The major indices diverged sharply for the second consecutive day, as small caps continued to show leadership. Stocks traded sideways throughout the morning, rallied in the early afternoon, then pulled back in the final hour. The S&P 500 lost 0.1% and the Dow Jones Industrial Average was unchanged, but the small-cap Russell 2000 rallied 0.8%. The Nasdaq Composite advanced 0.4%, while the S&P Midcap 400 closed 0.2% higher. Divergence was also found in the intraday patterns. The Nasdaq and Russell both closed in the upper third of their intraday ranges, but the S&P and Dow both finished in the bottom third.

Total volume in the Nasdaq was 1% higher than the previous day's level, helping to confirm the gains in that index. Volume in the NYSE, however, declined 18%. Since both the S&P and Dow closed slightly lower, it's positive that turnover receded. In the Nasdaq, advancing volume exceeded declining volume by a margin of just under 2 to 1. The NYSE ratio was flat.

Over the past three days, the market has been clearly telling astute traders that four-letter tickers is where to find the action. Many S&P and Dow-related industry sectors appear to be entering a period of consolidation, or even setting up for a retracement, while a variety of Nasdaq sectors are waking up. In addition to the semiconductor sector that we have already analyzed, biotechs may be ready to move higher. After a healthy correction off its late-April high, the Biotech Index ($BTK) now appears ready to resume its primary uptrend. As you can see on the chart below, it finished yesterday back above its 20-day exponential moving average and closed right at resistance of its multi-week downtrend line:



As we have pointed out several times in recent months, the popular Biotech HOLDR (BBH) is a laggard ETF and should be avoided. Instead, consider the StreetTRACKS Biotech (XBI), which is showing relative strength to the actual $BTK Index. Notice how XBI closed at a new 52-week high yesterday, even though the $BTK is still trading below its high:



Because of its relative strength, any subsequent gains in XBI should rival those of the $BTK index. On a pullback, one could also expect XBI to retrace less than the $BTK. The First Trust Biotech (FBT) is another option, as its chart pattern most closely mirrors the $BTK Index.

In yesterday's newsletter, we pointed out the potential trade setups that were forming in both the iShares Russell 2000 (IWM) and the Semiconductor HOLDR (SMH). Both setups triggered yesterday, prompting us to buy them. We bought IWM when it broke out above the high of its consolidation. It subsequently closed at a fresh record high. We bought SMH when it rallied above resistance of its hourly downtrend line, though it closed a few cents below our entry point. Unfortunately, negative earnings news from semiconductor company Analog Devices (ADI) may also put some pressure on SMH today.

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.