Will we finally see a bounce? This chart tells you

To the delight of bears but dismay of
bulls, the broad market maintained its smooth and steady downtrend

that began on October 4. Like the previous day, stocks attempted to rally on the
open, but the buying pressure lasted only thirty minutes. The major indices
spent the remainder of the day grinding lower before eventually closing near
their intraday lows. Small and midcap stocks again showed the most relative
weakness. Both the Russell 2000
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and S&P 400
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plummeted 1.3% yesterday. The Nasdaq Composite fell
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1.1%, the S&P
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0.6%, and the Dow Jones Industrials
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0.4%. Former market
leading sectors such as Oil, Utilities, and Building Materials were among the
biggest losers yesterday, but positive reciprocal money flow into other sectors
could not be found. Every strong market consists of at least a few
market-leading industry sectors, but there simply aren’t any right now. Instead
of institutional sector rotation that occurs in healthy markets, we are simply
seeing broad-based distribution.

As we have become accustomed to seeing on most of the recent
down days, total market volume increased in both exchanges. Turnover in both the
NYSE and Nasdaq was 10% higher than the previous day’s levels. Declining volume
exceeded advancing volume by a margin of more than 3 to 1 in both exchanges. The
broad-based losses on higher volume gave both the S&P and Nasdaq another bearish
“distribution day.” Five of the S&P’s last seven down days have occurred on
higher volume. This is a clear sign that the market’s recent losses were not a
result of small retail selling, but rather the result of institutional selling.
Because institutional activity makes up more than 70% of the stock market’s
daily volume, attempting to trade in the opposite direction of mutual funds,
hedge funds, and other institutional players is always a losing proposition.

When the major indices rallied into resistance of their daily
downtrend lines at the beginning of the month, we made a decision to short a few
of the broad-based ETFs. Because
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(iShares Russell 2000) and MDY (Midcap
S&P 400 SPDR) were market leaders in the broad market throughout the prior bull
market, we anticipated they would also be among the biggest losers if the
weakness in the broad market gathered downside momentum. Fortunately, this
worked out well because IWM and MDY have posted the largest percentage losses of
the broad-based ETFs this month. Although both ETFs are still looking pretty
bearish on their charts, we made a judgment call to take profits on those two
short positions into yesterday’s weakness because both could easily bounce from
here. Per intraday e-mail alert to subscribers, we covered the remaining shares
of our IWM short position for a profit of 4.48 points and covered half of the
MDY short position for a gain of nearly 2 points. We remain short a half
position of MDY with a marked to market gain of 2.5 points and have also
tightened the stop to protect the profit.
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, the ETF that tracks the
price of spot gold, hit our trailing stop of 47.26 yesterday, enabling us to
lock in a substantial gain of 6% on that trade.

As predicted in the October 11 issue of The Wagner Daily,
the Semiconductor Index
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sold off down to support of its 200-day moving
average yesterday, but closed just above it. This is significant because the
Nasdaq is so heavily weighted with semiconductor stocks. Therefore, if the $SOX
can hold above its 200-day moving average, it could serve as an impetus for the
Nasdaq to bounce off its lows. However, we still do not recommend going long any
of the broad-based ETFs unless you are only looking to play a one to two day
bounce. And if you do, be sure to wait for confirmation of a bounce rather than
trying to blindly guess where the bottom may be. Below is a chart of the $SOX
index, which you should follow closely today:

Taking a quick look at the daily charts of the major indices,
even a novice technical analyst will easily see the broad market is in bad
shape. The S&P 500 Index has closed lower in seven of the past eight sessions,
while the Nasdaq is now showing a month-to-date loss of 5.3%. Every one of the
major indices is now below their 200-day moving averages and many have broken
below support of their multi-year uptrend lines. Drilling down to look at the
performance of individual stocks, you will also see that a vast majority of
breakouts in nearly every sector are failing, while bullish consolidations near
the highs are few and far between. Obviously, being long any sector for anything
more than a day trade right now is a highly risky proposition. The broad market
will probably bounce from oversold conditions within the next day or two, but
the overall trend still remains down. Although it is a highly overused cliche,
it is quite effective to always remember that the trend is your friend!
Don’t fight it.

Open ETF positions:

Short small MDY position (regular subscribers to

The Wagner Daily
receive detailed stop and target prices on open
positions and detailed setup information on new ETF trade entry prices. Intraday
e-mail alerts are also sent as needed.)

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