Bullish momentum from the market’s latest rally enabled stocks to score another round of gains yesterday, but the test of several important resistance levels held the broad-based advance in check. The major indices gapped higher on the open, climbed further during the first hour of trading, then rolled over to new lows of the day. However, stocks found support just above the previous day’s closing prices, then drifted sideways throughout the rest of the day. The S&P 500, up 1.1% at its intraday high, finished with a 0.5% gain. The Nasdaq Composite and Dow Jones Industrial Average rose 0.7% and 0.4% respectively. The small-cap Russell 2000 climbed 1.0% and the S&P Midcap 400 increased 0.8%. The main stock market indexes settled at, or just below, the middle of their intraday ranges.

Not surprisingly, turnover remained quiet again. Total volume in the NYSE was 3% lighter than the previous day’s level, while volume in the Nasdaq declined 7%. The Veterans Day holiday likely had a hand in the slow pace of trading. Still, the Nasdaq registered its seventh straight day of lighter than average turnover. Curiously lethargic volume levels have been the modus operandi of the stock market’s current rally off the November 2 lows.

Yesterday, the benchmark S&P 500 Index briefly probed to a new 52-week high, but swiftly reversed after exceeding last month’s “swing high” by just four points. The “overcut” above the obvious level of resistance had the effect of running stops, causing short sellers to close their positions, and attracting traders who bought the breakout to a new high. It also caused the S&P to form a bearish “shooting star” candlestick on its daily chart. The “overcut” above the prior high, as well as the “shooting star” is highlighted on the chart below:


A “shooting star” candlestick often precedes a significant market reversal, especially when it forms after a “stop run” above a key level of resistance. However, the pattern needs to be confirmed the following day. Typically, the best confirmation comes in the form of an opening gap down, as it traps the bulls who bought the breakout, while attracting re-entries into shorts by the traders who just closed their positions the previous day. So far, in today’s pre-market session, the S&P futures are indicating an opening gap below yesterday’s low. It would be a negative signal if that pre-market weakness persists into the open.

The small-cap Russell 2000 Index bumped into resistance of its 50-day moving average yesterday, kissing that pivotal indicator of intermediate-term trend for the first time since breaking down below it in late October. This is shown on the daily chart of the iShares Russell 2000 (IWM), a popular ETF proxy for the Russell 2000 Index (the teal line is the 50-day MA):


Because small-cap stocks are generally considered to be “aggressive growth” companies, the Russell 2000 usually leads the market during broad market rallies. Conversely, the laggard behavior of the Russell back in mid-October, when the index failed to overcome its September high, was one factor that led to the stock market’s correction later that month. If the broad market enters into a short-term correction from here, IWM may now be a relatively low-risk way to play the short side of the market in the near-term. Buying the inversely correlated UltraShort Russell 2000 ProShares (TWM) is another possibility. However, we would NOT short the Russell unless the index at least breaks below yesterday’s low, putting it back below its 20-day exponential moving average as well.

The financial sector, another drag on the stock market during its recent correction, is also approaching key resistance levels, and should be monitored as a market indicator over the next few days. Bank of America (BAC), one of the weakest banking stocks over the past month, bumped into its 50-day MA yesterday, and must contend with a ton of overhead supply. There are others with similar patterns, as well as associated ETFs. The combination of the S&P forming a “shooting star” at resistance of its 52-week high, the Russell 2000 simultaneously running into its 50-day MA, and the financial stocks coming into pivotal resistance levels may have interesting implications for the short-term trend of the market. Nevertheless, given the stock market’s uncanny ability to seemingly move higher under any circumstances lately, we certainly won’t go so far as to say the market is forming any kind of top. Still, we can’t flatly ignore legitimate warning signs. As such, caution on the long side is highly advisable, including reduced position size and tight stops.

Open ETF positions:

Long – (none)
Short – TBT (an inversely correlated “short ETF”)

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 (morpheustrading.com), 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.

For a free trial to the full version of The Wagner Daily above, which includes detailed ETF trade setups and daily position updates, or to learn about our other newsletters, visit morpheustrading.com or send an e-mail to deron@morpheustrading.com.