Commentary:

Not surprisingly, the broad market gains from the “Saddam Rally” faded quickly yesterday morning as traders sold into the strength of a large opening gap. The major indices drifted lower throughout the morning session and gave back all their gains by mid-day. The downtrend that began in the morning subsequently continued throughout the afternoon and each of the major indices closed with losses and at their intraday lows. Wagner Daily subscribers were warned against blindly buying the market just because of the Saddam news yesterday, so hopefully this advice benefitted you. Once again, the Nasdaq Composite showed the most weakness and lost 1.6%, while the Dow showed the most relative strength and only closed 0.2% lower. The broader-based S&P 500 Index closed 0.6% lower than the previous day. The Semiconductor Index ($SOX.X) was one of the hardest hit sectors and lost 2.8%. As you may recall from last week’s discussion, the SOX has really been showing a lot of weakness lately and its daily chart is looking more and more bearish. Because the Semiconductors are so heavily weighted, the Nasdaq usually follows the SOX, and the rest of the market usually follows the Nasdaq. So, keep an eye on the performance of the SOX index in the coming days as an indicator to near-term market direction.

Adding to yesterday’s bearish price reversal was the fact that total market volume came in 25% higher than Friday. This makes the third bearish “distribution day” for the NYSE within the past two weeks and the fourth one for the Nasdaq. While a bull market can sustain one or two days of lower closing prices on higher volume, things start to get pretty shaky when you begin to see three or four of these within a short period of time. As we always say, volume does not lie and it has the added benefit of showing you what’s really happening beneath the surface, even though some charts may appear bullish at first glance.

When I was a new trader, I did not understand the importance of having a firm set of rules in place for dealing with opening gaps, but I soon learned the hard way that it was a very important aspect of becoming successful. Simply put, a “gap” is the difference between an index’s closing price and the next day’s opening price. The Nasdaq Composite, for example, “gapped up” 29 points yesterday morning because the index closed at 1949 last Friday, but opened at a price of 1978 yesterday. This correspondingly represented a 1.4% opening gap. Because most amateur investors have a “follow the herd” mentality, many people will blindly buy a large opening gap up or sell a large gap down due to fear of missing “the next big move.” While this is occasionally effective, many opening gaps fail to remain intact because large-scale professional and institutional traders often use gaps as an opportunity to either unload or accumulate positions (depending on the direction of the gap). When you trade in the opposite direction of a gap, this is known as “fading” the gap. In the case of yesterday, professional traders sold into the strength of the opening gap (“faded the gap”) in order to sell their long positions and initiate short positions at the best possible prices. The end result of failed opening gaps is that the average retail investor or amateur trader is left holding the bag. However, by following a firm set of rules for managing and trading gaps, you not only avoid getting stuck, but can profit from “fading” the gaps right along with the pros. To assist you with this, we have designed the MTG Opening Gap Rules , which we recommend you review at your convenience if you have not yet done so.

In a nutshell, the MTG Opening Gap Rules mandate that we only buy a large opening gap after the stock or index rallies to a new high after the first 20 minutes of trading. Conversely, we would only short a large opening gap down if the stock or index breaks down to a new low after the first 20 minutes of trading. Waiting 30 – 40 minutes for confirmation of a new high or low is even safer. In the case of a gap up, if the index fails to make a new high after the first 20 – 30 minutes of trading, we simply do not buy. In fact, we typically “fade the gap” and initiate short positions if the index or stock makes a new low after the first 20 – 30 minutes. If you followed the Morpheus rules for managing gaps, as we advised in yesterday morning’s newsletter, you stayed out of trouble yesterday because we never received a buy signal in any of the major indices. Not a single one of the indices made a new high after the first 20 minutes and their respective opening prices marked the high of the day. From that point, the broad market entered into a steady downtrend that eventually caused each of the major indices to close with losses. If you sustained losses from buying the opening gap up yesterday, chalk it up as tuition and a lesson learned. By implementing a strict set of rules for managing gaps in the future, you will consistently avoid substantial losses and even profit by not following the herd of lemmings over the edge of the cliff.

The most important technical chart to be aware of right now is that of QQQ (Nasdaq 100 Index) above. For the first time since the current uptrend began in March, the 20-day moving average has crossed down below the 50-day moving average. This technically signals a possible reversal in the current primary uptrend that has been intact for nine months. Confirmation of this reversal would occur if the prior lows from December 10 are broken. If that happens, it will be the first “lower low” that was set since the current rally began. Combined with the bearish moving average crossover, that would likely trigger program selling in the Nasdaq. Therefore, while the Nasdaq has been quite choppy lately, it is beginning to look like we may see some resolution out of the congestion of the past several months. We will be looking to short QQQ, and possibly other broad-based ETFs, on the first break of a prior low on the daily charts. For now, we are extremely cautious against being long anything other than commodity-based ETFs or sectors such as Gold. Many good short setups are starting to present themselves and we will look to enter some of them with a little more price confirmation.

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Today’s watch list:

There are no new plays today. However, we will send an intraday e-mail alert if we enter any new positions.

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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:

OIH long (HALF position, from Dec. 5) –
bought 58.05, sold 60.29, points = + 2.24, net P/L = + $110

Open Positions:

(none)

Notes:

OIH hit its trailing stop yesterday, so we are flat now.

Edited by
Deron Wagner,
MTG
Founder and President