Commentary:
The major indices closed last week in rather typical quadruple witching fashion — intraday trend in the morning, followed by counter-trend bounce into the final hour of trading. The broad market trended down slowly, but steadily, from the opening bell until 2:30 pm EST. Then, as we often see at that time of day, which is known as a “reversal period,” the major indices reversed and rallied slightly off the lows. In true technical analysis fashion, the bounce in the S&P futures came after the index found support at the prior highs of both September 5 and 17. Remember that prior resistance levels typically act as new support levels once the resistance is broken. The chart below illustrates how the S&P futures found support at the prior resistance of September 5 and 17, right at the 1030 level:
As you can see from the chart above, the bounce ran out of gas when the S&P futures tested its prior intraday high, around the 1035 level. This caused the S&P futures to close in the lower third of its intraday range and in the middle of the previous day’s range. Both the Dow Jones Industrial Average and the Nasdaq Composite traded in a very similar fashion on Friday and each of these major indices closed with minor losses on the day. Volume was only a few percentage points below the previous day in both the NYSE and Nasdaq, so not much relevance to discuss in that regard.
I want to shift gears and discuss something we rarely speak of — monthly charts. Although the time frame of monthly charts is too long to provide you with guidance for any detailed entry or exit points on multi-day “swing” trades, this time interval is very important in understanding the “big picture” of what is really happening in the markets. As you know, the longer the time interval of a chart, the more bearing or weighting that it provides with regard to market direction. For example, an hourly chart is more powerful than a five-minute chart, a daily chart is more important than an hourly chart, a weekly holds more weight than a daily chart, etc. As such, it is crucial to always utilize what I refer to as a “top-down” approach to analyzing the markets rather than a “bottom-up” approach. This simply means that I always begin my analysis by looking at the longer time frames and then subsequently narrowing the time intervals down to less significant levels. Doing so will occasionally cause me to miss a small move in a particular direction, but will always enable me to be trading on the correct side of the market with regard to the “big picture.” On the other hand, having a “bottom-up” approach to the markets will cause you to catch many small day-to-day moves, but will often cause you to be fighting the greater trend of what is really happening. This, consequentially, prevents you from catching the big moves that could earn you very large chunks of cash that would otherwise be earned through focusing on the “big picture.” If you look at the most successful traders and money managers you can think of, they all have one thing in common: they catch the big moves in the market and don’t worry about the day to day gyrations. This is not, of course, to say that day trading is not a good thing. But, my view is that day trading is simply the “icing on the cake” that enables you to generate monthly cash flow, while catching the big multi-month moves build your equity and personal net worth. Now that you understand why a focus on monthly charts is very important, let’s take a look at a monthly chart of the Dow Jones Industrial Average, starting with the the low of the year 1990. Commentary on the chart’s annotations is below the chart:
The first thing you will probably notice about this chart is that the Dow is up against its 40-month moving average (the purple line). Notice how resistance of this 40-period moving average marked the high of the Dow’s last major rally, which ended in March 2002. You will also notice that the 40-period moving average converges with the downtrend line from the high of May 2001 (the red line). I personally feel this convergence will act as major resistance on the Dow in the coming months. More importantly, notice how the Dow is currently trading more than 3000 points above its primary uptrend line (the black line). The support of the primary uptrend line is currently around 6400. As such, I would not be surprised to eventually see the Dow head back down to support of that primary uptrend line in the coming year. If you took this a step further and applied Fibonacci to a monthly chart of the Dow, you will see that the index is trading near its 50% retracement level, which is typically a key area of resistance for a down trending index.
I know that some of you will look at this chart and want to justify the Dow’s recent rally based on the improvement in economic fundamentals, corporate earnings growth, etc. However, I am simply presenting you with an unbiased view based purely on technical analysis, without regard to any fundamentals. But, fefore you start getting really bearish based on my monthly chart analysis of the Dow, remember the time interval you are looking at here is quite long! Each bar represents an entire month’s worth of data. Therefore, it could easily take one to two YEARS before we see this happen. Another scenario is that the Dow could enter into a sideways trading range and correct by time, rather than sell off to new lows. A correction by time would enable the trend line to eventually rise up to meet the price of the Dow without the Dow dropping down to meet it. If you think about it, a correction by time would be worse for us than a sell off because it is more difficult to profit from a sideways market than by simply shorting a down trending one.
Japan’s Nikkei saw a large 4% price correction overnight and the European markets are quite weak today as well. As such, both the S&P and Nasdaq futures are already trading down over 1% from Friday’s closing levels. Obviously, we are looking at a pretty weak opening today. Although many charts pointed to higher prices last week, the rallies were not very convincing to me, nor were the volume patterns. That is why we were testing the waters on the short side with a few positions last week. While we were a bit early to the party and took some small losses, we feel that today’s opening gap down could set in motion a significant price correction in the major indices IF, and only if, the market does not recover its losses within the first hour of trading today. If a large opening gap is not filled within the first hour of trading, the market will typically continue to trade further in the direction of the gap throughout the remainder of the day. Therefore, it would be very wise to close out any long positions that do not recover their losses within the first hour of trading. Don’t let your winning trades turn into losers! If, by some chance, the market would recover later in the day (which would statistically be unlikely), you can always get back in. As far as entering new short positions, we rarely advise shorting a large opening gap down because it is too risky that the gap could snap back. However, if the gap is not filled within the first thirty to sixty minutes of trading and market internals remain weak, we feel shorts are a safe bet. Remember to TRADE WHAT YOU SEE, NOT WHAT YOU THINK!
Today’s watch list:
MDY – MIDDIES (S&P Mid-Cap Index)
Short
Trigger = below 96.90 (below Friday’s low)
Target = 94.25 (support of prior low from Sept. 12)
Stop = 97.85 (above Friday’s high)
Notes = We like the risk/reward ratio on this setup once it trades below Friday’s low. Since it will probably gap down below the trigger price, remember to use the MTG Opening Gap Rules before shorting MDY. This basically states that we wait for a break of the low of the first 20-minutes before shorting. Doing so prevents shorting a gap that reverses immediately.
We may have a few other positions we enter today, but we want to see how the market reacts to the opening gap before listing too many plays here today. As always, we will e-mail you an alert with any new positions we enter.
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:
-
(none)
Open Positions:
-
TLT long (from Sept. 18) –
bought 85.60, new stop at 85.30, unrealized points = + 0.03, unrealized P/L = + $6
Notes:
Due to quadruple witching, there were not any new trade entries last Friday. We are, however, still long TLT and have raised the stop to minimize risk.
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
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.
Yours in success,
Deron M. Wagner