Commentary:

Last week ended with a solid day of follow-through off of Thursday’s rally. Given the strength of Thursday’s rally, we were not too surprised to see a continuation into Friday, but we were pleasantly surprised to see the market close near its highs on the second day of the rally, especially going into a weekend. While it has not been uncommon to see a bear-market bounce during the past several months, it has been a bit rare to see follow-through with a close near the intraday highs on the SECOND day of the rally. In other words, the buying interest showed continuation. In fact, Friday’s volume in the Nasdaq was the highest we have seen since July 29. This made us believe there is the possibility of a sustained move over the next several weeks.

Looking at a daily chart, both the S&P and Nasdaq closed above their 20-day moving averages for the first time since August 30. While a close above the 20-day moving average is certainly a step in the right direction, we still have a long way to go before we could come anywhere close to declaring “a bottom.” Primarily, we need to see the major indices close above their 40-day moving averages with volume holding steady. Now that resistance of the 20-day moving averages has been broken, we need to see the 20-day MAs now act as the new support level. If that happens, it is more likely we will see a sustained period of buying interest.

Friday’s close put the Nasdaq above the upper channel resistance of its trendline from the highs of August 22. However, the S&P only broke above the steeper downtrend line from the high of September 11 and is still below the primary trendline from August 22. This indicates the Nasdaq has been proportiantely recovering at a better pace than the S&P, led by major strength in the Semiconductor index, which closed up over 8% on Friday.

When analyzing markets that have broken above resistance levels on their daily charts, it becomes important to also look at the weekly charts, which hold much more bearing on whether or not we will see a sustained rally. The Nasdaq-100 closed right at resistance of the upper channel of its downtrend from the high of March 10. Therefore, a break above Friday’s high during the next several days would put the Nasdaq above this resistance level and set us up for a rally up to the 20 period moving average on the weekly chart, which is just below 1000. So let’s watch Friday’s high as a crucial point of resistance moving forward. As mentioned earlier, the S&P has much further to go than the Nasdaq with regard to breaking those same resistance levels on the weekly chart.

After two solid days of rallying, we are expecting either a day of consolidation or retracement today. In order for the rally to continue during the next several weeks, it would be healthy to see the market take a break here in order to get momentum for the next leg up. Remember that prices always correct in one of two ways — correction by time (consolidation) or correction by price (retracement). A correction by time means that prices will go sideways NEAR THE HIGHS of the rally. This enables the trendline support (and moving averages) to catch the price of the index through price consolidation. This is the more bullish of the two scenarios. The other possibility is a correction by price, which simply means that the market gives back or “retraces” some of the rally we have seen during the past two days. When markets retrace, we look for them to find support at 0.382 Fibonacci retracement levels, which simply means that the market should pull back roughly one-third (33%) from the lows of Thursday to the highs of Friday. For the s&P futures, that equates to price support right around Friday’s low of 815. For the Nasdaq futures, that equals a price of about 864, just above the 20-day moving averages. If either of the markets retrace more than those levels, it would be considered bearish and would diminish the odds of the rally continuing. If, on the other hand, the market goes higher without retracing at all, that’s all the more bullish. We’ll be ready either way!

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Today’s watch list:

RTH – Retail Index HOLDRS
Sector: Retail
Short

Trigger = 70.90 (below Friday afternoon’s low)
Target = 69.30 (the 20 and 40 MAs on the 60-minute chart)
Stop = 71.70 (above resistance on the daily)

Notes = This index, which has beens showing a lot of weakness over the past couple of weeks, was one of our plays from Friday that did not trigger. Volume was weak the past two days, despite the price strength. If we see any weakness in the market today, this will probably be one of the first sectors to see a selloff. Just remember the gap rules for entry.

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BBH – Biotech Index HOLDRS
Sector: Biotechnology
Long

Trigger = BELOW 82.25 (near Friday afternoon’s low)
Target = 85.00 (near Friday’s high)
Stop = 81.30 (below the 20-period MA on the 60-minute AND daily charts)

Notes = This is essentially a “fade” play, which means we are looking to go the opposite direction of the price move. We are looking to buy once BBH trades BELOW 82.25. Even though BBH was weak on Friday, it was largely due to major money flow into the tech stocks, especially the Semis. However, looking at the daily chart of BBH, you will notice that the Biotech index just broke out of a large consolidation around $82, which means that the 82 level should now serve as price support. We would also expect sector rotation back into the Biotechs today, especially if there is any weakness in the tech stocks. Therefore, the reward/risk ratio of entering on a pullback to support around 82 is good.

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Deron’s Report Card:

“Swing” trades (per The Wagner Daily)

Closed Positions:

SMH long – (from Oct. 10) – bought 18.27, sold 19.83, closed with + 1.56 (nearly a 9% gain)

QQQ long – (from Oct. 11) – bought 21.67, sold 21.95, closed with + 0.28 (we sold because it hit our price target on the same day as entry)

BBH long – (from Oct. 11) – bought 83.68, sold 83.57, closed with (0.11) (sold because the index showed relative weakness all day; notice selloff into the close)

MDY long – (did not enter; already hit our price target by the time it triggered)

RTH short – (did not trigger)

Open Positions:

WMH long (from Oct. 2) – bought 30.35, stop at 27.25, target 42.50, open with + 0.36

Intraday trades (per Intraday Updates E-mail Service)

(none)

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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
change.

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
updates.

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
trading day.

Unless otherwise noted, average holding time is 2 days to 2
weeks once a position is triggered. Updates on open positions are provided
daily.

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Yours in success,

Deron M. Wagner