Commentary:

The major indices finally broke out of a four-day downtrend on Friday, but the rally was not enough to erase losses from earlier in the week. The Dow again showed the most relative strength and closed 1.5% higher, the S&P closed 1.2% higher, and the Nasdaq Composite closed only 0.6% higher. The technology-related sectors were among the weakest on Friday, while the Consumer Cyclical sectors were strong. The Oil Service sector was very strong and OIH closed more than 4% higher on the day, surpassing our initial profit target from the July 17 entry. This sector rotation into the “more conservative” sectors such as cyclicals and oil services explains the recent strength in the Dow and weakness in the Nasdaq. We profited from several long positions in the ETF Real-Time Room on Friday and the chart below illustrates how the S&P futures broke out of the 4-day downtrend. Notice how a higher low first formed, then the ascending triangle (the orange lines), before finally breaking the upper channel resistance:

One thing I found interesting about last week was the number of “trending days” the broad market had. In a typical week, the major indices will consist of choppy or range-bound trading action for three or four days and will trend smoothly intraday only one or two days. It is, of course, during those trending days that intraday traders are able to realize the majority of their monthly profits. But last week consisted of four downtrending days and one uptrending day, meaning that every day last week was trending. Based on the law of averages, I would therefore expect to see an abundance of choppy and range-bound days this week. If I’m wrong, that’s all the better! But I just wanted to give you a heads-up as to a possible scenario in the coming week to assist you in preparing your weekly battle plan. Remember that it is best to avoid trading the broad-based ETFs (such as SPY, DIA, and QQQ) on the choppy days and instead focus on trading individual sector ETFs (such as SMH, BBH, OIH, PPH, etc.) that are showing relative strength or weakness. Or, better yet, don’t do anything on the choppy days and remain in cash. Successful traders know that simply shifting into SOH (sitting on hands) mode is often the best play.

Based on volume, Friday’s rally lacked conviction. Despite the fact that Friday was an options expiration day, total market volume was more than 16% lower than the previous day in both the NYSE and Nasdaq. Rather than there being an abundance of buyers on Friday, the light volume indicated simply that the sellers took a break. More importantly, remember that we saw two technical “distribution days” last week in which the broad market closed lower than the previous day, but on higher volume. This means that all of last week consisted of higher overall volume on the down days and lighter volume on the up days. This is the exact opposite of the volume you would want to see in a healthy bull market. Unless volume begins increasing on the up days, the heavy volume of the down days will eventually put too much pressure on the markets, eventually causing a collapse of price support. However, last week was really the first full week we noticed this bearish volume pattern since the rally began in mid-March. Therefore, it is too early to declare that the market has run out of gas. In fact, the weekly charts of the major indices continue to look solid, meaning that odds are good the broad market will make another attempt at new highs, perhaps after consolidating and correcting by time for a while longer. Furthermore, the Dow and S&P are now coming into key support of their 50-day moving averages, while the Nasdaq approaches its 20-day moving average. Below are daily charts of each of the three major indices that illustrate these key support levels to watch in the coming week:

As you can see, the major indices are each coming into critical support levels they are likely to test in the coming week. If those levels hold and volume begins increasing on the up days, then we will shift our bias to the bullish side. However, if last week’s bearish volume patterns continue, the indices could break below the support levels illustrated on the charts above. In that case, we would shift into a more bearish stance. For now, however, we remain in a relatively neutral bias and will be simply taking it “one day at a time.” Remember also that we remain in the middle of earnings season and many large companies have yet to report.

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Today’s watch list:

PPH (Pharmaceutical HOLDR)
Long

Trigger = above 79.87 (above Friday’s high and the 20-day MA)
Target = 81.10 (just below resistance of the 50-day MA)
Stop = 79.25 (below Friday’s support)

Notes = Just like Oil Service sector, the Pharmaceuticals have been out of favor for the past month, but are beginning to show signs of strength based on sector rotation back into the “old economy” sectors. We anticipate further strength after Friday’s reversal day in the index and we are just playing the bounce in the downtrend. Merck reports today as well.

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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:

OIH long (1/2 position from July 17) –
bought 56.81, sold 58.14, points
= + 1.33, net P/L = + $65

Open Positions:

EWJ long (full position from July 15 – 17) –
bought 7.81 (avg.), stop at 7.35, target of 8.80,
unrealized points = (0.17), unrealized P/L = ($148)

Notes:

We sold the rest of OIH for a solid profit on Friday and are still long a full position of EWJ, which bounced perfectly off of its uptrend line.

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)

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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.

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Yours in success,

Deron M. Wagner