesterday’s closing price of 1,297 means that we will soon see whether or not
new support of the prior high will hold up. If the S&P fails to go lower, it
will be a positive sign that its technical support level is working. However, a
slide back below the 1,295 level would not be good because it would indicate a
failed breakout to its multi-year high that occurred last week:



Finally, take a look at both the S&P Midcap 400 and Russell
2000 indices, which can be traded through the MDY and IWM exchange traded funds.
As you can see, both indices have been unable to break out to new high over the
past several weeks:



Yesterday’s bearish reversals that occurred after several of
the major indices failed at key resistance levels was a great example of how an
index’s prior lows and highs always act as support and resistance levels. It is
these fundamental elements of technical analysis that we like the best because
they are consistently reliable. Why are prior lows and highs always good
predictors of future support and resistance levels? Simply because human
psychology never changes. Most people who bought a stock at a higher price will
always look to sell when the stock recovers to near the break-even entry price.
This, of course, causes resistance to form by creating additional overhead
supply. The inverse is true with regard to how support levels are formed.

Going into today, we now expect further downward pressure. A
lot of selling momentum was created by the mid-day reversal that trapped the
people who bought stocks in the morning breakout. This, in turn, attracted short
sellers, many of whom are also likely to show up on the scene today. Therefore,
we feel it is imperative to keep tight stops on your long positions in the event
of further institutional selling that began yesterday. At present, we do not
have any long positions and are already positioned for further downside with
three open short positions: IWM (Russell 2000), IGW (iShares Semiconductor), and
EWZ (iShares Brazil). As of yesterday’s close, each one is showing an unrealized
gain, but a bit of caution is still required on the short side until the S&P 500
closes below 1,295 and the Nasdaq falls below its choppy, sloppy trading range
on its daily chart.


Open ETF positions:

Short IWM, IGW, and EWZ (regular subscribers to

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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
.