When news of Iraq’s decision to allow inspectors back into the country hit the tape on Monday night, the Globex futures rallied hard, which lasted into the open yesterday morning. However, the market sold off hard and filled the gap within the first thirty minutes of trading. Statistically, gaps of that nature tend to hold as an intraday support level, but that was not the case yesterday. What ultimately surprised us even more was that not only did the gap get filled, but the market eventually sold off enough to take out the lows of the prior three days! When the market gaps up above the previous day’s high and sells off to close below the previous day’s low, this forms what is known as an ENGULFING candlestick formation on a daily chart. It is called an Engulfing candle because the trading range of the day completely “engulfs” the range of the previous day. Take a look:
This formation is among the most bearish of candlestick patterns because it not only traps those who bought yesterday’s gap and didn’t cut their losses, but it also traps those who were long from anywhere during the prior three days. Confirmation of this bearish pattern would occur by trading below yesterday’s low when the market opens today. The market ultimately tipped its hand yesterday by showing us that investors and traders still fear a war with Iraq because Bush doesn’t really believe what Saddam says anyway. On a positive note, however, the volume was actually decent yesterday and will hopefully continue to increase.
This week starts earnings warning season and it will be interesting to see how last night’s bearish warning by JP Morgan affects the market today. Our guess is that we either see a bloodbath today or the markets rebound sharply off of this morning’s gap down in the futures. Either way, the safest thing to do going is to today is to be patient and wait out the first thirty minutes of trading to see which way the market wants to go. To aggressively enter new short positions without waiting for a trend to be established this morning is dangerous because yesterday’s selloff was so severe if you consider the entire range from the high of the day to the low. Even though there are quite a few good short setups that have formed, let’s be patient on the open to ensure a trend is going to be established before getting too aggressive.
Today’s watch list:
DIA – DIAMONDS (Dow Jones Industrial Average tracking stock)
Trigger = 81.90
Target = 80.10
Stop = 82.87
Notes = Looking at the daily chart, you will see that the Dow (DIA) is hanging on the edge of a cliff after having a big volume selloff yesterday. We will be looking to short DIA on a break below yesterday’s low. Since the futures are gapping down pre-market, we will wait for a break of the opening 20-minute low before selling short. If DIA gets below yesterday’s low and doesn’t recover on the open, DIA will likely selloff down to test the lows of August 5, especially given the fact that JPM (a Dow component) is likely to be a drag on the index. Our stop is just above the lows of September 13 and 16.
SPY – SPYDERS (S&P 500 Index tracking stock)
Trigger = 87.40
Target = 85.05
Stop = 88.60
Notes = This chart looks just like the Dow and will probably either lose support and collapse today or rebound off of a probe of the lows. We will be looking to short the S&P if it trades below the low of September 5, which was 87.50. Our target is the low of August 6, which is just below the gap from July 26. Stop is just above the lows of September 13 and 16. Remember the gap rules apply!
BBH – Biotech Index HOLDRS ETF
Trigger = 82.25
Target = 84.52
Stop = 81.45
Notes = This is a play we were watching for a trigger point yesterday afternoon, but it never triggered because of the final hour’s selloff. Nevertheless, this index showed a lot of relative strength all day yesterday except the final hour of trading. Therefore, we expect this index to be among the strongest indexes in the event the market rallies today. We will be looking to buy BBH when it gets above yesterday’s resistance of 82.25. Target is the 200 period moving average on the 60-minute chart. Stop is just below yesterday afternoon’s support level, which is also the 100 period MA on the 60-minute chart.
Deron’s Report Card:
Although OIH was a great overnight setup that showed a good potential for follow-through into the next morning, Monday night’s news about Iraq letting weapons inspectors back into the country released the pressure off the prices of oil coming into yesterday. This led to OIH stopping us out immediately on the open using the 5-minute low rule. Monday was the first time we felt comfortable taking anything long overnight in nearly two weeks, so it’s pretty ironic that Saddam decided to make that announcement on that particular evening. Ha! That’s trading for ya’ and it just goes to show that no matter how good the setup is or how confident you feel about a particular play, it is never a sure thing. Keeps you humble. The important thing is that we were disciplined and quickly took our stop loss. As long as you keep that discipline when you are wrong, you will always live to fight another day in the markets!
Neither BBH nor QQQ took out the opening twenty-minute high, but BBH showed relative strength to the Nasdaq for most of the day, up until the final hour of trading. When we saw the strength of BBH, we tested the waters by buying on a Fibo retracement (support) level off the morning highs with a tight stop below the low of the day, but got stopped out as the market not only filled its gap, but also took out the prior several day’s lows. Because we used a tightened stop, buying on a pullback off the gap was a minimal risk play. We were long and simply wrong.
SMH short triggered and we took it overnight. Adjusted stop listed below.
OIH long – bought 52.30, stopped out 51.10, closed with (1.20)
BBH long – bought 82.55, stopped out 82.15, closed with (0.40)
QQQ long – (never triggered due to opening gap rule)
- SMH short – shorted 21.82, stop lowered to 22.10, open with + 0.22
Glossary and Notes:
Remember that opening gaps that cause stocks
to trigger immediately on the open carry a higher degree of risk because the
gaps (both up and down) often do not hold. Use caution if trading stocks with
large opening gaps.
Trigger = Exact price that stock must trade
through before I will enter the trade. If a long position, I will only enter the
stock if it trades at the trigger price or higher. For a short position, I will
only enter the stock if it trades at the trigger price or lower. It is really
important to only enter the position if the trigger price is hit, otherwise the
trade becomes riskier.
Target = The anticipated price I am
expecting the stock to go to. However, this does not mean that I will
always hold the stock to that price. If conditions warrant, I will sometimes
take profits before that price, in which case I will notify you of the
Stop = The price at which I will have a physical stop
market order set. As a position becomes profitable, this stop price will often
be adjusted to lock in profits. Again, you will always be notified of such
changes in the next daily report or intraday if you subscribe to intraday
SOH = Sit On Hands (Don’t Make Trades)
Closed P&L under Deron’s Report Card is based on the actual
price I closed my trade at, not just the theoretical target or stop price listed
for each stock. Open P&L is based on the closing prices of the most recent
Unless otherwise noted, average holding time is 2 days to 2
weeks once a position is triggered. Updates on open positions are provided
Yours in success,
Deron M. Wagner