The hidden truth about the Nasdaq rally

It's a tough start to the week for stocks, as the S&P has its worst day since early August, and the Nasdaq slides more than 1 percent for its worst session since July. But for technician Carter Worth of Sterne Agee, what's more surprising is the recent strength of Nasdaq, as it has come even as the breadth of the market has shrank, with the average Nasdaq stock badly underperforming the index as a whole.

In fact, for that reason, Worth sees the current weakness as merely the beginning of a larger correction.

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First, the technician points out the mean stock in the Nasdaq 100 has risen a lot less than the index as a whole—and the median stock has risen even less than that.

"This is the story of the market," Worth said Friday on CNBC's "Options Action." "It's being skewed by a few big names."

Visually, Worth shows this by taking a chart of the index, and comparing it to a chart comparing the number of stocks that are advancing to the number that are declining (commonly known as the "advance/decline line").

"The markets continue higher and yet the breadth has not been confirming," Worth said. The advance/decline line "hasn't made a new high since March. Apple, and others, are influencing the Nasdaq. But the average stock is not participating."

Worth says the lack of breadth is also evidenced by the relatively low number of stock above their respective 150-day moving averages.

"Less than half of all the stocks in the Nasdaq Composite are actually above trend, as measured by the 150-day moving average," he said.

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A final way to look at the breadth? The number of stocks at new 52-week highs.

"We're making new highs in the Nasdsaq," Worth said on Friday, "and yet the 'New High' list is contracting. That's a divergence, a problem."

So given this "lack of confirmation," the technician takes a look at the chart of the Nasdaq 100 ETF, which trades under the ticker symbol (QQQ).

He points out that the chart has tended to stay near its trendline, and when it gets too far above, the best move is to "play for a prospective sell-off."

"You're above to trend, we think you fall back to the middle," down to about $90 on the QQQ, Worth said.

On the fundamental side, DASH Financial chief strategist Mike Khouw sees the merit in Carter's concers.

If big stocks like Apple "are starting to have a hard time hitting new highs now, then what, exactly, is going to propel the (QQQ) higher?"

To hedge against Nasdaq exposure, then, Khouw recommends buying the January 99-strike put for $3. This trade will make money if the ETF is below $96 at January expiration.

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Host Bio

  • Melissa Lee

    Melissa Lee is the host of CNBC's “Fast Money” and “Options Action.”

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