Yesterday was a roller coaster ride as the major indices traded from the low of the day up to the high of the day, and back to the low. This pattern, which repeated itself twice during the course of yesterday’s trading session, was very challenging to trade for anyone other than a “scalper” because of the numerous false breakdowns and breakouts all within the same day. In addition, yesterday was the narrowest range trading day we have seen all year, as evidenced by the short length of yesterday’s candlestick on the daily charts. This made it even more difficult to profit from any moves.
Shortly after the ISM number was released at 10 am, all three major indices (SPY, DIA, and QQQ) broke resistance of the upper channel of their respective downtrend lines from the highs of January 15. This prompted us to buy 1/2 positions in each of those indices. However, each of the major indices were unable to get past price resistance from the previous week. SPY formed a double top at the high of Jan. 30, DIA formed a double top at the high of Jan. 29, while QQQ was unable to rally past its Jan. 31 high. Rather than consolidating near the highs of the price resistance or retracing a small fraction, each of the three indices retraced beyond 50% of their intraday range, hitting our stops which were at the 0.618% intraday retracement levels. This turned out to be a good thing because the indices later retraced nearly 100% of the intraday range before heading back higher. By mid-day, we realized the market was likely to stay in a narrow sideways range for the remainder of the day, so we used discipline and remained in cash for the rest of the day. Undoubtedly, this saved us additional losses.
Because price retracements beyond 50% of the intraday range usually cause a trend reversal, our stops were in the right place (at a 61.8% retracement) and enabled us to keep our losses small. We further managed risk by only buying 1/2 position sizes on our initial entries and waiting for a break of last week’s highs to add to the positions (which never happened). Through the combination of buying 1/2 share size and using a tight stop at the 0.618 retracement level, we were able to take a calculated risk to make some decent profits if yesterday’s rally would have held, but we also did not risk much capital. Remember that the first question you ask yourself, especially in this environment, should always be “How much money am I risking?” rather than “How much money can I make?” Capital preservation MUST BE your top priority in this environment if you want to be in this business for the long-term.
The biggest culprit of yesterday’s narrow range and roller coaster action was the lack of volume across the board. NYSE and Nasdaq both had their second lightest volume days of the year (behind January 3) and both indices traded just over 1.2 billion shares. This tells us that the “smart money” is sitting on the sidelines for now because they see no good reason to be in the market until some type of direction is established.
Volume is the most important technical indicator we have at our disposal, yet many traders underestimate the importance of volume. Without strong or at least average volume, intraday trends easily reverse, breakouts and breakdowns fail, and whippy trading conditions usually prevail. This is because it only takes a small percentage of buyers or sellers stepping in the markets at any time to move the markets in the opposite direction of the trend. However, intraday trends, breakouts, and breakdowns are much more likely to follow-through when volume is strong because there are enough buyers (or sellers) to continue the direction of the trend even if a few large orders are traded in the opposite direction of the trend. The bottom line is that we can usually profit from nearly any type of trading conditions except light volume days. What is the solution to light volume days? Simply sit in cash and wait for volume to return.
The daily charts of the major indices are each in “no-man’s land” and are not telling us much about the short-term direction from here. It looks as if SPY and DIA are both trying to break resistance of the past six trading days, but there has not been enough volume for the breakouts to occur. As we have been discussing, QQQ is now out of sync and showing relative weakness to SPY and DIA due to overhead price resistance on its daily chart, which is making it more difficult for SPY and DIA to rally and increasing the odds that QQQ makes another leg lower. It’s beginning to look like SPY and DIA are correcting from oversold conditions by trading sideways for a while rather than bouncing to higher prices. This type of action, known as a “correction by time,” enables the daily moving averages to meet the price of the indices, which would probably push prices lower.
Volume is likely to remain light again today as traders await the report of Cisco (CSCO) earnings after the close. The next quarter’s outlook from Cisco is likely to provide some much needed direction in the Nasdaq. While it does not really matter to us which direction the Nasdaq goes, it certainly would be nice to see some type of trend develop soon. In addition, Colin Powell’s presentation about the Iraq situation tomorrow may help the markets to establish a trend, especially for traders who are in the “let’s just get it over with” line of thinking. In the meantime, we see no reason to be aggressive in the markets right now because odds are good that you won’t miss much in the short-term.
Today’s watch list:
QQQ – Nasdaq 100 Index Tracking Stock
Trigger = below 24.31 (below Feb. 3 low and support base at 24.40 area)
Target = 23.25 (0.618 Fibonacci retracement from October low to December high)
Stop = 24.80 (above the 200-MA on 15 min. chart)
Notes = Since QQQ has been lagging the market, any broad weakness in the market is likely to be reflected in the Nasdaq. If QQQ trades below 24.35 again, it will be below its 0.50 Fibo retracement and will probably set new lows for the year on the way down to the 0.618 level. This would likely be a multi-day play if it triggers.
SWH – Software HOLDRS
Trigger = below 27.65 (below 200-day MA)
Target = 26.00 (0.50 Fibo retracement from Oct. low to Dec. high)
Stop = 28.25 (above upper channel of downtrend line from high of Jan. 13)
Notes = We made a nice profit on this trade over the past several days, but closed the short position when it traded back above its 200-day MA. We feel the bounce will be short-lived and are prepared to re-enter this short if it trades below its 200-day MA.
Also, note that we have changed the multiplier ratio for SWH based on the MTG Position Sizing Model. The former multiplier was 0.5, but it is now 1.0 due to decreased volatility and tighter spread. This means that a full position of SWH is the same number of shares as a full position of SPY.
DIA – DIAMONDS (Dow Jones Industrial Average Tracking Stock)
Trigger = HALF above 81.70, HALF above 81.85 (break of Feb. 3 high, then add on break of Jan. 27 high)
Target = 82.90 (0.382 Fibo retracment of the January selloff; also the low of Dec. 27)
Stop = 81.20 (below the 20-MA on 15 min. chart)
Notes = The futures are gapping down pre-market, but this is a potential long play if the market reverses (as it does so often intraday). DIA (and the Dow) has tried to break the 81.60 area of resistance several times within the past week. Based on yesterday’s close near the breakout point, odds are good that DIA will break out IF it tests that level again. Of course, strong market volume will be the key.
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).
SWH short (HALF position from Jan. 30) –
Shorted 28.73 (avg.), covered 28.15,
points = + 0.58, net P/L = + $55
SPY long (HALF position from Feb. 3) –
Bought 86.51, sold 86.19,
points = (0.32), net P/L = ($35)
Notes: We closed the rest of SWH short for a profit yesterday when it hit our trailing stop.
Click here for a detailed explanation of how daily trade performance is calculated.
Click here for a detailed cumulative report 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
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
SOH = Sit On Hands (Don’t Make Trades)
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.
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