Not surprisingly, the major indices each opened with a large gap down of about 2%, barely bounced, then slid into an intraday downtrend that lasted throughout most of the day. At 2:30 pm, the market attempted to rally, but it fizzled out and the major indices traded sideways instead, closing near their intraday lows. Yesterday’s opening gap down is commonly referred to as a “Bull Trap” because the previous day (Friday) was a high-volume, wide range uptrending day that closed at the intraday highs, but the next day (Monday) gapped down to open near Friday’s LOWS. The net result is that people who bought on Friday and held over the weekend, which was very risky given the overbought conditions, were instantly trapped with losses as soon as the opening bell rang yesterday. When this type of situation occurs, it is rare that the market recovers and the gap gets filled the same day because there is too much overhead supply (resistance) and not enough demand. Therefore, the odds were good that the market would trade sideways to slightly lower throughout the rest of the day, even though the market already made a large move right out of the gates. As such, we waited for a small bounce after the open and shorted SPY and DIA, last week’s most overbought indexes. We covered shortly thereafter and netted a total profit of nearly one point, despite the fact that we were not short coming into the opening gap down. Even though many would argue that a change in perception of the war over the weekend was the sole cause of the large gap down, I would also point to the fact that SPY perfectly ran into resistance of its 200-day MA, while QQQ and SMH both ran into resistance of their January highs on Friday. Regardless of news, there were several technical reasons that the market was expected to retrace as well.
As I mentioned in the ETF Real-Time Room yesterday, opening gaps are great if you are on the right side of the market (most traders never are), they’re quite nasty if you are on the wrong side, and they are often just plain boring if you are in cash. Well, we were in cash coming into the day, but still managed to net a decent profit through several well-planned and executed intraday trades. The point is that you don’t need to catch every gap to make money in this business. Being short over the weekend would have been equally as risky as being long because of all the variables that could have occurred with the war. We chose the risk-adverse route of cash, but still managed to profit without the huge overnight risk.
Given the huge percentage gains of last week, you should not have been too surprised to see the minor price correction that occurred yesterday. Although a 300-point drop in the Dow may seem huge, you need to put it all in context and realize that a 300-point drop after a 1000-point rally is only a 30% retracement. Since we typically consider a 38.2% – 50% Fibonacci retracement to be a healthy pullback that often positions an index for continuation to the upside, the Dow could actually drop another 100 – 200 points and still be technically healthy. In fact, none of the major indices have even retraced to their first Fibonacci support level from the March 12 lows to the March 21 highs. DIA showed the most relative strength during yesterday’s selloff, followed by SPY (S&P 500 Index), and then QQQ (Nasdaq-100 Index). DIA came close to hitting our price target from yesterday’s newsletter and SPY actually did trade down to the target. If you read yesterday’s newsletter, you will see that the price targets were set to be just above support of the low of March 20. Amazingly, take a look at where SPY found support yesterday:
Yesterday’s selloff was healthy and necessary in order for the market to have a chance at building momentum to break last week’s high. Remember that markets don’t go up (or down) in a straight line and corrections either by time or price are a necessary part of establishing trends. Therefore, our plan is to use the next several days to look for potential swing trade entries on the long side as the major indices come down to support. Because prior resistance becomes the new support level once the resistance has been broken, the beginning part of last week’s trading range should now act as support for the indexes. In particular, we have our eyes on buying QQQ in its current price range because it broke major resistance of a 2-year downtrend line last week and now has retraced to the prior breakout point, which should now act as support and provide us with a good risk/reward ratio for buying. The weekly chart of QQQ below illustrates this:
As you can see, the risk/reward ratio of buying QQQ here and holding indefinitely is pretty good because you can set your stop just below support at the 25.50 area, risking only 1/2 point, but giving yourself the potential to make several points on the upside. The same thing could also be said about SPY, but I would like to see it retrace a little more first. Since we have seen QQQ and the Nasdaq lagging the S&P and Dow over the past week, I expect to see sector rotation back into the Nasdaq over the next few days.
The most ideal scenario going into today would be to have an opening gap down, which we would plan on buying (also known as “fading”). However, based on pre-market futures action, it looks like the market will gap up today. This slightly increases the risk of buying because the gap could easily get filled, sending us right back down to yesterday’s lows. Therefore, we are comfortable with testing the waters in some long positions if the market gaps down today, but will be more cautious and patient if it gaps up.
Just to give you a heads-up, the Consumer Confidence AND New Home Sales reports will be released at 10 am EST today. While most traders are focused more on war news than economic news, a large surprise to either of these reports could potentially move the markets. Finally, keep in mind that allied forces will probably enter Baghdad sometime today and the rumors and news will be flying! For that reason, be very cautious out there because there are so many variables that could occur and each one of them is a potential market mover.
Today’s watch list:
For the first time in months, we have a few trade setups in mind that we are comfortable building a position and holding for several weeks as “long-term” trades. Be aware that the trades below have a longer time horizon than most of our trades, although you can adjust the trigger and target prices to turn them into shorter-term trades.
QQQ – Nasdaq 100 Index Tracking Stock
Trigger = above $26.25 OR below $25.95 (above yesterday’s resistance or gap down below the low)
Target = $28.75 (high of December 2, 2002)
Stop = $25.10 (below daily trendline support, also 20 and 50-day MAs)
Notes = This is a “longer-term” trade that we intend to hold for several weeks if market conditions allow. However, because of the war uncertainties, we recommend keeping initial position size small and GRADUALLY building a position. Target may be raised, depending on momentum of QQQ as it approaches. You can also daytrade around the position, but this is one of the best looking “long-term” setups I have seen in quite a while. Of course, we always use the stop in case we are wrong.
BBH – Biotechnology HOLDR
Trigger = above $92.55 OR below $91.85 (above yesterday’s resistance or gap down below the low)
Target = $101.20 (high of May 29, 2002)
Stop = $89.20 (below support at $90)
Notes = Just like QQQ above, this is a “longer-term” trade that we intend to hold for several weeks if market conditions allow. However, because of the war uncertainties, we recommend keeping initial position size small and GRADUALLY building a position. Also keep in mind that BBH is quite volatile, so adjust your share size accordingly using the MTG Position Sizing Model. For example, one full position of BBH is equal to 50% the share size of a full position of SPY and only 25% the share size of a full position of QQQ. Adjusting your share size accordingly helps to reduce risk and makes it easier to mentally accept volatile price swings.
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).
SPY short (HALF position from March 24) –
shorted 87.84, covered 87.36 (avg.),
points = + 0.48, net P/L = + $45
DIA short (HALF position from March 24) –
shorted 83.35, covered 82.91 (avg.),
points = + 0.44, net P/L = + $41
Notes: We only shorted 1/2 size positions of yesterday’s setups due to the large percentage opening gap down. Nevertheless, we netted nearly a point of profit with minimized risk through precise position management.
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