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Nasdaq Soars Ahead of the Rest

David Becker
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There is a robust rally taking place in the stock market. It’s not obvious or easy to see, but the rally generated a breakout in January and continues to move higher on strong momentum. Although many market pundits have made it clear that they believe this year’s strength will be in individual stocks, both large cap technology names and small caps have been market leaders and show no signs of slowing down.

The Nasdaq 100 is in the black for 2014 but when compared to the S&P 500 the technology index has notched up nearly a 1.5% gain. The spread between the Nasdaq 100 and the S&P 500 index has broken out on a daily basis and is poised to test the recent highs on a weekly chart which has not been seen since February 2012. The price spread is calculated by dividing the Nasdaq 100 by the S&P 500, and technical indicators can be used to forecast this spread.

The spread was above in early 2014 to bounce off of support near the 50-day moving average and is poised to test resistance levels. Momentum is strong as the MACD (moving average convergence divergence) index has generated a buy signal. This occurs as the spread (the 12-day moving average minus the 26-day moving average) crossed above the 9-day moving average of the spread. The MACD moved from negative to positive territory confirming the buy signal. The relative strength index (RSI) which is an oscillator that measures momentum by creating and index from 1-100, moved higher along with the differential between the Nasdaq and the S&P 500 reflecting accelerating momentum, while printing near 66, which is on the upper end of the neutral range.

So how can an investor take advantage of this situation? Investors can use a pair trade to catch this rally. A pair trade is a trade in which an investors take a long position in a stock and simultaneously shorts another stock that is highly correlated to the stock that they plan to purchase.

The QQQ ETF is a proxy for the Nasdaq while the SPY (Spider Trust ETF) is a proxy for the S&P 500 index. By purchasing the QQQ and shorting the SPY a trader will generate a pair trade that can catch the rally in the major averages.

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