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Bouncy bottoming action? - May 27, 2010

|Includes: IYT, SMH, SPDR S&P Retail ETF (XRT)

An encouraging start turned into a disappointing finish yesterday, as stocks surrendered solid morning gains and finished in negative territory. After trading more than 2% higher shortly after the open, the Nasdaq Composite eventually crumbled to a 0.7% closing loss. The S&P 500 similarly turned a 1.5% intraday gain into a decline of 0.6%. Like the Nasdaq, the Dow Jones Industrial Average fell 0.7%. Showing a bit of relative strength, small and mid-cap stocks still finished in the plus column. The Russell 2000 and S&P Midcap 400 indices gained 0.4% and 0.3% respectively. However, all the major indices settled near their intraday lows.

Turnover edged higher across the board. Total volume in the NYSE increased 2% above the previous day's level, while volume in the Nasdaq rose 5%. Although most of the main stock market indexes closed with losses, a closer look at the intraday volume pattern indicates a bullish price to volume relationship. That's because turnover was actually stronger throughout the morning strength, then decreased as the afternoon selling kicked in. As such, the session hinted at a bit of institutional accumulation, at least in the first half of the day. This was a positive follow-up to the sharply higher volume that accompanied the previous day's bullish reversal pattern.

On May 21, the main stock market indexes tested their May 6 "flash crash" lows, then rallied to close the day sharply higher. However, the major indices gave back their gains the following day. On May 25, stocks traded several percent lower on an intraday basis, but reversed to close at their intraday highs and near unchanged levels. But unfortunately, in yesterday's session, the broad markets was again unable to hold onto its strength for more than a few hours. This puts most short-term traders in a challenging position. On one hand, the main stock market indexes have not been demonstrating enough bullish action to hold stocks for longer than a daytrade. However, major support of the February 2010 lows, combined with near-term bottoming patterns, means the reward-risk of new short positions at current levels is not very hot either.

It's quite possible the volatility and indecision stocks have experienced over the past few days is the market's way of trying to find a near-term bottom. With such a huge decline over a very short period of time, it's not surprising to see a tug-of-war between the bulls and bears right now. Nevertheless, clear, technical setups are virtually non-existent right now because price action has been all over the map. Therefore, we do not see any worthy, actionable trade setups going into today. As discussed in yesterday's commentary, forcing new trade entries just for the sake of action is a loser's game over the long-term.

One of the most productive things a trader could do right now is begin building a fresh list of ETFs that have been showing relative strength, In case the stock market eventually gets some legs, those ETFs could be the next group to show leadership to the upside. Since the main stock market indexes recently traded below their May 6 "flash crash" lows, and all the way down to test their February 2010 lows, a quick and easy way to spot basic relative strength is to look for ETFs that held above their February lows when the major indices did not. Presently, a few industry sector ETFs fit the bill: Retail (NYSEARCA:XRT), Transportation (BATS:IYT), and Semiconductors (NYSEARCA:SMH). Consider adding these ETFs to your relative strength watchlist, but wait for buyable bottoming patterns before actually entering these, or any other ETFs, right now. Furthermore, don't forget the best intermediate-term play is probably to wait for substantial bounces in ETFs with the most relative weakness (such as IYM and USO), then initiate new short positions as they test major levels of overhead resistance.

Open ETF positions:

Long - UNG
Short (including inversely correlated "short ETFs") - (none)

The commentary above is an abbreviated version of a daily ETF trading newsletter, The Wagner Daily. Regular subscribers receive daily updates on all open positions, as well as new ETF trade setups with detailed trigger, stop, and target prices. Intraday Trade Alerts are also sent via e-mail and/or text message, on as-needed basis. For your free 1-month trial to the full version of The Wagner Daily, or to learn about our other services, please visit

Deron Wagner is the Founder and Head Portfolio Manager of Morpheus Trading Group, a capital management and trader education firm launched in 2001. Wagner is the author of the best-selling book, Trading ETFs: Gaining An Edge With Technical Analysis (Bloomberg Press, August 2008), and also appears in the popular DVD video, Sector Trading Strategies (Marketplace Books, June 2002). He is also 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. Wagner is a frequent guest speaker at various trading and financial conferences around the world, and can be reached by sending e-mail to

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