The Wagner Daily


Despite the breaks of the 50-day moving averages and “bearish engulfing” candlesticks that formed on Tuesday, the major indices showed resilience yesterday and bounced to close modestly higher. After beginning the day with a small opening gap up, the broad market trended slightly higher in the morning session, traded sideways in a tight range for several hours, then made another leg up in the afternoon session. SPY (S&P 500 Index), DIA (Dow Jones Industrial Avg.), and QQQ (Nasdaq 100 Index) each closed in approximately the middle of their respective ranges of the previous day. Because the major indices closed lower during the prior four days, it was normal to see a small bounce yesterday. Just as markets don’t go straight up without correcting along the way, they don’t go straight down either.

Although a breakdown to new lows could have easily occurred, we were not too surprised that the major indices did not follow through with further selling yesterday. Regardless of the bearish chart patterns, the most important factor we have been discussing over the past several days is that the volume of the past week’s selloff has been relatively light. As such, it does not take a lot of buying activity to move prices higher because the light volume tells us that most of this week’s lower prices were the result of a lack of buyers rather than a large abundance of sellers. But, interestingly, volume did not increase on the rally day yesterday either. In the NYSE, volume was fractionally higher than the previous day, but actually came in slightly below the previous day for the Nasdaq. So, it appears that institutions are currently not taking a heavy stance in either direction and instead are sitting mostly on the sidelines.

Compared with previous bounces off the 50-day moving averages, yesterday’s rally lacked momentum because the major indices actually retraced just a small portion of its losses. In order to better gauge an accurate idea of the market’s true strength on a reversal day, one of the best tools you can use is Fibonacci (click here to read a short article on Fibonacci). Of the three major Fibonacci retracement levels that we usually follow (38.2%, 50%, and 61.8%), we typically expect a counter-trend retracement to stop at either the 38.2% or 50% level. If an index or stock retraces beyond that level, such as to the 61.8% level or more, the odds of a complete reversal of trend are strongly increased. If you measured the amount of yesterday’s bounce and price retracement, you would see that the bounce was minor, relative to the amount of the selloff from the November 14 highs. The hourly (60-minute) chart of QQQ (Nasdaq 100 Index) below illustrates this:

As you can see, the Nasdaq ran into resistance of its 20-MA on the hourly chart and did not even have enough juice to bounce to its first major Fibo retracement level of 38.2%. However, measuring that same range in DIA (Dow Jones Industrials) and SPY (S&P 500 Index), you will see that those indexes rallied exactly up to their respective 38.2% Fibo levels, which is where they ran into resistance yesterday afternoon. Of the three indices, the Nasdaq has been the weakest, based on its inability to bounce much. Take a look at how both SPY and DIA rallied beyond their 20-MAs on the hourly charts and also made it up to the 38.2% levels:

The broad market’s inability to rally beyond the first Fibo levels yesterday tells us that we must assume the downtrend that began a few days ago remains intact. However, a rally above the 50%, and especially the 61.8% levels, over the next day or two would tip the odds towards the long side of the market. Therefore, it would be a good idea to write down the primary Fibonacci resistance levels for each of the major indices, as illustrated on the charts above.

In addition to the resistance of the next Fibonacci levels, there is a lot of horizontal price resistance that lies overhead in the major indices. Since prior support becomes the new resistance once that support level is broken, this means there is now a lot of resistance overhead that was created when the bulls became trapped in this week’s selloff. The daily chart of SPY below illustrates the new resistance level to watch:

Notice also how the 20-day moving average converges with the horizontal price resistance on the daily chart. This convergence illustrated above makes it likely that any further attempt to build on yesterday’s gains will be met with sellers. Of course, the only way to get through those sellers is if we see an increase in buy-side volume, so keep a close eye on the price/volume relationship of the broad market in the coming days. On the downside, a break of the November 18 lows would be a no-brainer to sell short due to the confirmed break of the 50-day moving averages. But, until that happens, caution continues to be in order on the short side.

The bottom line is that the market is not showing much conviction in either direction right now, as evidenced by the light volume of the past week. However, the overall technical patterns on the daily charts favor sideways to lower prices. At this point, it is probably okay to position yourself on both sides of the market, just as long as you keep your share size minimal to reduce risk of a sudden reversal. In the near-term, your odds of profitability marginally favor the short side of the market, but there are specific sectors that are showing relative strength and may provide low-risk long opportunities. In particular, the drug stocks continue to consolidate at their highs after showing a large gain and breakout last week. You can trade PPH, the Pharmaceutical HOLDR, or consider a basket of leading drug stocks such as PFE, LLY, JNJ, and MRK. The Gold sector also continues to show amazing strength and you can participate in that strength by trading in leading gold stocks such as NEM, ABX, GFI, AU, and PDG. The Gold ETF will eventually be trading on the markets, but you can look at individual gold stocks in the interim. On the downside, check out MDY, which is the ETF for the S&P Mid-cap Index. MDY has been showing relative strength to the broad market for the past month, but began to show signs of relative weakness yesterday and may be due for a correction here. You may also find short opportunities in the Home Construction Index, which failed to react to positive economic housing data yesterday morning. Leading home builder stocks to check out include: LEN, RYL, BZH, KBH, PHM, DHI, and CTX.

Today’s watch list:

MDY – S&P Mid-Cap Index

Trigger =
below 100.35 (below yesterday afternoon’s support)
Target = 98.60 (support of the 50-day MA)

Stop = 101.05(above yesterday’s high)

Notes = As discussed in commentary above, we are looking to short MDY on a break of support, in anticipation of it selling off down to its 50-day moving average. Like the other indices, it has resistance of its 20-day MA overhead. In the event of an opening gap down below its trigger price, remember to use the MTG Opening Gap Rules, which basically state we will wait for a break of the 20-minute low before shorting.

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:

    DIA short (from Nov. 18) –
    shorted 97.38, covered 97.08, points = + 0.30, net P/L = + $54

Open Positions:

    EWJ long (1/2 position, averaged from Nov. 17 and 19) –
    bought 8.66 (avg.), stop at 7.90, unrealized points = + 0.02, unrealized P/L = $8


We attempted to ride a profitable trade in the DIA short, but yesterday’s bounce caused us to take a relatively small profit of 30 cents on the trade. Nevertheless, DIA rallied further after hitting our trailing stop and may provide us with a re-entry opportunity at a better price than where we covered the short. Per intraday e-mail alert, we also bought another 1/4 position of EWJ for long term (several months) because it dropped down to key support of its 20-WEEK moving average. We will continue to look for low-risk levels to complete the long position’s share size. In the interim, we will stick with the half position size of EWJ.

Edited by Deron Wagner,
MTG Founder and President