Why I’m buying XLF and RKH

Thursday’s
volatile session resembled a wild roller coaster ride
, but the major
indices eventually finished mostly higher. After beginning the day with an
opening gap down to a fresh one-week low, the Nasdaq Composite
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swiftly reversed and surged back up to the previous day’s high, but sellers
stepped in just as quickly and sent the index back down to negative territory.
The bulls again arrived on the scene and sent the Nasdaq to new intraday highs,
but the rally began to fizzle out at mid-day and caused the index to close just
above the middle of its intraday range. The other major indices followed similar
tug-of-war patterns. The Nasdaq Composite closed with a 0.5% gain, while both
the S&P 500
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and the Dow Jones Industrials
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advanced 0.3%. The
negative was that small-cap stocks showed major relative weakness and completely
ignored the broad-based rally attempt. As such, the Russell 2000 Index
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actually lost 0.5%. Mid-cap stocks also diverged from the broad market,
as the S&P Midcap 400 was unchanged.

As we often see on reversal days, volume spiked higher across
the board. Total volume in the NYSE rose by 17%, while volume in the Nasdaq
zoomed 43% above the previous day’s level. Curiously, according to our research,
yesterday was the highest volume day in the Nasdaq since December 7, 2004! It’s
positive that the market gained on such higher volume yesterday, but market
internals were rather weak. In the NYSE, declining volume fractionally exceeded
advancing volume. The Nasdaq ratio was positive, but only by 3 to 2. Considering
the huge volume spike, we would have expected to see really strong internals on
an up day, but divergent losses in the small and mid-caps were likely the
culprit for weak market internals.

Many oil and metal stocks sold off pretty sharply yesterday,
telling us that those sectors may be starting a correction. If long, be sure to
trail tight stops from here. Gold, however, continues to hold up pretty well.
One sector that may be starting to show new sector leadership is Banking. The
Regional Bank HOLDR (RKH) broke out to a new all-time high yesterday on volume
that was nearly 3.5 times greater than its 50-day average volume level:



Similarly, the S&P Select Financial SPDR
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also broke
out of a multi-month base of consolidation to a new high:

Because of yesterday’s action in RKH and XLF, we would
consider buying either of those ETFs, or stocks within those sectors, on any
pullback above the breakout level. Conversely, the daily chart of the DB
Commodity Tracking Index (DBC) shows that a correction may be taking place
within the commodities. We are not advising shorting DBC, but just
pointing out that gold, oil, and other metals may be near a short-term top.
Notice how DBC closed yesterday below its daily uptrend line:



Like the massive volume spike in the Nasdaq yesterday, we
found it very interesting that a handful of broad-based ETFs showed very high
volume levels as well. Obviously, ETFs are synthetic instruments and their
volume levels are not directly tied to the supply and demand of the ETF itself.
Regardless, it’s important to pay close attention to major changes in volume
because it tells us what institutions may be doing. Volume in the iShares
Russell 2000 Index
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, for example, swelled to 260% of its 50-day average
volume yesterday. It was the single largest volume day in IWM since it began
trading in June of 2000:


Both the Dow Jones Industrials
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and the Nasdaq 100
Index
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had their highest volume levels since January 20 of this year,
while the S&P 500 SPDR
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had its biggest volume since October 20, 2005:


Unfortunately, one can only speculate and debate the meaning
of these volume spikes in the broad-based ETFs. At the very least, it definitely
tells us that mutual and hedge funds suddenly began to show an interest in
taking positions in the broad market. Most likely, there is some hedging going
on, but against what? Typically, such high volume levels occur near
intermediate-term tops and bottoms, as institutions always begin to buy and sell
their positions ahead of the general public. As an example, notice how many
stocks and ETFs also showed similarly high volume right before the market put in
a bottom in October 2005. The only thing we can definitively conclude from
yesterday’s diverse volume spikes is that a big move in either direction is
likely to happen in the near future. Such an occurrence would certainly be a
welcome reprieve from the months of choppy conditions.

Finally, the long-awaited launch of the new iShares Silver
Trust (SLV), which tracks the price of the silver commodity, is expected to
launch today. One share of SLV will represent 10 ounces of silver held in a
vault. We are pleased that silver now joins the list of other commodities being
traded as ETFs. You can read more about SLV in


this article on Marketwatch.com.


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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
.