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The Wagner Daily


Commentary:

A bad earnings report from Intel yesterday helped cause the Nasdaq to gap down below the lows of Tuesday, effectively trapping the bulls who bought Tuesday’s big gap up and held their positions overnight. This aided in both the Nasdaq and S&P futures establishing a steady, tradeable downtrend that lasted through the first half of the day. Although the S&P futures attempted to break the opening high of the day around 10:00 am, there was too much resistance from Tuesday that was caused by bulls who bought near the highs and were selling in an attempt to break even on their positions. This resulted in the S&P quickly falling back to the low of the day, which was equal to Tuesday’s lows. Since we knew that Tuesday’s gap could act as support, we covered half the shares of our short positions on the test of Tuesday’s lows. However, we also knew that if we broke below those lows, we would likely see a big selloff and attempt to fill the gap to the downside, which is why we kept half of our short positions on.

As it turned out, we ended up breaking the lows of Tuesday and partially filling the gap. We then used trailing stops to lock in profits all the way down and eventually covered our SPY and DIA shorts near the lows of the day. Trailing stops, which work best in a trending market like we had yesterday morning, are a great way to lock in profits while simultaneously preventing you from taking profits too soon. Each time the market set a new high that was lower than the previous high, we simply lowered our stop to just above the previous high price. Therefore, if the downtrend was broken by setting a subsequent higher high, we would immediately be out of our short positions. However, this also enabled us to stay short as long as the downtrend continued.

Yesterday morning also provided us with a prime example of how once a support level is broken, it becomes the new resistance level. We are referring in particular to the 20-period moving average on the 15-minute chart, which acted as a rock-solid support level on Tuesday and prevented the S&P from selling off into Tuesday’s close. However, since we gapped down well below that level yesterday morning, that same 20 MA became the new resistance level. Take a look at the 15-minute chart of SPY below, which demonstrates this. Also notice how the lower channel support of the 4-day uptrend corresponded with the lows of Tuesday:

Although our typical rule for entering shorts during a gap down is to wait for a break below the 20-minute low, there are sometimes exceptions that enable advanced traders to enter shorts into a rally after a gap down. Since the market gapped down so hard and also consolidated in such a tight range yesterday, it seemed unlikely to us that the S&P was going to have enough momentum to rally right through yesterday’s resistance. This is what caused us to raise our trigger price on the SPY short rather than waiting for a break of the 20-minute low. We could have also done the same thing with DIA, but we waited for a break of the 20-minute low on that one instead. Additionally, our risk of selling short into resistance resulted in less overall risk because our stop was just above the 20-period MA, which is where we sold short. This made the reward/risk ratio very positive because if we were wrong, we would have gotten right out with a small loss. However, if we were right, we would realize large profit potential because we would have gotten short near the high of the day and been able to ride the short down to all subsequent lows of the day, which is what we did on both our SPY and DIA shorts.

It looks like last evening’s positive earnings report from IBM is going to cause the market to gap up above yesterday’s highs. This week has been interesting so far because it has been filled with so many gaps that were driven by earnings reports. It will be interesting to see whether the market eventually sustains the rally off this week’s earnings reports or whether we head back down. Our gut tells us that we will probably see a sustainable rally as long as we can get back above the highs of Tuesday within the next several days. Going into this morning, the key levels to watch are yesterday morning’s highs in both the S&P and Nasdaq futures. If the market opens above yesterday’s highs, those levels should act as support today, while Tuesday’s highs will be resistance. Then, if we subsequently break Tuesday’s highs on the various indices, the rally could really kick in high gear. However, we recommend waiting the first 30 minutes to make sure the gap is going to hold before going crazy buying positions. Also, remember there is the Philly Fed number at 12 noon today, so that could throw the market for a loop if those nubmers are bad. Anyway, it sure will be interesting to see what happens today after all these gaps we have seen the past couple of days.



Today’s watch list:


PPH – Pharmaceutical Index HOLDRS
Sector: Pharmaceutical
Long

Trigger = 76.10 (above yesterday’s high)
Target = 78.10 (just below the high of Aug. 27)
Stop = 75.05 (below the high of October 15)

Notes = The Pharmaceutical Index (DRG.X) has shown a lot of relative strength to the market during the past several weeks, especially yesterday when the index gapped up and barely sold off as the broad market was getting whacked. This is one of the few sectors that is also above resistance of its 20-MA on the weekly chart and is well above its 40-MA on the daily. If we break above yesterday’s high, there is not much resistance until the high of August 27. Because of the huge gap this morning, remember that we will only be looking to enter if PPH breaks its 20-minute opening high (unless it doesn’t gap beyond the trigger).



SMH – Semiconductor Index HOLDRS
Sector: Semiconductor
Long

Trigger = HALF at 22.25, HALF at 22.43 (above the 20-day moving average, then the high of October 15)
Target = 25.25 (resistance of the high of September 11; also the 20-week moving average)
Stop = 21.48 (below the low of October 15)

Notes = IBM’s earnings is likely to spur the Semiconductor (SOX) index, which was also strong on Tuesday. This sector has been one of the more oversold sectors, but once Tuesday’s highs are broken (and the 20-day MA), there is not much resistance until the September 11 highs. Time horizon on this trade is probably one week (maybe less if we’re likely). Remember the gap rules.


Deron’s Report Card:

“Swing” trades (per The Wagner Daily)

Closed Positions:

    SPY short – shorted 87.63, covered half 86.98, covered half 86.23, closed with + 1.02 (avg. profit)

    DIA short – shorted 81.45, covered half 81.07, covered half 80.63, closed with + 0.60 (avg. profit)

Open Positions:

    WMH long (from Oct. 2) – bought 30.35, stop raised to 30.20, target 42.50, open with + 0.35

Intraday trades (per Intraday Updates E-mail Service)

    (none)

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.


Yours in success,

Deron M. Wagner

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