The Wagner Daily | December 18, 2003

Commentary:

Yesterday was a rather quiet and uneventful day as the major indices spent the entire day trading in a narrow range, near their respective closing prices of the previous day. A small wave of buyers stepped into the markets during the final thirty minutes of trading and barely pushed both the Dow Jones Industrials and the S&P 500 Index into positive territory, causing closing gains of 0.2% and 0.1% respectively. However, the Nasdaq Composite once again lagged behind the Dow and closed 0.2% lower. Total market volume dropped considerably from the previous day and came in 17% lighter in the Nasdaq and 6% lighter in the NYSE. Advancing volume fractionally outpaced declining volume in the NYSE by a ratio of 1.3 to 1, but the volume breadth in the Nasdaq was actually negative in the Nasdaq, with declining volume outpacing advancing volume by 1.4 to 1. This divergence between the positive and negative volume breadth in the NYSE versus the Nasdaq confirms the sharp price divergence between the major indices that we have been discussing for the past two weeks.

Based on yesterday’s dull market action, it is difficult to surmise an abundance of new thoughts on the broad market without being redundant from our analysis of the past several days. The most important, yet understated, leading indicator of market direction, volume, continues to show a pattern of lighter to flat broad market volume on the up days, but heavier volume on the down days. Within the past two weeks, there have been three bearish “distribution days” in which the broad market closed lower, but on higher volume. This is exactly the opposite pattern you would want to see in a healthy bull market. Nevertheless, the Dow Jones Industrial Average has been demonstrating an impressive amount of resilience and continues to hold onto its recent gains at its 52-week high. The Nasdaq Composite, on the other hand, continues to show a lot of relative weakness and has closed below its closely-watched 50-day moving average in 5 out of the last 7 days. The last time the Nasdaq Composite closed below its 50-day MA for more than 4 out of 7 consecutive days was back in the beginning of March, exactly when the current primary uptrend began. The daily chart of the Nasdaq Composite below illustrates this:

The Nasdaq Composite’s recent inability to remain above the 50-day MA, combined with the quadruple top on the daily chart, the bearish moving average crossover in the Nasdaq 100 Index, and the bearish volume patterns, should give the bulls plenty of reasons to be cautious. Even though the Dow has been showing strength lately, we mentioned yesterday that Dow leadership is rarely sustainable. Historically, it has often marked the end of intermediate-term bull markets because it represents a flight to “safety.”

We initiated a small short position in DIA (Dow Jones Industrial Average) yesterday morning because the Dow appeared to be exhibiting relative weakness for the first time in several weeks. While we are not in the habit of picking tops or bottoms, the broad market’s recent inability to follow-through with breakdowns and breakouts has caused us to shift our strategy from buying breakouts and shorting breakdowns to one of selling into strength and buying into weakness. In other words, the risk/reward has been much more favorable lately by trading in the opposite direction of the market’s attempts at breaking higher or lower because the market has been so indecisive and mixed. Because we knew there was higher risk involved with shorting DIA near its recent highs yesterday, we only shorted HALF the normal position size in order to compensate for the increased risk. Since DIA rallied up to our stop in the after-hours market yesterday, we have adjusted the stop using the 20-minute rule for today’s open (see the MTG Opening Gap Rules for more details).

On December 16, we netted a 4-point profit in the Intraday Real Time Room from covering a short position (half size) in Beazer Homes (BZH). We shorted BZH for a swing trade on December 12 after it rallied up to resistance of its 50% Fibonacci retracement from the large selloff it had the previous week. This provided us with a low-risk entry point to re-short BZH, and we covered partial position size when it came back down to test its prior lows of December 10. The reason we tell you all of this information is because BZH has been closely mirroring the performance of the Dow Jones U.S. Home Builder
Index ($DJUSHB), which we feel may be prime to short right now. Take a look at a daily chart of the index below:

Looking at the chart above, notice how the index has rallied to close at its 50% Fibonacci retracement from the December 10 low up to the December 2 high, after breaking below support of a steep uptrend on December 9 (the red line). Since the 50% retracement often acts as strong resistance, yesterday’s rally may provide you with a low-risk entry point to short the index. If you look at the volume of several leading home builders, you will notice that the selling volume from December 9 and 10 was much higher than the volume during the retracement over the past two days. This tells us that the index has been seeing some bearish distribution and institutional selling. We remain short a small position of BZH in the Intraday Real Time Room, and anticipate the Home Builder index will break below its 50-day moving average and the December 10 low. The target is a selloff down to support of its primary uptrend line (in blue) over the next several weeks. There is not an ETF for the index, but you may consider shorting a small basket of leading stocks within the index instead. Be warned that most of the stocks in this index are VERY VOLATILE, so simply reduce your share size to compensate. Some individual stocks to consider are: BZH, LEN, CTX, PHM, RYL, KBH, TOL, DHI.

Note that volume may be light today ahead of Triple Witching Options Expiration tomorrow. With the upcoming holiday next week, volume will probably continue diminishing until after the first of the year. Lighter volume typically means more chop and less follow-through, so be careful not to overtrade and churn your account.

Today’s watch list:

We are already in two open positions, but there are no new plays today. Due to Options Expiration tomorrow and the holiday next week, we don’t want to get too loaded up with open positions because we anticipate light volume.

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:

Open Positions:

unrealized P/L = ($67)

IWM short (from Dec. 16) –
shorted 105.88, new stop at 108.10, target
100.30 (Oct. 24 low), unrealized points = (1.22), unrealized P/L = ($122)

Notes:

Per intraday e-mail alert, we shorted HALF position of DIA (see explanation in commentary above). Due to a small opening gap up today, we are using the MTG Opening Gap Rules to manage the stop. This means that we will mark the high of DIA after the first 20-minutes of trading, and the new stop will be exactly 10 cents above that price. This prevents us getting stopped out if the gap fails (as it did on Monday). We have also lowered the stop on IWM as per above.

Edited by
Deron Wagner,
MTG
Founder and President