The major indices closed last week with a rebound off of Thursday’s broad-based selloff. Both the S&P and Dow “filled the gap” from Thursday morning’s opening drop, while the Nasdaq showed slight relative weakness and was unable to follow suit. However, Friday’s volume was very light, about 16% lower than the previous day for the NYSE and 12% lower in the Nasdaq. This means that the selling volume on Thursday was significantly higher than the buying volume on Friday. In a healthy bull market, you would normally want to see the opposite volume pattern. But, Friday afternoons in the Summer are typically marked by lighter volume to begin with, so we need to wait for more volume confirmation this week before declaring a continuation of bearish volume patterns.
Friday’s recovery enabled the S&P, Dow, and Nasdaq to each close higher on the week, with the Nasdaq clearly showing the most strength. Although SPY (S&P 500) and DIA (Dow Jones Industrials) failed to break above their mid-June highs last week, QQQ (Nasdaq 100) closed the week above its mid-June highs. Clearly, QQQ has been the recent leader, especially in the small-cap arena. DIA continues to show relative weakness and is the only one of the major broad-based ETFs that closed the week below its 20-day moving average. The big test in the coming weeks will be whether or not the S&P and Dow have enough momentum to pierce above their mid-June highs. Because the longer-term weekly charts remain bullish, it seems likely that the broad market will make another leg higher in the intermediate term, but the unknown is whether the S&P and Dow will first enter a long period of consolidation or whether the current correction will be short-lived. For now, there are too many mixed signals to make an accurate prediction, but Friday’s resiliency and ability to recover Thursday’s losses certainly has a bullish overtone.
Friday was a good example of how technical analysis dictates that prior support becomes the new resistance level once the support is broken. As you may recall, the S&P futures spent much of last week in a narrow-range trading zone between the 1000 – 1005 level, before finally breaking below support of 1000 on Thursday. Since the 1000 level acted as support for three days in the middle of last week, that same level acted as resistance on Friday. Interestingly, take a look at the chart below and notice where Friday’s rally stopped:
As you can see, Friday’s high in the S&P futures was 1000.20, indicating that the S&P found resistance exactly at the prior support level of 1000. The reason that prior support levels become new resistance levels after support is broken is because people who were formerly long become “trapped” once support is broken (because most retail investors don’t use stop orders). Therefore, as the market attempts to recover, the rally is stopped at the prior support level because that is the point where many sell orders are located. Why? People simply have the mentality “let me just sell to breakeven.” Though it is certainly not the correct way to trade, it is the reason that prior support levels become new resistance levels. Furthermore, large round numbers such as 1000 often act as psychological support and resistance levels because many amateur investors simply set their stop orders right at simple numbers such as 1000. Going into this week, that range of consolidation between 1000 – 1005 will continue to act as resistance until it is broken.
This will be a very busy week because there are a ton of earnings reports due to be released, as well as testimony from Greenspan on Tuesday, and the usual glut of economic reports. Bank of America reported earnings before the open today and easily beat expectations, causing a pop in the futures. Citigroup is also scheduled to report before the open. There are too many big companies reporting to be named, but you can click here for an earnings calendar from the Yahoo! Finance web site. Overall, the quantity of earnings warnings was relatively small, so it’s not likely that many companies will disappoint. But, as you know, it’s not the actual report that matters, but rather it is the market’s reaction that matters. Therefore, I advise you to not read too much into any reports this week and instead focus simply on what the market is telling you.
Our bias entering the week is relatively neutral because there have been several mixed bullish and bearish signals during the past week. As such, we were all cash over the weekend. Most likely, the short-term direction will be determined by the market’s interpretation of this week’s earnings reports, although you can use technicals to predict pivotal support and resistance levels. We strongly advise caution on both sides of the market until the near-term direction of the trend is re-established. When the market is at pivotal points, as it is right now, the reversals are often fast and furious because traders who bet wrong side of the market are forced to close their positions and reverse or go to cash. As always, use those stops religiously and remember to TRADE WHAT YOU SEE, NOT WHAT YOU THINK!
Today’s watch list:
EWJ – iShares Japan Fund
Trigger = HALF POSITION above 7.89 (above Friday’s high)
Target = 8.70 (just below July 2002 high)
Stop = 7.55 (below July 2 low)
Notes = As you know, we have been stalking EWJ for a long re-entry point since closing our position for 11% gain last week. Ideally, we would like to see another day or two of price correction, but the Nikkei is just too resilient and we are not seeing much of a correction. Therefore, we are looking to build a position SLOWLY by buying only HALF position if EWJ trades over 7.89 today. We will then look to add another half position on a further price correction or breakout. Remember that a half position of EWJ equals 400 shares, based on the MTG Position Sizing Model. Building a position slowly enables you to minimize risk, but still participate in any upside movement.
In addition to EWJ, we also like SPY long above the 101 area, but the gap up is very strong and we need to use caution when buying a gap up. Therefore, we are not listing SPY as an “official” play, but you could consider buying it over 101, as long as the gap holds for the first 20 minutes. Financials (XLF) may also be quite strong today. See the MTG Opening Gap Rules for more information about how we enter new trades after a large opening gap up.
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
There were not any net trade entries or exits on Friday and we were flat 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
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