Following up two days of strong gains, the stock market showed surprising resilience against profit taking yesterday. The major indices opened nearly flat, oscillated in a narrow, sideways range throughout the day, then finished near unchanged levels. The S&P 500 edged 0.1% higher, while both the Nasdaq Composite and Dow Jones Industrial Average advanced 0.2%. The small-cap Russell 2000 fell 0.5%, but its loss was modest relative to the prior day's 3.6% gain. The S&P Midcap 400 was unchanged. All of the main stock market indexes settled in the upper third of their intraday ranges.

Total volume in the NYSE ticked 19% lower, as volume in the Nasdaq dipped 11% below the previous day's level. In both exchanges, turnover trickled in below 50-day average levels. Lighter volume during consolidation days is positive because it tells us traders are not selling into strength while the bulls are taking a rest. In both the NYSE and Nasdaq, advancing volume was roughly on par with declining volume. This further confirmed the bullish consolidation near the highs.

In addition to the Utilities sector that we discussed yesterday, the Biotech Index ($BTK) is another industry showing relative strength to the broad market. After bouncing off support of its 200-day MA, the index broke out above its six-week downtrend line on Wednesday, then closed yesterday at its 50-day MA. The index may take a rest for a few days to absorb its recent gains, but a subsequent breakout above yesterday's high would be bullish. The setup is shown on the daily chart of the $BTK below:



Of the five main biotech ETFs we follow (BBH, IBB, FBT, PBE, and XBI), the SPDR S&P Biotech (XBI) is showing the most relative strength within the sector. Having barely corrected with the broad market over the past month, it is now poised to break out to fresh all-time high. Yesterday, XBI closed just four cents shy of its record closing high. A rally above yesterday's high would trigger a potential long entry. The bullish setup is illustrated on the daily chart of XBI below:



Comparing the charts of the $BTK index and XBI, one will quickly see that XBI is showing relative strength to its underlying index. While the $BTK has just broken out above an intermediate-term downtrend line, XBI is ready to break out to a new high. Within our top-down process of sector trading, we first identify the overall stock market trend, then find the sector index(es) with the most relative strength (or weakness) to the major indices. Upon doing so, we then determine which ETF family is showing the most relative strength to the sector index itself. Comparing charts of all the Biotech ETF families, XBI is the only one near its high. It therefore should gain the most on further strength, while pulling back the least in the event of a market correction.

With the major indices closing near the flat line, the resistance levels we illustrated in yesterday's commentary remain in effect. Specifically, I will be sure to monitor price action closely if the Nasdaq Composite approaches its 50-day MA (2,720) or the S&P 50 nears its 200-day MA (1,484). Below, the 20-day MA in both indexes should now act as near-term support. Those levels approximately coincide with yesterday's lows. Until the market proves otherwise, any stocks or ETFs bought should be viewed within the context of playing a short-term bounce within a longer-term downtrend. The overall short-term market trends remain bullish, but the intermediate-term trends are still bearish. A recovery above the 61.8% Fibonacci retracement levels of the entire sell-off could reverse the bearish intermediate-term bias.

Open ETF positions:

Long - IDU
Short - (none)

Deron Wagner is the Founder and Head Trader of both Morpheus Capital LP, a U.S. hedge fund, and Morpheus Trading Group, a trader education firm launched in 2001 that provides daily technical analysis of the leading ETFs and stocks. For a free trial to the full version of The Wagner Daily or to learn about Wagner's other services, visit MorpheusTrading.com or send an e-mail to deron@morpheustrading.com.