The Wagner Daily | March 17, 2003

Commentary:

After the large percentage rally we saw in the broad markets on Wednesday and Thursday of last week, the market took a rest on Friday and consolidated in a sideways trading range. Because the market rarely goes in a straight line for more than a day or two, the correction was largely anticipated on Friday and was actually a very healthy occurrence that was necessary in order for the market to have a chance of making another leg higher. Although there were a few intraday patterns in the broad market that offered some tradeable moves, the market essentially remained in a narrow range the entire day and closed marginally higher than the previous day.

As we have discussed in the past, there are two types of corrections that can occur after a strong trend in the markets (a rally in this case). They are a correction by price and a correction by time.

A correction by price occurs when the price of the market or an index retraces a certain percentage into the range of the trend. This retracement often drops the market to support levels of important intraday moving averages, which in turn act as a base to launch the market higher (assuming the trend continues). This is where the “buy the pullbacks, sell the rallies” mantra comes from. For example, if SPY rallied 3 points and closed at the high of the day and then opened flat and retraced 1 point the next day, that would be a correction by price. In this case, it would be the equivalent of a 33% retracement off the high, which is roughly equal to the first Fibonacci support level of 38.2%. Barring any unusual circumstances, the 33% retracement would offer a relatively low risk re-entry point on the long side of the market. This is typically much “safer” than buying at the high of the previous day without any type of correction first.

A correction by time occurs when the market, rather than retracing into the range of the rally, trades sideways at or near the high of the rally. This is also known as a consolidation pattern and is actually more bullish than a correction by price in which the market retraces. Why is it more bullish? Because it indicates that although the buyers are taking a rest, and hence preventing the market from going higher, it also means that sellers are not stepping in to take profits from the recent rally. By trading sideways, this also enables the key intraday moving average levels to eventually rise to support the price of the market even though there was no retracement. If volume stays high, you will often see new highs set shortly thereafter even without a correction by price. Of course, the same concept applies in a strong downtrend that does not see a bounce, which would be more bearish than seeing a bounce off the lows. To illustrate the concept of a correction by time, take a look at a 3-day, 15 minute charts of SPY (S&P 500 Index):

In the first chart above, you notice how SPY essentially traded sideways near the close of the previous day. By mid-afternoon, this caused the 40-period moving average on the 15 minute chart to rise up and provide support to the price of SPY. Notice how SPY never traded below that level for the remainder of the day. Also, SPY never came close to retracing to its first Fibonacci support level. Next, take a look at an hourly chart of SPY, which goes back 9 days:

Notice how the previous resistance of the highs of March 5 – 7 acted as support on Friday. This is a clear example of the basic technical analysis concept that a prior resistance level becomes a new support level once that prior resistance level is broken (and vice versa).

As I am sure you are aware, all eyes will be on the U.S./Iraq situation over the next several days. Bush has stated that today, Monday, is the “moment of truth for the world,” meaning that he has set today as the firm deadline for full Iraqi compliance. We are therefore to assume that a war with Iraq will begin within the next few days barring any sudden changes on Iraq’s end. Although there is an FOMC meeting on Tuesday where current fiscal policy and interest rates will be discussed, we frankly think the market will perceive any action by the Feds as secondary compared to the Iraq situation. Obviously, it is impossible to know how the market will react when/if the actual war begins. However, we can look to similar historical events and see that the market’s initial reaction has traditionally usually bullish begins it removes uncertainty, although the big question is whether or not any rally would be sustainable given the domestic economic conditions.

If you take a look at the March 14 issue of The Wagner Daily, you will be reminded that the strong volume we saw last week is definitely something to be aware of and is perhaps the single most bullish technical signal we have seen in a long time. In addition, QQQ (Nasdaq 100 Index) closed the week ABOVE its trendline resistance of the downtrend from May 2001. If QQQ breaks its 50-week moving average at 26.02, it could really set the tone for sustained upside prices in the broad market. If the action in the latter half of last week is any indication of how the market will react to the war, then we could see more follow-through to the upside. But, it’s too early to predict that with any certainty.

Today’s watch list:

Based on technical analysis, we believe there is a good chance for sustained upside price action and follow-through on last week’s rally. However, the markets are likely to be quite volatile during the next several days and every little piece of news regarding Iraq will probably move the markets. As such, we do not feel there is any good reason to enter new positions today. Instead, we will focus on managing each of our existing “half-size” positions from over the weekend, which we have taken with a longer-term outlook of several days to a week (see extensive notes under “Daily Reality Report” below). Let’s take a “wait and see” approach before adding more shares to our existing positions or entering new positions. If last week truly was the start of something significant, there will be plenty more opportunities to get more aggressive in the days to come.

When/if the market rallies, keep a close eye on QQQ and BBH, both of which are poised to make significant multi-week moves if they break out. If QQQ can break the 26.00 area, it should see a rally up to its high of the year, set on January 13, which is around 27.50. For BBH, we want to see it break the 92 – 93 area, which has been a key area of resistance for many months.

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

BBH long (from March 14) –
Bought 90.85, sold 91.01,
points = + 0.16, net P/L = + $6

SPY short (HALF position from March 14) –
Shorted 83.89, covered 83.98,
points = (0.09), net P/L = ($12)

Open Positions:

open P/L = + $31

SPY long (HALF position from March 14) –
bought 83.71, stop 82.20, target 86.30
open points = + 0.42, open P/L = + $39

DIA long (HALF position from March 14) –
bought 78.63, stop 76.80, target 81.25
open points = + 0.33, open P/L = + $30

RTH long (from March 14) –
bought 67.20, stop 65.60, target 70.30
open points = (0.10), open P/L = ($11)

Notes: We had a few round-trip intraday trades in the ETF Real-Time Room on Friday, which we alerted you to via e-mail. Despite the geopolitical risk, we positioned ourselves with small share size on the long side of the market in anticipation of follow-through on last week’s rally. We feel that the technicals, especially the sharp increase in volume, were strong enough to merit taking a calculated risk over the weekend, although we were fully aware that “anything can happen” with the Iraq situation. We controlled the risk by only taking “half-size” positions.

We have carefully been watching the overnight Globex futures action in both the S&P and Nasdaq markets and have noticed quite a bit of resiliency. At its worst point around 3:00am EST, the S&P futures were down more about 12 points from Friday’s close. However, as we approach the market’s open, the futures are acting quite well and have recovered to being down only 3 points as of the time of this writing. If the futures open above Friday’s low, that increases the odds that we sustain Friday’s consolidation pattern, which would position us for higher prices within the next few days. However, if we open below Friday’s low, we need to be careful because it could trigger a wave of selling if the gap is not filled quickly. We will keep you updated on our thoughts via e-mail.

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
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