Commentary:
Because the market closed near the lows on strong volume Monday, we were anticipating a gap down and follow-through selling going into yesterday morning, which is exactly what occurred. Although the market also closed near the lows after a weak day on Friday, the volume was so light that the odds of follow-through the next morning was diminished, which is why we only took one small short position over the weekend. However, because the volume in Monday’s selloff was much stronger, the odds of follow-through the next morning were greater, which is why we were well positioned going into yesterday morning with our PPH and SMH shorts from overnight, both of which started to break support the previous day. Obviously, no technical setup works 100% of the time, but by simply playing the odds, we realize that we have a profitable advantage over time, as long as we use stops when we are wrong. Playing the overnight gaps is a strategy we have successfully used over time, but it involves a lot of analysis to make sure you are not missing any key support or resistance levels on a different time frame.
The opening gap down in the market put each of the major indices below their 200-period moving averages on their respective 15-minute charts. This acted as a key support level the previous day, so we expected it to be an equally important resistance level once the market gapped down below it. Remember that former support levels become the new resistance levels once those support levels are broken. After the gap down below the 200-MAs, the indices never looked back and sold off sharply for the entire morning session until we saw a little reversal just after 12 noon.
The weakest of the three indices yesterday was the Nasdaq, which was weaker than the S&P the entire day. The morning selloff in QQQ tested the lows of Nov. 26, but SPY was a bit stronger and found support at the lows of Nov. 27. Semiconductors were very weak yesterday, so we added to our overnight short position in SMH into the first small bounce of the morning. We then legged out of the position as SMH began to approach the lows of Nov. 26, which is where it found support before the noon reversal. Our overnight short in PPH also worked out well and we covered before the reversal due to MRK reaffirming profit guidance.
By 12 noon, we began to anticipate a reversal, or at least a decent bounce, because each of the major indices were finding support at the lows of a few days prior. Because the morning selloff was so sharp, the 200-MAs were no longer a factor to watch, so we began focusing on the 20-period MA instead, which is a much shorter measure of resistance. When the bounce started to come going into the early afternoon, we used the 20-MA as a resistance point to re-short SMH and QQQ. This worked out great and enabled us to re-short both of those ETFs within a few pennies of their afternoon highs. Notice how the 20-MA perfectly acted as resistance for SMH (and QQQ also):
We rode both of these positions down to support of the 11:00 am swing low and decided to cover because the Nasdaq began forming an inverse head and shoulders on the intraday chart. It turned out to be a good decision because the market reversed a few minutes later and the Nasdaq rallied above where we shorted it. Sometimes we’re more in sync with the market than other times, and yesterday we were certainly in sync (but we can’t sing as well as InSync).
We made the decision to go to cash overnight primarily because the Nasdaq futures (and QQQ) closed right on the lower channel support of its uptrend from the lows of November 11. When this occurs, the market often gaps up the next day, which usually gives us a lower risk entry point for getting short. Notice how that trendline perfectly acted as support for QQQ into the close yesterday:
The 60-minute chart above is a good example of the importance of always studying multiple chart time frames because this trendline is not evident on the shorter-term 15-minute chart and is not clearly visible on a daily chart either. By studying multiple time frames, the odds of you missing a key support or resistance level are greatly reduced.
Going into today, the key is to watch yesterday’s low in QQQ because a break below that level would represent a break of an uptrend that has been intact for nearly a month. In fact, looking at the daily chart of QQQ, the index closed very close to the lower channel support of its uptrend from when the rally began in the beginning of October. However, if that support level holds, it also would indicate a low-risk entry point on the long side. In the pre-market, the Nasdaq is looking like it will gap down below the trendline, which would give us a potential short play with a stop just over resistance of the trendline. However, we will be applying our gap rules to make sure it doesn’t gap down on the open and quickly reverse and trap the bears.
Finally, remember to watch those daily and weekly charts. Most of the daily charts show the major indices losing support of the most recent rally, but there is also support of the 20-day moving averages just below. Any selloff today will probably slow down or find support at each of the indices’ respective 20-day MAs. In fact, we would even consider getting long QQQ if it trades down to its 20-day MA because that is a big area of support and today would be the third day of selling. The weekly charts, as we mentioned a few days ago, are starting to turn bearish and most have formed reversal candlestick patterns, indicating that the recent rally may be done for a while.
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Today’s watch list:
QQQ – Nasdaq 100 Index Tracking Stock
Long
Trigger = any price BELOW 26.60, but ABOVE 26.45 (near support of the 20-day moving average)
Target = 27.00 (resistance near yesterday’s low)
Stop = 26.40 (below support of the 20-day moving average)
Notes = As mentioned above, this is a fade setup, meaning that we will be looking to buy weakness due to anticipated support of the 20-day moving average. Because it is a fade, our long will only trigger once QQQ trades BELOW the specific price listed above, but yet ABOVE support of the the moving average. Gap down rules do not apply in this case because we are fading the gap and buying, NOT looking to sell short the gap down.
This is a higher risk trade that is only recommended for advanced traders who are able to take profits quickly in the event of a reversal back down. In addition, we are using a tighter stop than usual because of the nature of the trade.
SMH – Semiconductor Index HOLDRS
Short
Trigger = 27.85 (below yesterday’s low)
Target = 26.75(support of the high of Nov. 20 and also the 20-day moving average)
Stop = 28.30 (above resistance of yesterday’s close)
Notes = A break below yesterday’s low in SMH will likely bring SMH quickly down to its 20-day moving average before finding support. However, the large pre-market gap may throw the risk/reward ratio out of whack on this play if SMH gaps down too much. Remember to wait for a break of the 20-minute lows before shorting the gap down to our trigger price.
Daily Reality Report:
We had a profitable day yesterday and made a point in PPH short from overnight and also a nice profit from multiple entries in SMH short, as well as one QQQ short entry. Our only losing trade was a short in DIA, which stopped us out for a small loss early in the morning. We will update and provide exact P/L figures in the next daily report.
We were cash overnight.
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