The Wagner Daily


Last Friday sure was an interesting day. Within the first half hour of trading, the S&P 500 Index was trading at a new 52-week high and it appeared that we would see a bullish day with new high closing prices across the board. However, the Nasdaq, and especially the tech stocks, showed relative weakness that morning and failed to follow-through to new highs with the S&P. The Nasdaq weakness acted as an anchor on the S&P and quickly caused the S&P to fail its breakout to new highs. By the end of the day, momentum had completely reversed and each of the major indices closed significantly lower, trapping the bulls who bought the morning breakout. Volume was a few percentage points lower than the previous day, indicating there was not a mad rush for the exit doors, but the technical damage was significant because it represented the first lower high that the Nasdaq set between subsequent bounces off its 20-day moving average (more on that in a moment). The Nasdaq has closed lower in five out of the past six sessions and lost 2.1% for the week. The Dow Jones Industrials had a fractional loss for the week, while the S&P 500 was basically unchanged.

Friday morning’s rally to new highs stopped us out of the RTH (retail) short position, but the afternoon selloff in the Nasdaq triggered our short sale in QQQ (Nasdaq 100 Index), which we took over the weekend with an unrealized gain of 50 cents, which is pretty good for QQQ. Based on the MTG Position Sizing Model, a full position of QQQ is four times the position size of RTH. Of particular interest in last Friday’s session was PPH (Pharmaceutical HOLDR), which showed incredible relative strength after breaking out from its downtrend on Wednesday. The Pharmaceutical Index ignored the broad-market weakness and closed nearly 2% higher on Friday. After Thursday’s strong rally, we expected Friday to be a day of consolidation, but the momentum was very strong and the index again closed higher. This is important to note because the S&P would have closed much lower on the day if not for the pocket of strength within the drug sector. Besides the pharmaceuticals, the Gold Index was one of the only other sectors that closed positive on Friday.

From a technical perspective, the most important event that occurred was the Nasdaq Composite’s close below its 20-day moving average. It’s not the actual close below the 20-day MA that was such a big deal, but the fact that it closed below that level after bouncing sharply off that level only two days prior. This confirms the trend that I have been warning of for the past several weeks; the length of time between each test of the major moving averages has been steadily decreasing for each of the major indices. To illustrate this, take a look at a daily chart of the Nasdaq Composite:

On the chart above, we have circled each bounce off the 20-day moving average. Starting on August 15, the first bounce off the 20-day moving average resulted in a sustained move that held the Nasdaq above the 20-day MA for 28 days, until the index crossed back below the 20-day MA on September 24. The next bounce back above the 20-day MA lasted from October 3 through October 22, which was a total of only 14 trading days, exactly half of the last period. The Nasdaq again bounced off the 20-day MA on October 28, but this time the bounce only lasted 11 days before it came down to its 20-day MA on November 11. Finally, the Nasdaq bounced off its 20-day MA on November 12, but closed below it again on November 14, only two days later! Do you notice the pattern? The length of time the Nasdaq has spent above its 20-day moving average on each bounce has been steadily decreasing since mid-August as follows: 28 days, 14 days, 11 days, 2 days. This means that the buyers have been gradually drying up on each bounce off of support. Furthermore, unlike previous bounces off its 20-day moving average, the Nasdaq failed to set a new price high on its last bounce off the 20-day MA last week. This is the first time that a lower high has been established between bounces off the 20-day moving average.

What does the decreasing length of time between bounces and inability to set a new high mean to all of us? Simply that most signs now point to a moderate market correction very soon. While it is true that institutions watch the 50-day moving average more closely than the 20-day MA, the bounces off the 50-day MA have been showing the same trend of a decreasing length of time between each subsequent bounce. Based on Friday’s selloff and today’s pre-market gap down in the futures, there is a good chance that the Nasdaq will once again test its 50-day moving average after only trading above it for 15 days. If the Nasdaq closes below its 50-day moving average within the next day or two, we will be paying close attention to how it acts in the days that follow. As you can see from the Nasdaq chart above, each test of the 50-day moving average has been short-lived before buyers stepped back in and rallied the index. So, if the index closes below its 50-day MA and fails to quickly bounce off of it, that will give us the final confirmation that a broad-based correction of 10% or more from the prior highs is probable.

If the Nasdaq closes below its 50-day MA with conviction, we expect the low of October 24 to serve as the next support level, at the 1841 area (73.63 for ONEQ). Below that level, it would represent the first significant “lower low” that, combined with last week’s “lower high,” would represent a short-term downtrend. On the other hand, the Nasdaq could easily trade down to its prior lows, find support, and enter into a narrow and choppy sideways trading range. So, we cannot assume the market will correct by price because a correction by time (consolidation) is just as likely at this point. Remember that prior support levels become the new resistance levels once the support is broken. Therefore, expect the Nasdaq’s 20-day moving average to act as resistance, assuming the index remains below it.

For the sake of brevity, we have only analyzed the Nasdaq, but both the S&P 500 Index and Dow Jones Industrials are showing similar daily chart patterns to the Nasdaq. Both the S&P and Dow are still (barely) above their 20-day moving averages, but today’s opening gap down will put both indices below their 20-day MAs as well (assuming the pre-market gap down remains intact into the open). Like the Nasdaq, expect the October 24 lows to provide support. This is at 1018 for the S&P 500 (102.18 for SPY) and 9497 for the Dow (95.10 for DIA). All three major indices have support of their 20-WEEK moving averages just below their October 24 lows as well. Therefore, while we do not expect a sudden collapse below the October 24 lows, it is looking probable that those levels will at least be tested, especially if the indices close below their 50-day MAs within the next day or two.

We spoke about EWJ (Japan Fund) last week and the fact that we have been looking for a re-entry point. With the Nikkei down nearly 4% overnight, it appears that we may soon see our re-entry point. As you may recall, we are looking to buy EWJ around the 8.60 area, which is support of its 20-week moving average. So, we will continue stalking EWJ and wait for signs of stabilization, but just a quick reminder on that one.

As it appears that the major indices may be headed for a moderate correction, we’ll wrap up with a reminder — don’t be stubborn and hold on to any losing long positions you may have! The worst thing a trader can do to his pocketbook AND his soul is let a small loss turn into a big loser. If you still like a specific stock or ETF and are afraid that you will miss a move when it heads back up, remember that you can always re-enter, and usually at a better price than where you sold. If you are still aggressively long, capital preservation MUST be your primary focus right now.

Today’s watch list:

We are short QQQ from over the weekend and are considering also initiating short positions in both SPY and DIA as well. However, we want to make sure the pre-market gap down in the futures remains intact into the first reversal period today. If it does, we will probably short SPY and/or DIA for swing trades, and we will e-mail you an alert when/if we do. Just don’t want to list a specific trigger price today until we see how the market reacts at this key test of 20-day MA support for the S&P and Dow.

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 (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:

    RTH short (from Nov. 13) –
    shorted 92.27 (avg.), covered 93.18, points = (0.91), net P/L = ($94)

Open Positions:

    QQQ short (from Nov. 14) –
    shorted 35.48, WILL COVER HALF POSITION ON THE OPEN, new stop of 35.05 for remaining shares, unrealized points = + 0.45, unrealized P/L = + $180


Per Friday’s newsletter, we shorted QQQ when it triggered in the afternoon and took the whole position over the weekend. Note that we will be covering half the position size immediately on today’s open and will use a stop of 35.05 for the second half of the position. RTH stopped us out when the S&P broke out to new highs in the morning.

Edited by Deron Wagner,
MTG Founder and President