The major indices followed through on Monday’s bounce off the 50-day moving averages, scoring another round of large gains yesterday. After rallying throughout the first half of the day, stocks initially became threatened by an afternoon sell-off that sent stocks down to test their intraday lows, but a recovery in the final hour of trading lifted the main stock market indexes back up. Led by strength in the tech arena, the Nasdaq Composite rose 1.7%. The S&P 500 and Dow Jones Industrial Average garnered matching gains of 1.4%. The small-cap Russell 2000 gained 1.9%, as the S&P Midcap 400 climbed 1.4%. After clawing their way back from significant, early afternoon weakness, the major indices settled near the upper quarter of their intraday ranges.

The most positive thing about yesterday’s session was the higher volume that accompanied it. Total volume in the NYSE increased 10% above the previous day’s level, while volume in the Nasdaq swelled 15%. The higher volume gains enabled both the S&P and Nasdaq to register a bullish “accumulation day,” the first clear sign of institutional buying interest in two weeks. Nevertheless, turnover in the NYSE remained below its 50-day average level; institutions still maintained relatively restrained buying interest. In both exchanges, advancing volume clearly beat declining volume. However, the adv/dec volume ratios finished well below the extremely positive levels of the morning. At the intraday peak of the broad market, advancing volume in the NYSE was beating declining volume by a whopping margin of more than 13 to 1, but the adv/dec volume ratio had trended down to 4 to 1 by the closing bell. The Nasdaq adv/dec volume ratio was positive by less than 3 to 1.

In my book, Trading ETFs: Gaining An Edge With Technical Analysis, I explain one key step of my “top-down” strategy of ETF trading is to determine which industry sector indexes are showing the most relative strength or weakness to the broad market. By doing so, one can subsequently compare the performance of individual ETF families within that sector, in order to determine which ETF is showing the most relative strength or weakness to the sector index. To spot relative strength or weakness, I suggested setting up a workspace on your trading software that uses numerous “percentage change charts” comparing the price action of various industry sector indexes to the price pattern of the S&P 500. Recently, a few subscribers have asked me to show an actual screenshot of this, and I’m happy to do so. Check out the graphic below (excuse the larger than usual size, but it was necessary in order to see the image clearly):


Click the image above to view a full-sized version in your web browser.

What you’re looking at is 25 different charts, each comparing the percentage change of the S&P 500 Index (the black lines) with a specific industry sector index. (the blue lines). Each chart is set to display the most recent ten days of data. Though the data is updated real-time, it could just as well be updated on an end-of-day basis. The basic idea here is to quickly determine which areas of the stock market are seeing sector rotation at any given time. The sector indexes outperforming the gains of the S&P 500 Index usually have “relative strength,” while those underperforming could be said to have “relative weakness.” From this information, one could easily know which sectors may present the best buying and/or short selling opportunities. However, the next, very important step, would be to look at the longer-term daily chart pattern of the index to make sure the chart pattern does not overly conflict with what is being shown on the short-term overlay chart.

On the graphic above, I’ve used red text to label a few notable charts at the present time. The “RS” annotation means the index is showing relative strength and the “RW” stands for relative weakness. The quickest way to spot RS or RW is to look for sector indexes whose prices are diverging from the pattern of the S&P 500. It’s not so much the actual percentage gains or losses that matter; rather, it’s the relative price trends we’re concerned with. For example, indexes making “higher highs” and “higher lows” while the S&P 500 moves sideways to lower would be considered to have RS. Those making “lower highs” and “lower lows” ahead of the S&P 500, or while the S&P started reversing higher, would have RW. What about the indexes that closely follow the pattern of the S&P 500? We’re not interested in those, as they are simply following the broad market, rather than displaying relative strength or weakness.

The iShares Emerging Market Index (EEM) and SPDR Gold Trust (GLD) are two charts labeled as “Gaining RS.” This means they have recently started outperforming the broad market, and are sectors that deserve a closer look on the various chart timeframes. In the case of EEM, subtle relative strength is observed based on the fact that it set a “higher high” yesterday, as the S&P 500 remained below its prior high (from late September). Also, at the beginning of the month, EEM formed a “double bottom” at its prior low, but the S&P 500 formed a “lower low.” The relative strength of GLD is more obvious, as its price has been trending higher for the past week, as the S&P 500 has traded in a range. Over the past two days, the relative strength has become much more apparent, but this same chart, viewed at the end of last week, showed early signs of relative strength in GLD, which finally busted out to a fresh all-time high yesterday.

One chart, iShares Lehman 20+ year T-Bond (TLT), is labeled “Losing RS.” This means we’re observing signs that prior relative strength is starting to fade. If long, this could serve as an early warning sign to tighten stops or take profits. The fading of relative strength is determined by the fact that TLT has started moving lower over the past two days, as the S&P 500 has moved higher. It’s common for bond ETFs to move in the opposite direction of the broad market.

Three charts are labeled as having relative weakness (RW). They are: DJ Transportation Average ($DJT), World Solar Energy Index ($SOLEX), and DJ Equity REIT ($DJR). Each of these charts are displaying RW because they have been outperforming the S&P 500 to the downside. While the S&P 500 was moving lower, these indexes fell at a faster rate. Then, as the S&P 500 recovered, these indexes lagged on the way back up. Notice how each of those indexes set new “swing lows” ahead of the S&P 500, and remains further away from its previous “swing high” than the S&P 500. These indexes might be expected to be downside leaders if the broad market heads back down from here.

Obviously, the entire strategy of relative strength ETF sector trading cannot be explained within the confines of today’s newsletter. However, we thought subscribers might appreciate a little educational insight as to how we quickly spot divergent trends (relative strength or weakness) within the broad market. Upon doing so, we analyze the various chart timeframes to see which of those sectors might present the next trading opportunity. If you have any questions, feel free to send us an e-mail (please be patient with response time).

Open ETF positions:

Short – MOO, DUG (an inversely correlated ETF we’re long)

NOTE: Regular subscribers to The Wagner Daily receive daily updates on the open positions above, as well as new ETF trade setups, including trigger, stop, and target prices. Intraday Trade Alerts are also sent via e-mail and/or mobile phone text message on as-needed basis.

Deron Wagner is the head trader of Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (, which he launched in 2001. Wagner’s new book, Trading ETFs: Gaining An Edge With Technical Analysis, was published by Bloomberg Press in August, 2008. Wagner also 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.

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