For the second consecutive day, the major indices began the day with a large opening gap down below the previous day’s lows. But this time the broad market did not subsequently enter into an intraday downtrend. The S&P 500 Index and Dow Jones Industrial Average both corrected slightly from the previous day’s selloff and bounced to close fractionally higher. However, we once again saw relative weakness in the Nasdaq, which diverged from the S&P and Dow and closed 0.7% lower. After gapping down below the previous day’s low, QQQ (Nasdaq 100 Index) traded sideways in a choppy and relatively narrow range. QQQ attempted to bounce several times throughout the day, but each time it was met by overhead resistance from the previous day’s low. Remember that previous support becomes the new resistance level once the support is broken. QQQ’s inability to rally back above prior support of the previous day’s low is a good example of this basic element of technical analysis. The 15-minute chart below illustrates how QQQ kept running into resistance of the previous day’s low:
It’s also interesting to note that the 20-day moving average, which formerly acted as support for each of the major indices, acted perfectly as resistance yesterday. This is another good example of how prior support becomes the new resistance once the support level is broken. The daily charts of below illustrate how both QQQ (Nasdaq 100 Index) and DIA (Dow Jones Industrial Avg.) traded above their 20-day moving averages yesterday, but were unable to close near it:
Like we mentioned in yesterday’s newsletter, it’s likely that the major indices will quickly trade down to their 50-day moving averages once the 20-day MAs were broken. Since that occurred yesterday, we anticipate a test of the 50-day moving averages within the next day or two.
Overall, I consider yesterday’s price action to be a correction by time in which the major indices “caught their breath” by trading sideways at or below the lows of the previous day. Just as markets don’t go straight up without taking a rest, they rarely go straight down without correcting either by price (a bounce) or correcting by time (consolidation at the lows). As you may know, a correction by time is generally considered to be more bearish than a correction by price because it indicates there was not even enough buying interest to cause the market to bounce. Instead, it indicates the sellers merely took a break, but the buyers did not step in; hence the sideways trading at or below the previous day’s lows. Even though both the S&P and Dow rallied slightly and closed higher yesterday, the amount of the correction relative to the range of the previous day’s losses was minor, less than the first Fibonacci resistance level of 38.2%. The Nasdaq picture was, of course, even more bearish because it could not even bounce. When you see this type of trading action on the day after a big selloff, it often leads to another day of losses the following day because the bulls who bought just two days ago become trapped and begin to sell aggressively once they realize the market is not bouncing back to their entry prices.
In the NYSE, total market volume was about 2% lower than the previous day. Since the S&P and Dow both closed higher, but on lighter volume, this does not mean much. However, the volume in the Nasdaq came in 12% higher than the previous day, meaning that yesterday was a bearish distribution day for the Nasdaq, but not the NYSE. Interestingly, the previous day was a distribution day for the NYSE, but not the Nasdaq. Yesterday marked the second distribution day (lower closing price on higher volume) for the Nasdaq within the past seven trading sessions. While a bull market can generally absorb one or two of these days in a short period, three or more distribution days within a two week span is usually enough to cause the broad market to see a correction of 10% or more. Since more than 70% of daily trading volume is institutional, it’s very important to track what the institutions are doing with their money, and we do that by following the daily relationship between closing prices and volume changes.
Microsoft reported earnings after the close yesterday and the stock immediately traded lower, dragging the Nasdaq futures down with it. We shorted QQQ a few minutes before the close yesterday in anticipation of the Nasdaq gapping down to its 50-day moving average today. Based on the current pre-market futures action, it looks like that is exactly what will happen this morning. After the open, we will trail a tight stop on QQQ to protect our profits in the event of a strong bounce off the 50-day MA. However, if the bounce does not come, we will remain short our half position of QQQ and continue trailing a stop lower throughout the day.
It is still too early to determine if the market is in for a significant price correction that will last more than a week or two, but do you have a solid game plan if the recent weakness continues? Failure to change your trading strategy to meet the ever-changing market conditions is one of the top reasons that many traders fail. They latch on to a particular strategy that is working well for them, they make some decent profits, but then give all their profits back as soon as the market conditions change because they failed to also change when the market did. For example, buying breakouts to new 52-week highs has been a very profitable strategy, especially with individual stocks, for the past year. When a stock has broken out, it would keep running higher for several more days. However, when the overall bias of the market is negative, there is a tendency for those breakouts to fail. If you don’t recognize when these changes occur, your account will suffer a slow bleed of losses. So, make sure you are in tune with the market and don’t be too stubborn to change your strategy if you see it is no longer working.
The most obvious change to make to your trading style is to shift your bias from “buying pullbacks to support” to one of “selling short the rallies into resistance.” Selling short is an obvious way to increase your odds of profitability in a downtrending market, but many traders and investors have psychological difficulty doing so. Furthermore, those of you who trade retirement accounts do not even have the legal ability to sell short. If that is the case, you can still profit from buying the market if you can learn to spot which sectors money is flowing out of and in to. Even in bear markets, there are always market sectors that are strong because institutional money must always flow somewhere. Your job, therefore, is simply to determine which sectors are seeing the money flow. When investors get scared, money often flows out of more aggressive sectors such as technology-related stocks and into the “old economy” sectors such as Utilities, Energy, Pharmaceuticals, and Metals. If you buy these same sectors, you can often profit from upside movement, even if the broad market is weak. The great thing about ETF trading is that there is an exchange traded fund for just about every major market sector, which enables you to shift your money around just as an institution does. If you ever require assistance in locating an ETF of a particular sector, just send us an e-mail and we’ll help you out.
Today’s watch list:
(Due to the large opening gap down, our trade setups for today are once again invalidated. Unfortunately, opening gaps really make it tricky to call low-risk entry points. But, we are short QQQ from overnight, so the gap down will enable us to profit from that position. As always, we will e-mail you an alert if we find any low risk swing trade setups that we enter today.)
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
QQQ short (HALF position from October 23) –
shorted 34.25, stop at 34.50, unrealized points = + 0.09, unrealized P/L = + $18
Per an intraday e-mail alert, we shorted half position of QQQ a few minutes before the close yesterday, due to the Nasdaq’s relative weakness and anticipation of further weakness today. Rather than trailing a stop lower as we usually do, we may cover the position into weakness this morning. As always, we will update you via e-mail if we do so.
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