Commentary:
Despite several intraday attempts to break out of last week’s consolidation on Friday, the major indices once again closed within the middle of the four-day trading range. SPY (S&P 500 Index) showed relative strength and briefly probed above the high of the trading range on Friday, but the breakout was not sustainable. Relative weakness was clearly present in QQQ (Nasdaq 100 Index), which held down the S&P and Dow. In particular, both the Semiconductor (SOX) and Biotech (BTK) indexes showed the most relative weakness. Because Friday was an options expiration day, it was not surprising that the trading range continued for another day. Breakouts and breakdowns often do not follow-through on options expiration days due to institutional price manipulation that allows traders to cover their positions at the best strike prices.
Overall, the market action of last week reminded me of a broken record album that constantly keeps repeating the same words over and over again without progressing to the next song. We have seen the same pricing patterns for the past four days; attempted breakout in the morning, weakness in the early afternoon, and slight buying pressure into the close. Since narrow trading ranges are not much fun, the good news is that the market is very likely to break out of the range within the next day or two because it is rare for such a tight range to continue for more than three to four days without resolution to one direction or the other. Also remember that the longer a consolidation period continues, the greater and more powerful the breakout or breakdown will be when it eventually happens. Just look at a weekly chart of BBH for proof of that concept.
Most traders expect a break of the range in the coming week, but the big question on their minds is “which way will it go?” As last week progressed, we began to see more and more mixed signals that are equally bearish and bullish; hence the choppiness. On the bullish side of the argument, it could be said that prices of the major indices are simply correcting by time through consolidation at their highs. There is also a clear lack of short setups out there because just about every industry sector is showing at least moderate relative strength, which is bullish and indicates positive breadth in the market. This is necessary in order for the rally to be sustained. Above all, the most significant, yet basic, bullish indicator is that the major indices are still above the lower channel support of their daily uptrend lines.
As we discussed last week, strength in the small caps has been providing support to the Nasdaq, but IWM (Russell 2000 Index) showed a lot of relative weakness on Friday, causing me to think the run in small caps will at least be taking a break. If that happens, the Nasdaq will also correct because most of the rally in the Nasdaq has been due to small and mid-caps. More importantly, bears keep pointing to the shift in the pattern of total market volume that occurred last week. While some technical signals sometimes provide mixed signals, volume never lies and it is one of the most reliable leading indicators at your disposal! As we discussed just about every day last week, there are two very subtle, but extremely important, points about the total market volume right now. First is that the volume on the breakout of May 12 was much lighter than it was during the previous two “swing highs” set on the daily charts. These occurred on May 6 and April 23. The May 12 breakout caused the S&P 500 to close at a new high of the calendar year and caused the Nasdaq Composite to close above its pivot point of the December 2 high. The May 12 breakouts in the S&P and Nasdaq should have been confirmed by much higher volume than during the previous two breakouts. However, volume was significantly lower.
More importantly than the lack of volume on the May 12 breakout, we continued to see increasing volume during the subsequent four trading days, but prices failed to go higher. In fact, Friday was the highest volume day of the week, but prices closed in the middle of the range, which is quite bearish. The chart of total market volume below illustrates this:
The pattern of declining volume on the breakouts and increasing volume when in a consolidation period is clearly a sign of distribution that indicates institutions are selling into strength. In a healthy bull market, volume typically declines during consolidation periods of sideways price action, but we are seeing the opposite. With the market churning and burning through its “fuel” (volume) without correspondingly setting higher prices, it will take a significant wave of fresh buyers to provide enough juice for the market to break above the consolidation period. Therefore, there must be some impetus to cause this to happen, otherwise the institutional distribution will win the battle. But, since we did not yet get the price confirmation through the break of support, be alert and stay nimble out there! Keep yourself mentally prepared to jump on either side of the market, depending on which way the break occurs. Most importantly, make sure you quickly close any open positions that are on the wrong side of the break because we are likely to see a powerful, multi-day move in the direction of the break.
Although we still feel confident that QQQ will see a significant price correction within the next few days, we were all cash over the weekend because QQQ short hit our trailing stop on Friday. Because of the erratic moves that often occur during options expiration, we did not want to give QQQ too loose of a stop. However, now that the artificial price support of options expiration has passed, it looks like QQQ (and the other broad-based ETFs) will gap down lower this morning. If the futures open at the lows of their pre-market levels, both the S&P and Nasdaq futures will open BELOW the support of the four-day trading range. We are currently flat and do not want to chase any trades, but we will re-enter the short side of the market if the gap down does not recover within the first 20 – 30 minutes of trading. But if the gap is filled, putting us once again in the middle of the range, we will continue to wait on the sidelines. Being fully in cash allows us to be mentally free and completely nimble, ready to react to either direction the market may go. As always, remember to TRADE WHAT YOU SEE, NOT WHAT YOU THINK!
Today’s watch list:
MDY – S&P Mid-Cap Index SPYDER
Short
Trigger = below 82.85 (below Friday’s low of the consolidation)
Target = 81.25 (support of the prior low on daily chart)
Stop = 83.55 (above Friday’s close)
Notes = MDY began showing relative weakness on Friday and closed near its lows of the consolidation. Should be one of the first indexes to lose support if the gap down does not recover today because it is perilously close to breaking support of its uptrend line.
QQQ – Nasdaq 100 Index Tracking Stock
Short
Trigger = below 28.33 (below the low of the consolidation)
Target = 27.80 (support of the prior low on daily chart)
Stop = 28.60 (above Friday’s low)
Notes = We got a little bit chopped up in QQQ last week, but are not afraid to re-short on a clear break of last week’s consolidation. Again, Nasdaq has been showing the most relative weakness
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). Net P/L figures are based on the
quantity of shares represented in the MTG Position Sizing
Model.
Closed Positions:
-
QQQ short (1/2 position re-entry from May 14) –
shorted 28.55, covered 28.75, points = (0.20), net P/L = ($46)
Open Positions:
-
(none)
Notes:
QQQ hit its trailing stop on Friday, leaving us all cash over the weekend.
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