The Wagner Daily | January 14, 2003

Commentary:

Did anyone notice that yesterday morning’s opening gap in the market was an inverse mirror image of the previous day (January 10)? After closing in the middle of the previous day’s trading range, SPY (and the S&P futures) gapped up yesterday to open at the previous day’s high. On January 10, SPY inversely gapped down to open at the previous day’s low. On both days, SPY quickly reversed in the opposite direction of the gap and then either rallied sharply (January 10) or sold off quickly (yesterday). At 11:15 am on both days, the SPY reversed the direction of the morning trend and retraced more than 50% of its intraday range in the opposite direction. On both days, the severe retracement during the mid-day doldrums caused SPY to enter into a narrow and choppy trading range that lasted the duration of the trading day. We found it rather interesting how yesterday and the previous day (January 10) were so similar, except in an inverse pattern. The chart of SPY below illustrates this unusual scenario:

Needless to say, trading action of the past two days has been quite tricky and rather challenging. When big reversal moves occur after a significant opening gap, entering new trades once the gap has been filled becomes a bit risky because the market often enters into range-bound and choppy trading thereafter like we have seen the past two days. If anticipating that an afternoon trend is going to continue in the direction of the morning reversal, one needs to wait for a 0.382 Fibonacci retracement in order to have a low-risk entry point. Although we were disciplined and waited for a 0.382 intraday retracement before entering positions during the past two days, the retracement was so severe that it would have been dangerous to stay in our positions because retracements of more than 50% often cause the market to completely reverse its trend. For trend traders, it was difficult to profit from the reversals off the opening gaps because it is difficult to know if the reversal will continue beyond just filling the gap or whether the market will turn back around as soon as the gap is filled.

Although we were stopped out in several intraday trades mentioned in the ETF Real-Time Room during the past two days, we kept the losses small through properly managing risk. This was done through three ways: 1.) Waiting for a significant retracement before entering a trade 2.) Only entering HALF share size positions 3.) Not entering trades in the direction of the gap due to the MTG Opening Gap Rules. First, by entering on a 0.382 intraday retracement, the risk was minimal because our stops were just beyond the 0.50 retracement level. Second, entering only HALF share sizes of each position further controlled risk by limiting us to half our normal equity exposure. We were only willing to add to the positions on confirmation that the trade was in the money. Third, we were disciplined with regard to following our opening gap rules which require waiting twenty minutes before entering new trades in the direction of the gap if the opening gap causes trades to immediately trade at their trigger prices. This prevented significant losses that would have occurred if we went short on the January 10 gap down or bought yesterday’s gap up. If we had not done any of these three things, trading losses could have been substantial. Each one of these three elements was a subtle, yet very important, key to minimizing and properly controlling risk. Interestingly, MTG’s net losses from intraday trading the past two days are less than just one of our average winning days! Many traders conversely make the mistake of allowing one day of losses to wipe out many days worth of gains. Learning proper risk management techniques through a variety of methods is one of the greatest benefits of MTG’s supplemental ETF Real-Time Room.

As you might have guessed by the choppiness of the past two days, there is a lot of indecision in the markets right now that makes buying and shorting equally risky. On the bearish side, a variety of geopolitical factors have been weighing on the market and making investors nervous about buying the market at current prices. On a technical basis, many indices are close to, and have even probed below, the lower channel support of the uptrend line from the lows of December 31. If this trendline is convincingly broken, it could trigger substantial selling. However, on the bullish side, corporate earnings season is now in full swing and any positive guidance from the “big boys” could set the market on fire again (Intel reports today after the close). In addition, if you smooth out all the intraday choppiness and look at daily charts of the major indices, you will notice a decent consolidation and base of support has been building over the past week. The weekly charts of the indices are even more interesting, especially the Nasdaq which is poised to break a 1.5 year downtrend line IF it sets new highs this month.

The bottom line is be cautious over the next couple of days until the market figures out which way it wants to go. Rather than trying to guess the next major move, it’s a lot safer to let the market decide for itself and simply tag along for the ride. We will be ready either way.

Today’s watch list:

DIA – DIAMONDS (Dow Jones Industrial Average Tracking Stock)

Short

Trigger = HALF below 87.70, HALF below 87.55 (break of trendline support from Dec. 31 lows)
Target = 85.95 (200-MA on 60 min. chart)
Stop = 88.27 (above price resistance during past week of 88.20)

Notes = The Dow is very close to breaking the lower channel support of the uptrend line from December 31 lows. We want to short after confirmation of the breakdown.

Daily Reality Report:

Below is Morpheus Trading Group’s daily performance report of closed trades and an update on all open positions from The Wagner Daily (ETF Intraday Real-Time Room trades are reported separately in The Wagner Weekly).

Closed
Positions:

net P/L = + $72

Open Positions:

(none)

Notes: We sold half of the RTH position at 72.45 into the opening gap yesterday and trailed a stop on the rest, which was hit at 71.40 later in the morning. As mentioned in an e-mail alert, SPY and SMH long trades were not entered yesterday due to the MTG Opening Gap Rules.

Click here for a detailed explanation of how daily trade performance is calculated.

Click here for a cumulative summary of MTG’s trading performance (updated weekly)

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 1 to 3 days once a position is
triggered. Updates on open positions are provided daily.

Yours in success,

Deron M. Wagner