Last week was certainly an impressive week for the markets and the week closed near the highs on Friday. Each of the major broad-based indices closed at new highs for the calendar year and volume was equally as impressive. There’s no denying that the market is resilient right now and we remain relatively bullish on the broad market in the intermediate term. However, before you get wrapped up in blindly buying the market, you need to keep your feet on the ground and be aware of some key levels that the market is approaching. The weekly charts of the major indices are closing in on some very critical tests of resistance that you need to be aware of, so we will begin by looking at a weekly chart of SPY (S&P 500 Index):
Looking at the purple ellipses on the chart above, you will see that SPY is at a critical test of price resistance from the high of August 22, which is 97.15. SPY closed above the August 22 closing price of 96.68 on Friday, but it failed to close above the Aug. 22 intraday high of 97.15. In fact, the intraday high of SPY on Friday was 97.09, only six cents below the August 22 intraday high. Because this test of price resistance is so obvious, you can be sure that just about every technical analyst will be watching the 97.15 level going into this week.
In addition to the highs of August 22 acting as resistance, notice that SPY is also approaching resistance of its 50% Fibonacci retracement level. While SPY broke its 38.2% Fibo retracement level easily, it is rare that indices break above their 50% Fibonacci resistance levels on the first attempt. Instead, they usually see a small price correction first. Given the fact that the 50% Fibo resistance level is just above the horizontal price resistance from the August 22 highs, the mid $97 area in SPY becomes an even more critical test of resistance. If, however, SPY breaks above its 50% Fibonacci retracement level and holds onto its gains, it is likely to see its 61.8% Fibo retracement level relatively quickly. The 61.8% retracement level is just over $102. This, of course, would be quite bullish, but we don’t expect SPY to see the $102 area without correcting first. Now take a look at a weekly chart of the Nasdaq Composite (COMPX), also labeled with the Fibo resistance levels:
Do you notice any similarities on the chart above compared with the SPY chart? That’s right! The Nasdaq Composite is also approaching resistance of its 50% Fibo retracement level. In addition, notice the area of price resistance from April – May 2002 (circled in purple). This price resistance converges with last week’s closing prices and will add to the price resistance that the 50% Fibo retracement level provides. Does the Dow Jones Average (DIA) also show impending resistance of its 50% retracement level? It sure does!
Those of you who have been trading long enough to have been through both bull and bear markets have probably learned that the media is often a good contrarian indicator for the short to intermediate-term direction of the market. While the press was talking about a “new paradigm” during the middle of the year 2000, it meanwhile marked the highs and the end of an extraordinary bull market. In each of the three sharp periods of selling we have seen since then, the press has been extremely skilled at marking the short-term bottom of the moves just as soon as they began talking about “the end of the world.” Now that we are seeing a substantial recovery in the markets, we see the press once again touting “a new bull market.” This alone is reason for us to be cautious on the bullish side because the press has typically been such an accurate and wonderful contrarian indicator. Combined with the Fibonacci resistance levels discussed above, we also have a technical reason to be cautious on the long side.
The best way to summarize my thoughts going into this week is that we are definitely not interested in shorting into a strong rally without first having some type of confirmation that the market is ready to correct. That would be equivalent to jumping in front of a freight train, which is never a good idea. However, we are not interested in “chasing the rally” at this point and feel that getting long at the current prices offers a negative risk/reward ratio. This means that you would be risking reasonably more if you are wrong than you could hope to gain if you are correct. You basically would be risking several points of downside price action in SPY, DIA, or QQQ in the hopes of making maybe another one point of profit before the major indices run into resistance of the upper channels of the intermediate-term uptrend.
Are there still low-risk buying opportunities out there? Sure! But you just need to dig a little deeper to find them. We are not too excited about getting long the U.S. broad-based indices here, but we, for example, remain quite bullish on the Asian markets. Japan’s Nikkei Index has been showing impressive gains over the past month and has just broken above the upper channel of a downtrend line that has been in place for several years. After dropping to a 20-year low, we continue to feel the recovery in the Nikkei index offers a low-risk buying opportunity that offers potentially significant upside gains. We also feel that we will start to see money flow out of the U.S. markets and into the Asian markets, which potentially offer a better risk/reward ratio at this time. That’s why we have been long EWJ (iShares Japan Fund) since May 22 and are planning on buying more shares if it breaks its next resistance level going into today. If you do, however, trade the U.S. markets going into the next week, we recommend caution on both sides of the market because the moves, both up and down, can often be violent when an index tests critical resistance levels as we discussed above. We will be cautious on the broad-based markets and most likely stay on the sidelines for now, but will be ready to either buy the next breakout or short the breakdown.
Today’s watch list:
EWJ – iShares Japan Fund
Trigger = above 6.95 (above May 14 high and 200-day MA)
Target = 7.70 (high of Sept. 18, 2002)
Stop = 6.65 (same as existing stop)
Notes = Per the commentary above, we are looking to add to our existing open position of EWJ. If it triggers, we will have a double size position, but will still have less than 25% of total equity in this position due to low price of EWJ. Based on the MTG Position Sizing Model, one full position of EWJ is equal to 4 times a full position of SPY. Therefore, a double position would be equal to 8 times a full SPY position (1600 shares based on the model). Remember that adding to the winners (and quickly bailing out of losers) is the key to long-term profitability!
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
EWJ long (from May 22) –
bought 6.70 (avg.), NEW STOP at 6.65, target of 7.70, unrealized points = + 0.09, unrealized P/L = + $60
There were no new trades from The Wagner Daily on Friday.
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