Not surprisingly, the broad market spent most of yesterday in a consolidation pattern, digesting its recent gains. Although it closed slightly positive, the S&P 500 Index traded sideways in a tight and narrow range of only five points throughout the whole day. The Dow traded in a similar fashion and also closed higher, but showed slight relative strength to the S&P. The Nasdaq began the day with an opening gap and traded sideways most of the day, but saw a wave of selling hit in the late afternoon that caused the index to lose its earlier gains from the gap up and close only slightly higher.
As you know, markets don’t go straight up for many days without pausing to correct either by time or price. A correction by price occurs in the form of a retracement or pullback, while a correction by time means that the index trades sideways (consolidates). Both forms of correction accomplish the same thing in that they allow an index to absorb gains and enable intraday moving averages to rise up to meet the price of the index. The primary difference between the two types of corrections is that a correction by time is generally considered to be more bullish (in the case of an uptrend) than a correction by price. This is because it indicates that a market was so strong that sellers did not step in to cause the market to drop. Instead, it indicates that the buyers simply took a break and prices remained in equilibrium, despite the lack of buyers. However, there is one important thing to look for to confirm a healthy correction by time: lower volume in the index than the previous day.
If market volume increases on a day in which prices traded sideways or down, it is generally considered to be bearish because it indicates a lot of trading activity occurred, but the market was unable to go anywhere. For a consolidation to be healthy, you want to see volume decrease compared to the previous day, indicating the buyers were just taking a break. However, when volume is higher than the previous day but prices trade sideways, it usually means that many buyers were trying to move the market higher, but the sellers were equally strong and prevented prices from rising. Those sellers are typically the institutions. When the price of an index or stock closes LOWER than the previous day, but on HIGHER volume than the previous day, this is known as a “distribution day,” which is generally considered to be a bearish yellow flag that institutions may be selling into strength. While this selling activity is transparent to the average investor or lay person, a thorough analysis of volume compared to price activity shows what is really happening “behind the scenes.” Most of the time, an increase in volume without any significant gain in prices leads to lower prices over the next several days. Volume is your first clue and it is the one technical indicator that never lies.
Why are we spending so much time discussing the relationship between price and volume on consolidation days? Because volume increased by 14% in the NYSE and 30% in the Nasdaq yesterday; but, after the opening gap, prices were mostly sideways across the board. Though not technically a distribution day because prices closed higher, it does tell us that a short-term correction is quite possible over the next several days, which would actually be quite healthy for the market. While I don’t think the market will go much lower this week because of the multitude of recent high-volume breakouts, odds are good we will see small price retracements and corrections in the sectors and indices that have rallied the most. In particular, watch the Semiconductor, Software, and Retail indexes, each of which have been very strong lately. SMH (Semiconductor HOLDR) began showing weakness relative to the broad market yesterday afternoon and we expect to see continued weakness for another day or two, simply as a technical correction. The 15-minute chart of SMH below illustrates the relative weakness into the close:
Like I said yesterday, this does not seem to be a good place to enter new long positions, but I would indeed feel comfortable doing so on a pullback to support of the previous breakout point. If you are currently long, you may wish to tighten your stops to protect gains. As for shorts, I would equally be cautious on the short side because we are obviously in an uptrend and you don’t want to fight it unless you are just “scalping” for quick profits on an intraday basis.
Today’s watch list:
PPH – Pharmaceutical HOLDR
Trigger = above 74.95 (above yesterday’s consolidation)
Target = 76.90 (prior “swing high” on daily chart)
Stop = 74.30 (below yesterday’s low)
Notes = We took profits on PPH yesterday, but we like the way it consolidated and held up through the close. It seems that PPH is poised to make another leg higher to at least test its prior high on the daily chart. We will look to buy back into PPH above yesterday afternoon’s consolidation at 74.95 area and will use a stop below yesterday’s low, which gives us a positive risk/reward ratio.
QQQ – Nasdaq 100 Index Tracking Stock
Trigger = below 33.58
(below yesterday’s low)
Target = 33.00 (hourly trend line support from Aug. 8 low)
Stop = 33.86 (above yesterday’s close)
Notes = Just looking to short the Nasdaq for a short-term trade that may only last one day. QQQ just got a little ahead of itself and will likely pull back to its hourly trend line support.
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
PPH long (from Aug. 26) –
bought 73.27, sold 74.84 (avg.), points = + 1.57, net P/L =
UTH long (HALF position from Sept. 2) –
bought 70.77, sold 71.75, points = + 0.98, net P/L =
UTH long (HALF position from Sept. 2) –
bought 70.77, new stop at 71.75, target of 72.95, unrealized points = + 1.26, unrealized P/L = + $62
We took profits on the PPH position yesterday through the use of trailing stops. We also sold half of the UTH position to lock in gains, but remain long the second half of the position with a tighter stop.
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