After oscillating in a choppy, lethargic range for five straight days, the major indices made a substantial move yesterday, as each index climbed at least one percent. Stocks gapped higher on the open, rallied throughout the morning, then consolidated near their intraday highs throughout the rest of the session. The Nasdaq Composite ($COMPX) jumped 1.4%, the S&P 500 Index ($SPX) 1.1%, and the Dow Jones Industrial Average ($DJIA) 1.0%. Showing quite a bit of relative strength, the S&P Midcap 400 Index ($MID) zoomed 2.4% higher, but the small-cap Russell 2000 curiously increased only 1.1%. It is unusual for there to be such a large price divergence between the small and mid-cap indexes.
Unfortunately for the bulls, yesterday’s rally lacked the convincing punch of institutional trading activity. Total volume in the Nasdaq managed to increase 3%, but turnover in the NYSE was 3% lighter than the previous day’s level. Nevertheless, trade remained above 50-day average levels in both the Nasdaq and NYSE. In both exchanges, advancing volume exceeded declining volume by a ratio of approximately 4 to 1. This obviously indicated positive breadth in the market, but the ADV/DEC volume ratio was not extreme.
On the surface, yesterday’s large percentage gains of the main stock market indexes may seem encouraging, or even impressive, to the casual observer. However, it is important to keep yesterday’s bounce in perspective with the degree of the overall decline in the latter half of September and throughout the month of October. For example, PowerShares QQQ Trust ($QQQ), a popular ETF proxy for the Nasdaq 100 Index, fell 7.8% from its September high down to its October low (based on closing prices). Therefore, yesterday’s 1.7% rally in QQQ means the Nasdaq 100 is still sitting within the bottom 25% of its peak to trough range over the past six weeks. Put another way, yesterday’s stock market advance was technically nothing more than an overdue bounce off the lows. This, of course, does not mean yesterday’s rally could not go on to be the start of an eventual upside trend reversal, but one mere day of price action, no matter how bullish or bearish, does not make a new trend.
Overall, our near-term plan remains the same as we’ve mentioned several times over the past week, which is to view any significant market bounce as an opportunity to initiate new short positions on the weakest ETFs as they approach new overhead resistance levels. One of the ETFs we are monitoring for an ideal short sale entry point is indeed QQQ. On the annotated daily chart of QQQ below, notice that yesterday’s (November 1) rally followed an “undercut” of major support of its 200–day moving average, which provided the perfect technical excuse for a bounce. Our ideal zone for selling short QQQ on a bounce (or buying an inversely correlated “short ETF”) is labeled on the following chart:
Although the chart of QQQ shows the most ideal price levels for selling short, there is obviously no way of knowing if the market will cooperate with us. Given the kind of weakness that we’ve seen lately, including continued relative weakness in key large-cap tech stocks like Apple ($AAPL), it would not be surprising if there is minimal upside follow-through on yesterday’s bounce. But even if there are further gains to be had in the coming days, and these ETFs manage to bounce into our target area for selling short, we still will not blindly initiate new short positions the instant these ETFs first touch resistance. Rather, we then need to wait for the proper signal to sell short, such as a bearish reversal candle or a significant opening gap down that follows any bounce into resistance. To learn more about a winning trading strategy for swing traders, check out this trading blog: http://www.morpheustrading.com/blog
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