As expected, the major indices followed through to the downside yesterday on the heels of last Friday’s distribution day. The shooting star candlestick formation that we discussed in yesterday’s newsletter is almost always followed by at least one subsequent day of selling due to the bearish momentum the pattern creates. Although the major indices trended steadily lower yesterday, the most important thing to be aware of is that volume was very light compared to recent levels. Even though declining volume outpaced advancing volume by 4 to 1 yesterday, total volume in the NYSE was 30% lighter than the previous day, while volume in the Nasdaq was over 38% lower. This sharp drop in volume yesterday is actually bullish because it indicates a lack of institutional selling, as was present on Friday. If volume would have been high again yesterday, it would have indicated a second consecutive day of distribution, which would have been bearish. Despite losses of more than 1% in both the Nasdaq and S&P, yesterday’s price retracement was healthy for the market because it allowed the major indices to digest some of the huge gains we have seen over the past several weeks. Because volume was light yesterday, the bullish technicals remain intact for now and it is likely that the market will attempt to head back up to test last week’s highs over the next few days.
One of the most reliable indicators you can use to determine whether a pullback in an index is healthy or not is Fibonacci (click here for an explanation). When using Fibonacci in an uptrend, we measure the from the bottom to the top of the most recent rally. The Fibonacci levels then predict the amount of that the index will retrace. Generally speaking, a retracement to the first level of 38.2% is considered normal and healthy, as is a retracement to the 50% level. However, if an index retraces beyond 50% of the gains, the rally is often in danger of failing. Taking a look at a daily chart of SPY (S&P 500) below, you will notice that the low of yesterday’s selloff was exactly equal to the 38.2% Fibonacci retracement level:
Looking at this chart, you will see that we drew the Fibonacci lines from the lows of mid-May to the high of June 6 (both circled in orange). Do you notice how the 38.2% Fibonacci retracement level provided support at yesterday’s low? This confirms the most recent rally is technically still intact. Also, notice how the 20-day moving average (circled in green) is just above the 61.8% retracement level. Therefore, the 20-day MA should also serve as support if the S&P happens to retrace beyond 50%. I also found it interesting that the highs from the first half of May converge with the 61.8% retracement level, further providing price support.
If you apply the same Fibonacci lines to a daily chart of the Nasdaq Composite, you will see that yesterday’s close was equal to a 38.2% retracement. The 50% retracement is at 1580, while the 61.8% retracement is at 1560, which converges with the 20-day moving average. For the sake of comparison, below is a daily chart of the Nasdaq Composite that I have also annotated with Fibonacci lines:
Based on the sheer momentum and strong volume of last week’s rally, I would be surprised if the market retraces much more (at least in the short term). Most likely, the market will trade sideways to slightly up over the next few days, further correcting by time, before attempting to rally back up to test the highs of last week. If, however, we see an additional price retracement, remember there is major support at the 965 level in the S&P (per last week’s analysis of the S&P weekly chart). The 965 level on the S&P 500 corresponds to a price slightly higher than the 50% Fibonacci retracement level illustrated on SPY above. When combined with support of the 20-day moving average, it is a fair assumption to say there is a decent level of technical support just below the current level of the S&P that should prevent the market from going much lower, lest the multi-month rally be in danger of ending. The Dow closed below 9000 yesterday, which may put a psychological damper on the party, but it is not a big deal as long as the Dow pops back above 9000 within the next several days.
Even though we think the market will start gradually heading back up to last week’s highs, it could be choppy due to indecision and overhead supply created from last Friday’s selloff. Therefore, when buying your positions, it is wise to “test the waters” by scaling into your positions slowly. For example, if you are planning on buying a 400 share position of a particular ETF, consider beginning with only 100 shares, then add another 100 or 200 when you get more confirmation, then add your final shares when things look smooth. By scaling in, you are able to dip your toes in the water without risking much capital. Then, if you are correct with your entry, you are adding to a winning position rather than being stuck with a large losing position if you are wrong. By the way, if you trade small share size, it is VERY important to use a broker who charges you “per share” commission fees rather than one who charges you “per trade” commission fees. By doing so, you can pay the SAME amount of commission to buy a total 400 shares at three different times than it costs you to buy 400 shares all at once. However, a “per trade” commission structure would cost you three times the commission costs. Just e-mail us if you would like a few suggestions on brokers to consider.
Today’s watch list:
SPY – SPYDERS (S&P 500 Index Tracking Stock)
Trigger = above $98.75 (above yesterday’s “swing high” and the 40-MA/15 min.)
Target = $99.90 (just below the 61.8% retracement from June 6 high to yesterday’s low)
Stop = $98.15 (below support of yesterday’s close)
Notes = The S&P could start heading back higher from here and we want to be ready with SPY. However, we will only buy SPY once the S&P confirms its strength by causing SPY to trade above yesterday’s intraday resistance. If SPY gaps up to open above its trigger price, remember the MTG Opening Gap Rules, which basically state we will wait for a break of the 20-minute highs to ensure the gap will hold.
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
IWM short (from June 9) –
shorted 89.79, covered 89.06 (avg.), net points = + 0.73, net P/L = + $70
EWJ long (half position) –
bought 6.83 (avg.), stop at 6.75, target of 7.70, unrealized points = + 0.25, unrealized P/L = + $94
Per yesterday’s Wagner Daily, we shorted IWM after it broke its 20-minute opening lows and subsequently covered incrementally per intraday e-mail alerts. We received reports that a few of you had trouble borrowing shares of IWM from your broker (for shorting). Although you will usually not have a problem borrowing shares of the ETFs we short, remember you can always substitute a different ETF if you cannot get shares of the one we are trading. In this case, trading MDY would have been similar (but not the same) as trading IWM.
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