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Canary in a coal mine? The drop in this ETF has traders worried

Traders work on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters
Traders work on the floor of the New York Stock Exchange.

If there's a tip of the arrow in the red-hot momentum names, it's been the biotech sector, so with a meltdown in that group traders are watching it for clues on whether a deeper stock market decline is on the horizon.

Volatile momentum names sometimes lead market shifts, and with biotech at the fore, traders have been watching the IBB, iShares Nasdaq Biotechnology ETF. It has been breaking down and is off more than 8 percent this week. The IBB fell through its 50-day moving average and was teetering on its 100 day—at about 331 Thursday afternoon—as the broad market declined.

"The IBB has been leading us lower, and it feels like the major indices are starting to catch up," said Scott Redler, partner at T3Live.com. Biotech and health care in general have been market leaders this year.

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Art Hogan, chief market strategist at Wunderlich Securities, said the IBB has tested support at the 50-day moving average six times since October when it broke through it and fell to the 100-day moving average. In that selloff, the whole market followed.

"The important thing to remember is people watch this a lot because it's momentum driven, and when momentum breaks sometimes that spreads to the broader market. If you look back to the October break, that was the last time it tested the 100 day," Hogan said.

The IBB fell 3 percent Thursday, closing at 333.66, several points above the 100 day. "The 100 day could also be support. Technically this hasn't happened since October, so all eyes will be on it," he said.

Traders said the market moves Thursday were in part related to the month end, and investors traded out of some sectors that had been working and into others that were underperforming. The IBB was still up more than 44 percent over the past 12 months, even with this week's decline.

One trader said the fact that the ETF closed below 334 could be very negative. "There's a good potential that's a major pivot. It creates a major top, and you have a major move toward the 200-day moving average which is about 10 percent," he said. "If you get a close below that, it's a signal to people that things are broken."

As the IBB sold off Monday, Redler said the S&P 500 experienced an outside day and failed to hold on to new highs. That was a signal that the S&P was not going to immediately stage the upside breakout traders had been looking for. The S&P on Thursday fell 1 percent to 2,085, and is down 1.5 percent for the week.

"There's concern that it (IBB) broke the 50 day, and it's really seeking out the 100 day. It really does depend how it reacts. If it doesn't react as support, that tends to drag the broader market with it. Then people will start to watch the social media ETF, and they'll watch the Russell 2000, and say we're getting a breakdown," Hogan said. The Russell was down 2.2 percent Thursday at 1,220.

Paul Hickey, co-founder of Bespoke, said while he doesn't see biotech as a leading indicator for the broader market, it does send a message about small caps and the Nasdaq. On Thursday, the Nasdaq helped lead the declines, losing 1.6 percent and tumbling below its 50-day moving average. Momentum names like Facebook, LinkedIn, Priceline and Amazon.com were all lower, and the Global X Social Media Index ETF SOCL was off 2.3 percent.

"It is more like a bellwether for the momentum, growth names. They all trade similarly," Hickey said. "This is typically a weak time of year for the group. We saw a similar trend play out last spring."