After a relatively flat opening on Friday, the broad market quickly sold off during the first thirty minutes of trading, which caused the
major indices to drop to support of the previous day’s mid-afternoon consolidation. For the next several hours, the major indices traded in a relatively narrow, sideways range until buyers stepped in during the final hour and pushed the S&P 500, Dow Jones Industrials, and Nasdaq Composite to new intraday highs. The end result was a mild 0.3% gain in each of those three indices. As we have seen for the past six Fridays, volume dropped off significantly over the previous day. Total market volume in the NYSE was 19% lower than the previous day, while volume in the Nasdaq was 16% lower. Nevertheless, breadth was positive as advancing volume outpaced declining volume by a ratio of 1.9 to 1 in the NYSE and 1.61 to 1 in the Nasdaq. For the week, the Dow was the clear winner and closed with a 1.8% gain, while the Nasdaq closed only 0.6% higher.
The recent leadership in the Dow has been interesting because it is rare for a rally to be sustained without the Nasdaq leading the way. For now, the relative strength in the Dow, combined with the recent “distribution days” in the Nasdaq, indicates institutional sector rotation out of the more aggressive growth sectors such as technology and biotech and into the “old economy” sectors such as energy and cyclicals. Astute traders can profit from both sides of the market by following the institutional money flow and initiating trades in the direction of the sector rotation. By riding along on the coat tails of the “big boys,” you significantly reduce your risk and increase your potential profits because you are not fighting the trend. For example, why would you want to have been long QQQ (Nasdaq 100 Index) over the past week when being long DIA (Dow Jones Industrials) would have clearly been a more profitable and lower-risk trade? It’s much easier for the Dow to close most days with gains right now than for the Nasdaq, simply because the Dow is sitting at a new 52-week high, but the Nasdaq is not. Just as water flows in the direction of the path of least resistance, stock indexes with the least overhead supply (resistance) will generally go the highest.
Friday’s fractional gains caused both the S&P 500 Index and Dow Jones Industrial Average to once again close at new 52-week highs. However, the Nasdaq is still 2.5% below its prior high, which was set on December 3. Below are daily charts of SPY (S&P 500 Index), DIA (Dow Jones Industrials), and QQQ (Nasdaq 100 Index) that illustrate this recent divergence:
More important than any technicals, the most important factor that is likely to determine today’s market direction will be the traders’ real reactions to the capture of Saddam Hussein over the weekend. Not surprisingly, the initial knee-jerk reaction has been very positive in both the global markets and in the U.S. pre-market futures markets. Among other things, it may be anticipated that the capture of Hussein will eventually lead to less resistance in Iraq, which could thereby aid a deficit reduction due to decreased U.S. military spending. If this occurs, the dollar could begin strengthening, thereby helping the economy. Of course, this is just one of many scenarios that traders will be betting on going into today. But, the big question is whether or not his capture will fuel a sustained rally or whether it will fizzle out in a day or two. If the violence in Iraq continues over the next several days, it may spark concern that the bombings are being orchestrated by that other sinister character, Bin Laden, rather than Hussein. In my opinion, continued Iraqi violence this week would probably counteract any market euphoria that resulted from the Hussein capture. Obviously, I am just speculating on different scenarios, but it important for traders to think about many different possible outcomes in a situation like this and not just blindly assume the market will rally. To do so is naive and dangerous.
We’re obviously looking at a large gap up in the markets today. As of the time of this writing, the S&P futures are up 10 points from Friday’s close, while the Nasaq futures are 22 points higher. While this is quite substantial, both futures markets are trading near their lows of the session since opening last evening. It is quite possible that the early morning downtrend in the pre-market futures will translate into a short-lived gap up in the regular session as well. To play it safe and prevent buying at the top, consider waiting until the first thirty minutes of trading has passed before initiating any new long positions. If the broad market is still holding near its highs of the day after the first half hour of trading, odds are good that the opening gap will be sustained, at least through the morning session. However, if traders immediately sell into the gap up and cause the market to sell off after the first thirty minutes, it would be dangerous to initiate new long positions today. If selling occurs, expect last week’s highs in the S&P to Dow to act as the new support levels. Historically, many intermediate-term market tops and bottoms have been formed on climatic news events, so the danger of blindly buying without waiting for price confirmation is very real. We’ll take a more in-depth look at technicals in tomorrow’s newsletter, after we see how the market reacts to the big news today.
Today’s watch list:
PPH – Pharmaceutical HOLDR
Trigger = above 78.10
(above prior high from November)
Target = 81.90 (retest of July high)
Stop = 76.40 (below Friday’s low)
Notes = We were looking for an entry last Friday, but it did not trigger. We still like this setup and are stalking it this week as well. However, since there is a big opening gap today, remember to use the MTG Opening Gap Rules. This means that, if PPH gaps open ABOVE its trigger price, we will only buy IF it breaks to a new high after the first 20 minutes of trading. This prevents us from buying at the top of a failed gap.
We are looking at a potentially large breakout in the Pharmaceutical Index, specifically if PPH rallies above
its prior highs from November. Weekly chart showing potential breakout as well,
with not much overhead resistance. As we see more rotation out of the tech
stocks, it is likely to flow into Drugs and other “old economy” sectors. If PPH
does not trigger today, we will keep watching for entry next week. If it does
trigger, realize the time horizon on this trade is intended to be several weeks
to a month.
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.
- OIH long (HALF position, from Dec. 5) –
bought 58.05, new stop 60.35, target
60.40 (surpassed), unrealized points = + 2.60, unrealized P/L = + $130
OIH rallied beyond our original profit target on Friday, giving us an unrealized gain of + 2.60 points. As such, we have raised the stop to just below Friday’s closing price and will continue to trail higher as we are able. PPH long did not trigger on Friday, but we are stalking it for entry today, as per above.
Founder and President