Momentum from the market's impressive string of gains kicked into monster overdrive yesterday, as the major indices rocketed at least 2% higher, and volume ramped up as well. Stocks opened nearly flat, marched steadily higher throughout the first half of the day, then drifted sideways to higher into the close. The Nasdaq Composite surged 2.5%, the S&P 500 2.3%, and the Dow Jones Industrial Average 2.1%. The small-cap Russell 2000 and S&P Midcap 400 indices increased 3.3% and 2.8% respectively. All the main stock market indexes closed near their intraday highs.

Total volume in the NYSE swelled 29%, while turnover in the Nasdaq increased 31% above the previous day's level. Trading was more brisk than usual, as volume in both exchanges moved back above 50-average levels. Not surprisingly, market internals were quite solid. Advancing volume in the NYSE exceeded declining volume by a margin of 5 to 1. The Nasdaq adv/dec volume ratio was positive by approximately 9 to 2.

After eleven consecutive days of gains in the Nasdaq, many traders (including us) were prepared for a minor pullback, or at least some type of price consolidation, in the broad market. Instead, stocks partied like it's 1999! On a more technical level, the bullish day also caused several key developments to occur on the charts of the major indices. In the July 22 issue of The Wagner Daily, we looked at the longer-term weekly charts of the main stock market indexes, with a specific focus on the location of their dominant, multi-year downtrend lines. Yesterday, the Nasdaq Composite actually rallied to close very near that pivotal level of resistance that could change its long-term trend. Take a look:



Frankly, we have no idea whether the bullish resiliency of the Nasdaq will enable the index to bust through its downtrend line this time. But one thing is certain. A key fundamental rule of technical analysis mandates that we must assume an instrument's trendline will remain intact until the index, stock, or ETF proves otherwise. Further, the longer a trend has been intact, the more difficult to reverse the dominant trend. However, countering resistance of the Nasdaq's multi-year downtrend line is the fact that the S&P and Dow both surged above resistance of their June 2009 highs yesterday. Their breakouts above this level of resistance we've been monitoring are shown on the daily charts below:





On one hand, yesterday's large gains in the major indices, combined with sharply higher volume, was bullish. On the other hand, yesterday's action resembled what is commonly referred to as an "exhaustion." When a stock, ETF, or index has been zooming higher for an extended period of time, without a correction along the way, the top of the move is often not formed until a sign of "exhaustion" occurs. This happens when all the "late to the party Charlies" who missed the start of the rally finally decide to hop on board, and start buying due to fear of missing further gains. This leads to a large volume spike accompanied by a massive rally. The difference between high volume gains being a sign of "accumulation," or one of "exhaustion" is where in the trend it occurs. "Exhaustion" can only occur after the market has reached what many traders label as "overbought," and volume should surge to the highest level of any day since the rally began (which is what happened yesterday). As you might have surmised, an "exhaustion" day often marks a short-term top in the market because the majority of punters in the market are wrong a majority of the time. The "late to the party Charlies" who missed the initial rally for whatever reason, then rush to buy at any price several weeks later, near the top of the move, are a good example of this.

After the close of trading, Microsoft (MSFT) announced an unimpressive quarterly earnings report that sent the stock 7% lower in after-hours trading. At the same time, online retailing giant Amazon (AMZN) reported a miss in revenue expectations, sending their stock 7% lower in the afterhours as well. Most importantly, the Nasdaq futures immediately tumbled after the closing bell, then fell further as the evening progressed. As of late Thursday night, the Nasdaq 100 Index is poised to open approximately 1.5% lower than the previous day's close. Curiously, this potential pullback coincides with the Nasdaq nearly bumping into resistance of its weekly downtrend line yesterday.

If the negative after-hours tone carries over into Friday's session, stocks could easily surrender all of the previous day's gains, thus confirming the potential "exhaustion" pattern discussed above. Nevertheless, we would actually welcome a healthy retracement in the stock market, as it would give us the opportunity to enter some of the strong ETFs we've been monitoring for potential buy entries on a broad-based pullback. In our next newsletter, we'll take an updated look at a few of the strongest ETFs, and analyze precise entry points to consider buying on a pullback that may soon present itself.

Open ETF positions:

Long - FXY, DGP
Short - (none)

Deron Wagner is the Founder and Head Trader of both Morpheus Capital LP, a U.S. hedge fund, and MorpheusTrading.com, a trader education firm.