In hindsight, it may look as if yesterday was a perfectly smooth down trending day that would have been easy to trade on the short side. In fact, if you sold short after the open, set your protective stops, and did not return to your computer until the end of day, there is a good chance you would have made money yesterday if you were short the right sectors. However, if you were attempting to make intraday trades by selling into the bounces and covering into the selloffs, it was very difficult to profit because of the numerous false breakouts and breakdowns throughout the course of the day. If you were closely watching the S&P and Nasdaq futures markets yesterday, I am certain you will agree that it was whacky, especially in the afternoon. Light total market volume was the root cause because there is a significant lack of buying interest in the markets, but nobody is particularly interested in dumping their shares at current prices either.
Besides price, volume is the most important technical indicator there is. Ironically, volume also tends to be the one indicator that novice traders, and even experienced ones, often forget to pay attention to because they get too wrapped up in analyzing trendlines, support/resistance levels, and moving averages. The fact is that none of those other indicators will as accurately predict price movement as volume because volume is a leading indicator to price. Very rarely will you ever see a sustained breakout or breakdown in the market without a relatively sharp increase in volume. Have you ever bought a breakout or sold short a breakdown in an index or stock that you thought was a “no-brainer” because all the technicals looked good, yet the trade failed anyway? Chances are that the volume was too light and did not confirm the price. Selloffs and breaks of support often do not follow-through if the volume does not simultaneously increase. This occurs because it only takes a small amount of buyers or sellers jumping into the market to move prices in the opposite direction of the trend. However, once those buyers or sellers are done, prices will often revert back to where they previously were, thereby causing a lack of follow-through and choppy conditions. Any trends that form on light overall market volume must be taken with a grain of salt and an extra ounce of caution. Light volume selloffs usually indicate a lack of buyers rather than an abundance of sellers, which is why we chose not to participate in shorting much of the selloff over the past couple of weeks. The short side did not show much conviction due to the light volume. This is what we mean we refer to the market being in a “slow bleed” over the past several weeks. Conversely, light volume rallies often fail because they are based on a lack of sellers, rather than an abundance of buyers. Therefore, it only takes a few big sellers to step in to make prices collapse. Overall, it is usually not a good risk to enter new positions when the total market volume is very thin.
In order to determine whether total market volume is heavy or light, we plot both a 5 and 50-day moving average to look for changes in volume. The 5-day moving average shows us the average daily volume for the past 5 trading days, which we have found to be a good time horizon to indicate short-term changes in volume. In general, we trade more aggressively when the total market volume is above the 5-day moving average because it indicates a short-term increase in volume, which typically leads to continued follow-through in pricing. However, when total volume is below the 5-day moving average, it usually leads to a lack of direction and less desirable trading conditions. The 50-day moving average gives us a longer term view of volume, which is useful in confirming multi-month trends (or lack thereof). We also use the crossover of the two moving averages as an indicator to a change in sentiment. When the 5-day is above the 50-day MA, it typically indicates a more sustained increase in volume. But, if the 5-day is below the 50-day MA, it points to a sustained period of decreased volume (and hence a lack of interest). Below is a daily chart of the total Nasdaq market volume, along with the moving averages discussed above:
Notice how the 5-day moving average is slowly drifting further away from the 50-day moving average. This indicates a steadily increasing lack of interest in the markets, which will continue to make trading difficult until that trend changes. Also notice how only one out of the last eight trading days have been above the 5-day moving average. Generally, it is not wise to be aggressively in the markets when volume is below the 5-day moving average.
One clear example of why markets are difficult to trade during light volume periods can be found by looking at a 15-minute chart of yesterday in the S&P futures:
Looking at the chart above, notice how after testing the 822 support level three times and breaking to a new low not seen since October of last year, which occurred around 1:15 pm EST yesterday, the S&P futures (and SPY) should have sharply and quickly collapsed to a new low. However, notice how the futures instead deliberated and actually rallied back ABOVE the upper channel trendline resistance of the downtrend from the past two days. Then, after everyone was stopped out of their short positions, the market eventually sold off to set new lows, though the futures only dropped 4 points below the support level. This was all the result of light market volume! Looking at the entire day, it looks like the 20-MA on the 15 min. chart formed resistance for a smooth and steady downtrend. But a closer look on a shorter time frame indicates why it was tricky to stay short in the afternoon.
We began noticing substantial changes in sector rotation yesterday, which is apparent by looking at the daily charts. In general, we noticed that the sectors which have been holding up well relative to the market during the selloff over the past month were very weak yesterday while the sectors which have been getting whacked down to their prior October lows were strong yesterday relative to the market. Pharmaceuticals (PPH), Biotechs (BBH), Software (SWH), and Oil Service (OIH), all of which have been holding up well over the past two months, were each very weak yesterday. However, sectors such as Semiconductors (SMH) and Retail (RTH), both of which are trading at or near their October 2002 lows, held up well relative to the market yesterday and did not even trade below the prior day’s lows. We took a long position of RTH overnight, as called in the ETF Real-Time Room, because we perceived it to be a low-risk trade due to the sector rotation and yesterday’s relative strength. By paying attention to which sectors are showing strength and weakness relative to the market, you can ensure you are always putting the odds of a profitable trade in your favor by being in the right sectors. For more details on sector trading, you may want to check out the March issue of Active Trader magazine in which I wrote about a specific strategy on sector trading the HOLDRS.
Unless volume picks up, I expect much of the same action we have been experiencing over the past several weeks. The jobless claims and retail sales reports come out at 8:30 AM today and Dell reports earnings after the close. Although technicals have been overshadowed by news lately, it’s important to note that the daily charts of SPY and DIA are now at the lower channel support of the downtrend from the December 9. Take a look at the SPY chart:
I think odds are pretty good the market bounces off the above support level today, but be prepared for anything to happen because the environment is quite uncertain right now. As always, remember to trade what you see, NOT what you think.
Today’s watch list:
We are not coming across any clear setups today because shorts present a high-risk given the support level of SPY and DIA. However, the are no clear entry points on the long side either. We will e-mail you an alert if we come across any trades that offer low-risk in our intraday scanning today. No reason to be in a hurry to trade right now anyway.
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).
Notes: The DIA short setup from yesterday did not trigger until the final hour of trading and we did not like the risk/reward of entering at that time of day, so we passed the trade by. We made a few trades in the ETF Real-Time Room yesterday and they will be reported in the next weekly newsletter (as usual).
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