The Wagner Daily | December 5, 2002

Commentary:

Yesterday was one of my least favorite types of days for intraday trading; a large opening gap with a tight trading range for the rest of the day. When the market has a big gap, as it did yesterday, overnight trades can be profitable if you were on the correct side the night before. However, low-risk intraday trading opportunities are difficult to find because the market often corrects by time and trades sideways after a large opening gap. In the case of yesterday, we did not profit from the opening gap down because we were cash overnight due to support of QQQ, which was sitting on the lower channel support of the daily uptrend line. After the market opened, the gap down was so large that most sectors held their lows, but also failed to move higher due to a lot of sellers that were creating overhead resistance. This created a narrow trading range that remained intact until about 2:30 pm when the market rallied and broke out to new intraday highs.

Because yesterday was the third downtrending day in a row while in the greater context of a multi-month uptrend, the odds were good that a reversal was going to come sometime yesterday afternoon. We identified our potential long entry point, which was based on a break of the 20-MA on the 15 min. chart. This also represented a break of the upper channel of the three-day downtrend resistance line. Since the Nasdaq was showing relative weakness to the S&P and the Dow, we bought SPY and DIA when they broke out, but did not buy QQQ because it never broke above its 20-MA the first time. Although our entry point was good, the weakness in the Nasdaq dragged SPY and DIA back down and stopped us out for small losses after the initial break of the 20-MA failed to hold. Take a look:

After the initial failed breakout attempt of SPY and DIA, both indices began rolling over and sold off all the way down to test their lows. Typically when you see this type of price action after three consecutive days of selling, the next move would be a “panic move” down to break new lows because the reversal that everyone was expecting did not happen. However, the major indices actually bounced off their lows and quickly reversed and broke not only their 20-MAs, but also set new intraday highs. Because the rally did not show much conviction, we believe a big part of the move was fueled by intraday short covering once traders saw the market failed to break new lows and broke the 20-MAs for the second time that day. The second breakout attempt did not afford us a low-risk entry point on the long side because by the time the major indices broke their highs, most of the move had already been made. This worked out to be a good thing because the market had already sold off back down to its morning trading range by the time the market closed. The rally was not very convincing.

Going into yesterday morning, we talked about the importance of watching the 20-day MA for support or resistance on the major indices. SPY and DIA stayed above their 20-day MAs, using that level as support, while QQQ gapped down below its 20-day MA, which became a new resistance level. This is one of the reasons why there was divergence in the market and the Nasdaq was having such a difficult time trying to break out. Whenever one of the major indices is not in sync with the other, there is bound to be choppy, range bound trading, which is what we saw for most of the day yesterday.

Yesterday’s volume was pretty decent because a lot of sellers hit the market early on. However, let’s watch the volume closely today. If the market has a rally attempt, we would expect volume to decrease which would confirm that buyers are nervous about buying at current levels. This indecision and light volume would probably result in the market having another leg down.

As we were scanning charts and doing our research, we noticed that the daily charts of the major indices each broke support of their uptrend lines that have been intact since the rally began on October 10. Although the indices bounced off their 20-day MAs yesterday, the break of support will now act as the new resistance levels, which has the potential to set up the market for some decent moves to the downside over the next week or so. Take a look at how QQQ (the Nasdaq 100) broke support yesterday. The DIA and SPY charts look the same:

We expect continued weakness in the Nasdaq and the tech stocks in particular because the indexes that rallied the most during the past several months will also be the sectors that correct the most if the market drops. In addition, the weekly charts continue to confirm a potential move lower based on the reversal patterns that are forming. While there are bound to be intraday rallies, we feel there is high risk of entering long positions for anything more than an intraday scalp. As such, we are going to be looking at rallies for opportunities to short the major indices for multi-day swing trades if we can get low-risk entries. Our stops will be the trendline that was broken yesterday because once support is broken, it becomes the new resistance level. Therefore, the closer to the trendline we can get short, the better the risk/reward ratio is.

Today’s watch list:

QQQ – Nasdaq 100 Index Tracking Stock

Short

Trigger = any price ABOVE 26.90 (just below resistance of the former uptrend line)

Target = 25.50 (support from lows of Nov. 19)

Stop = 27.55 (above the 200-MA on 15 min. chart)

Notes = Per the commentary above, we are looking to initiate a short position in QQQ for a multi-day swing trade. As such, we want to short into a rally up to the trendline that was broken in order to reduce risk. We will probably leg into the position as we get more confirmation.

SMH – Semiconductor Index HOLDRS

Short

Trigger = any price ABOVE 27.15 (just below resistance of Nov. 21 lows)

Target = 24.90 (just above lows of Nov. 19)

Stop = 28.15 (above resistance of yesterday’s close)

Notes = Similar play to the QQQ short above.

Daily Reality Report:

Our short setup in SMH did not work yesterday because the opening gap down was so large that SMH had already hit its profit target price by the time it opened for trading. Therefore, we never entered the trade. While we had the right idea to fade QQQ and buy into the opening gap down, we were stopped out for a small loss because the Nasdaq stayed in a tight range and did not recover until late afternoon. We also realized small losses when we bought SPY and DIA on the initial break of their three-day downtrend lines (and their 20-MAs on the 15 min. chart). However, we only took half positions in both of these, so the capital loss was minimal.

Monday and Tuesday’s trades are yet to be calculated due to our multiple entries in SMH. Will calculate before the weekly is released.

Click here to read the details on how we calculate our Reality Report statistics.

“Swing” trades (per The Wagner Daily)

Closed Positions:

net P/L = ($65)

Open Positions:

(none)

Intraday trades (per the ETF Real-Time Room)

net P/L = ($25)

SPY long (HALF position)-

bought 92.44, sold 92.05, points = (0.39), net P/L = ($29)

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