The S&P 500 rallied above resistance of its two-month sideways range and closed at a new five-year high last Friday, but lower turnover across the board failed to confirm the breakout. After beginning the day with an opening gap up, the broad market trended higher throughout the session and each of the major indices finished near their intraday highs. Strength in the blue chips enabled the Dow Jones Industrial Average to zoom 1.2% higher and finish at its highest level since January of 2000. Surprising to some traders and investors, the Dow is now less than 200 points off its all-time high. Both the S&P 500 and S&P Midcap 400 indices gained 1.0%, while the Nasdaq Composite and small-cap Russell 2000 lagged behind with gains of 0.8% and 0.9% respectively.

Looking purely at price action, the major indices made impressive gains, but the one thing suspiciously lacking was higher volume. When an index such as the S&P 500 breaks out of a choppy, sideways range that has been in place for several months, it normally coincides with a large surge in volume due to traders on the other side of the market covering their positions, as well as traders buying new positions on the breakout. But mysteriously, turnover in both exchanges declined last Friday. Total volume in the NYSE fell by 3%, while volume in the Nasdaq was 5% lower than the previous day's level. In the Nasdaq, it was also the second consecutive day in which volume came in below its 50-day average level. Today's issue of popular financial newspaper Investors Business Daily gave this example of how a negative divergence between price and volume can sometimes lead to surprising results: "Take the action of Jan. 26, 2004. On that day the Nasdaq powered ahead 1.4%, hitting a three-year high. But volume fell off sharply, retreating 14%. The Big Picture noted the curious gulf between the marketââ,¬â"¢s price and volume action. Stocks fell hard the next day, then sank into a 6 1/2-month downtrend." It should be noted, of course, that both the percentage gains and volume declines in last Friday's session were more moderate, but astute traders will nevertheless be on guard against a potential failed breakout in the broad market.

With the exception of the Computer Networking ($NWX) and Gold ($GOX) indices, both of which fell about 0.5%, all the major sectors we follow closed higher last Friday. On a percentage basis, the two biggest gainers were the Biotechnology Index ($BTK) and the Securities Broker/Dealer Index ($XBD). However, even though both sectors gained 3.2%, each one was formerly showing a lot of relative weakness. We therefore view Friday's gain in those sectors as a mere technical bounce. As such, we are not looking to enter new long positions in either sector. On the contrary, we are still stalking the $XBD for a potential short entry, but only if the index falls back down below last Friday's low.

The industry with the third largest percentage gain was the DJ Utilities Average ($DJU), which broke out above its 200-day moving average and advanced 2.2%. The strength in Utilities caused our long setup in the Utilities HOLDR (UTH) to trade through its trigger price as well. The daily chart of UTH below illustrates the breakout above its 200-day moving average, which occurred only two days after the index broke resistance of its four-month downtrend line:

The opening gap up in UTH caused our entry price to be a little higher than planned, but we are still showing a marked-to-market gain of more than one point regardless. From here, our upside price target in UTH is just below the $120 level, which corresponds to resistance of the January 2006 high. We will also trail a stop along the way to protect our profit.

As for our other positions, we made a judgment call to sell the Regional Bank HOLDR (RKH) into strength last Friday because it did not seem to be following up its April 27 breakout with the degree of momentum we had anticipated. Rather than be concerned with whether or not it would break through resistance of its April 29 high, we informed subscribers via intraday e-mail alert that we were taking the 1.5 point gain. The S&P Select Energy SPDR (XLE), which we sold short on May 3, moved against us a bit last Friday, but closed only twenty cents above our short entry. The short position in the iShares DJ Real Estate Index (IYR) came within three cents of our stop, but we remain short from our original entry on April 24.

For those who are not aware, the popular iShares family of ETFs launched ten new funds last Friday that enable traders and investors to capitalize on more specific sub-sectors of the market. Included in these ten new exchange traded funds are the iShares Home Construction Index (ITB), the well-timed iShares Broker-Dealers Index (IAI), and the iShares Aerospace and Defense Index (ITA). A complete description of the new ETFs can be found by going to ishares.com. Separately, we are also pleased to announce that our all-new Morpheus ETF Roundup, which lists every U.S. exchange traded fund, grouped by sector and sub-sector in a user-friendly format, will be released within the coming week. If you're confused by all the different ETFs out there and the new ones being released every day, the ETF Roundup is a great way to stay on top. The first issue will be free to all subscribers, so look for a download link to be posted here in the coming days.

Overall, we feel it is okay to continue buying the stocks and ETFs that are showing the most relative strength to the broad market, but just be alert and on top of your positions in case the situation changes. True, the S&P 500 did manage to break out of its range, but the lighter volume combined with the relative weakness in the Semiconductor Index keeps us cautious against a potential failed breakout. Short positions are a bit more risky now, but we feel that relatively weak sectors such as the Broker-Dealers can be sold short on any bounces into resistance.

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.