Stocks concluded the third calendar quarter with little fanfare last Friday, as the broad market snapped its four-day winning streak and finished modestly lower. The S&P 500 traded sideways in a tight, five-point range before closing 0.3% lower. The Dow Jones Industrial Average also shed 0.3%, while the Nasdaq Composite and S&P Midcap 400 fell 0.5% and 0.6% respectively. Small cap stocks fared the worst, as the Russell 2000 lost 1.0%. Although the trading ranges were pretty narrow, each of the major indices finished at their intraday lows, indicating a bit of profit taking into the close.

Total volume in both exchanges declined by 1% on Friday, enabling the S&P and Nasdaq to dodge a "distribution day." It was positive that the pullback occurred on lighter volume, as it indicates institutional investors did not rush for the exit door while the bulls took a break. For the past several weeks, the market's price to volume relationship has been pretty good overall. There have been a few days of higher volume selling, but that is normal within the context of an uptrending market. Last week, there were also several days of higher volume gains, a sign that institutions, and not just retail investors, were behind the buying activity. Still, the highest volume reading in the NYSE over the past two weeks was only 1.7 billion shares. Considering the Dow is testing its record high and the S&P is trading at a five-year high, one might expect more exciting volume to be coming into the market.

Over the weekend, we conducted the last in our series of live trading seminars in Los Angeles, each of which focused on a simple method for sector trading through the use of ETFs. Given all the speculation of whether or not the new highs in the S&P and Dow are going to stick, a discussion on the benefits of sector trading seems to appropriate right now.

At one time or another, most traders have taken a position in the common broad-based ETFs such as SPY, QQQQ, or DIA. But only a small percentage of traders pay attention to the plethora of ETFs that track specific industry sectors such as Retail, Pharmaceuticals, or Semiconductors. Through years of experience in trading all different types of ETFs, we have become convinced that the sector ETFs are consistently a better bet than the broad-based ones. While we occasionally take positions in the broad-based ETFs, regular subscribers know that we trade the sector ETFs much more frequently, and with good reason.

The problem with the broad-based ETFs is that they often tend to be choppy, making it difficult to participate in long-term trends. If, for example, you invested in QQQQ on January 1 of this year, you would be showing a gain of exactly 0.6% (24 cents) as of last Friday's close. Conversely, there are 15 ETFs that are showing a year-to-date gain of more than 20%. Did you know that the Telecom HOLDR (TTH), for example, is up 25% for the year? On the downside, the Internet HOLDR (HHH) is showing a year-to-date loss of 26%, a handsome profit if you were short. These ETFs may not be as exciting as trading QQQQ, but remember that we are in this business for profits, not thrills. You might be thinking, "That's great, Deron, but this is all in hindsight. How can I determine which sector ETFs are going to make big moves before they happen?" While this was discussed in detail during our seminar, it is obviously impossible to answer the question in great detail within the confines of a few paragraphs. Nevertheless, I will give you one big tip to get you started. It's called the "percentage change" overlay chart.

A standard stock chart shows only the price, along with optional technical indicators, of a stock or ETF. A "percentage change" chart, however, shows only the percentage that an equity has gained or lost during a specified period of time and ignores the actual price. When overlaying more than one ticker symbol on this type of chart, it becomes an excellent way to quickly determine the relative strength or weakness of one equity compared to another. Specifically, we use a broad market index such as the S&P 500 or Nasdaq Composite and overlay it with the ticker symbol of a sector ETF. If you create a separate chart of this type with all the major sectors, you will instantly be able to see which sectors are seeing positive or negative money flow for any given period. Then, it's as simple as buying the sectors with relative strength and selling short those with relative weakness. When using our "percentage change" overlay chart to compare the performance of the Utilities HOLDR (UTH) with the S&P 500 over the past two days, here is what you get:

As you can see, this type of chart enables you to easily spot divergent trends, and those are the stocks or ETFs you should be positioned in. Regardless of market conditions at any given time, it is always possible to profit from positions on both sides of the market because institutional money is constantly flowing out of one sector and into another. A good example of this is how our current short positions in the Utilities HOLDR (UTH) and Semiconductor HOLDR (SMH) both moved 1.1% further into the plus column last Friday, but our long position in the Biotech HOLDR (BBH) moved higher at the same time. Regardless of the time horizon for your trades, you can use this type of chart to find relatively strong or weak sector ETFs before the general public does. If a day trader, you might use a 5-minute intraday chart interval and see which sectors are strong or weak thirty minutes after the open. If a swing trader, you may use 60-minute intraday charts that go back a few days. If you hold positions for several weeks or more, consider using the daily price interval and looking for divergent trends over the past several weeks. With our hedge fund, we scan the percentage change charts of all the major sectors on a weekly basis, looking at how each sector performed relative to the broad market over the past five sessions. We use line charts instead of candlestick charts because it is easier to read the line charts when overlayed with two or more symbols.

This, of course, is only one part of the equation to profitably sector trading ETFs, but it will get you started nicely. If you learn to spot which sectors are seeing positive and negative institutional money flow, you can simply ride on the coattails of the "smart money" through simultaneously buying the ETFs with the most relative strength and selling short those with the most weakness. After a while, you won't really care which way the broad market is trending because you will always find opportunities on both sides of the market. The financial media is in a frenzy about whether or not the Dow will break out to a new all-time high, but we really don't care either way. There are lots of ETFs that are trending much better than the Dow and will continue to move in the direction of their primary trends regardless of whether or not the Dow breaks out.

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.