When I was a new trader, one of the biggest mistakes I made was focusing on individual stock trade setups first and paying attention to the big picture of the market second. This usually happened because I felt the need to always be in the markets (very bad idea) and was continually looking for trades to enter without full regard to the overall state of the market. While this approach sometimes enabled me to find profitable trade setups in the midst of bad overall trading conditions, I eventually learned that my approach was not effective for long-term success. Through my experiences, I eventually learned that a “top-down” approach to the markets was much more effective and profitable than a “bottom-up” approach. In other words, I completely reversed the order in which I analyzed and approached each trading day. Rather than focusing all my efforts on looking for good trade setups as soon as the market opens, I first assess the general market conditions and ask myself “What is the market saying to me?” If you listen without preconceived notions, you will usually know. Through this paradigm shift in my trading psychology, I now find myself OUT of the markets more than I am IN the markets and guess what. . .my monthly profitability is consistently higher as well! The reason I shared this information with you is because yesterday was a great example of how paying attention to only individual trade setups without full awareness to broad market conditions, primarily with regard to light volume, would have caused you to easily be on the wrong side of the market.
Total market volume in the NYSE yesterday was THE LIGHTEST day of the year and matched the volume of December 31, 2002. Basically, yesterday’s market volume was the equivalent of what we normally see during a holiday trading session, except that we are not in a holiday period. I got the feeling that many traders have covered their short positions, the market had its technical bounce from oversold conditions, and now everyone is trying to figure out what happens next. If you listen carefully, the light volume is very clearly telling us something. . .professional traders really don’t have a clue which way the market goes from here and hence are choosing to sit on the sidelines and wait for a clear direction. If that is the reality of what is happening, do you think it makes sense for us, the retail traders, to be aggressively in the markets right now? I highly doubt it! If there is any type of player in the markets who knows which way the market is headed on a day-to-day basis, it is the “smart money.” But, if “smart money” is sitting on the sidelines, I certainly don’t think I am so much smarter that I can jump into the markets right now and make a bundle of dough!
Because volume was so light yesterday, the major market indices spent most of the day in a narrow-range, slowly grinding lower. This enabled us to make a few profitable trades by shorting DIA and SPY in the ETF Real-Time Room, but we took profits quickly because we know that slow-grinding intraday trends can reverse easily and quickly on light volume days. In fact, heavy buying or selling by just one or two hedge funds is sometimes enough to move the market on a light volume day. Not surprisingly, that is exactly what happened yesterday as a few buyers stepped in during the final hour of trading and rallied the market back up to close in the upper third of its intraday range. Fortunately, we had already covered our short positions and were in cash when the reversal happened.
The most interesting thing about yesterday was that each of the three major indices (QQQ, SPY, and DIA) perfectly bounced off their 0.382 Fibonacci support levels from the most recent rally and immediately reversed. Despite the light volume, the Fibonacci support level worked perfectly, indicating that we could possibly be headed for higher prices in the days ahead because the market did not retrace beyond the 0.382 level, which is normally what happens when the retracements are severe and the uptrend is not very strong. I have annotated three charts below to show you the how the selloff yesterday afternoon perfectly lined up with the 0.382 Fibonacci support level in each of the three major indices (SPY, DIA, and QQQ):
As you can see, each of the three major indices perfectly bounced off Fibo support. If the indices do not retrace more than 0.382, that is bullish for the market because most retracements over the past month have been to at least 0.50 or 0.618, which is what has made it difficult to stay in positions because our stops are usually set near the 0.618 retracement level. For more information about using Fibonacci retracements, click here to read a short article MTG recently wrote.
Going into today, we will probably see an upward bias based on the recovery into yesterday’s close, which also caused SPY and DIA to both close above their 20-day moving averages, although both indices spent most of the day trading below that key level. However, we still have overhead resistance of both the 50 and 200-day MAs of QQQ. Coincidentally, the highs of SPY, QQQ, and DIA that were set on Tuesday (Feb. 18) are equal to a 0.382 Fibonacci retracement from the high of Jan. 15 to the lows of Feb. 13. This means that a rally above Tuesday’s highs is likely to propel the market up to the next Fibonacci resistance level, which is 0.50 (50%). So, let’s watch for a break of Tuesday’s highs for potential long entries. However, if Tuesday’s highs cannot be broken, there is a good chance the market heads back down to test its recent lows because a mere 0.382 bounce off of the big selloff is probably not going to be enough to reverse a downtrend. Either way, continue to keep a close eye on volume because volume will tell you the big picture of what is truly happening in the markets.
Today’s watch list:
PPH – Pharmaceutical HOLDRS
Trigger = below 70.47 (below shelf of price support around 70.60)
Target = 68.10 (matching low of Feb. 13)
Stop = 71.25 (above yesterday’s close)
Notes = The daily chart of PPH looks pretty ominous here and the bounce over the past few days has a lot of resistance overhead and is not likely to go much higher. We will look to short below the break of support at 70.47. Good risk/reward ratio on this setup (about 3:1)
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).
DIA short (HALF position from Feb. 19) –
Shorted 80.53, covered 80.35,
points = + 0.18, net P/L = + $15
Notes: We shorted DIA when the first half triggered, but we decided not to enter the second half at the trigger price due to light total market volume and very narrow trading range. Market conditions did not dictate taking DIA short overnight, so we took profits quickly. RTH did not trigger.
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