Commentary:

Like the previous several days, last Friday was a tug-of-war between the bulls and bears. Unlike the other days, the bears won this time. Due to a huge miss in payroll growth (1,000 new jobs versus 150,000 expected), the major indices began the day with a sharp opening gap down below the previous day’s respective lows. Despite the weak opening, the Nasdaq once again saw buying interest and reversed to “fill the gap” from a 0.8% opening loss to a 0.6% gain, as well as a new 52-week high, during the late morning session. The Nasdaq had a good chance of closing positive, but the Dow Jones Industrial Avg. really lagged behind and barely rallied off its lows while the Nasdaq rallied to a new high. Like the Dow, the S&P 500 also showed relative weakness and formed a double top at the previous day’s high rather than breaking through as the Nasdaq did. This sharp divergence between the major indices prevented the Nasdaq from holding onto its gains and the index eventually sold off during the final 90 minutes of trading to close with a 0.6% loss. The S&P 500 closed with a loss of 0.9%, while the Dow gave back 1.3%, its largest loss in several weeks. The two intraday charts below illustrate the divergence between Friday’s action in ONEQ (Nasdaq Composite Index) and DIA (Dow Jones Industrial Average):

Because the Dow was so weak on Friday, our DIA short position began working out and we also sent an intraday e-mail alert to Wagner Daily subscribers letting them know we shorted the second half of the position when DIA broke below 105.35. Based on Friday’s closing price, we now have an unrealized gain of just over 50 cents on a full position of DIA short. So far, the Dow Jones (and DIA) is reversing exactly at resistance of its monthly downtrend line from the January 2000 high. Take a look:

In addition to adding to the DIA short, the IWM (Russell 2000 Small Cap) short setup also triggered on Friday morning, but the strong late morning reversal in the Nasdaq caused IWM to rally above its high of the previous day and stop us out. Like the Nasdaq, IWM eventually rolled over and dropped down to test its morning low during the final hour of trading. Therefore, we may consider re-shorting IWM today because our timing on the entry was probably just a bit early.

It is our interpretation that Friday’s weakness in the broad market was the result of the previous several days of high volume churning that we have been discussing so extensively. Based on the huge volume increases, but minimal gains, of the S&P during January 7 and 8, it was not surprising that Friday was weak. When the market spins its wheels and “churns” on high volume, the end result is usually losses in the broad market, but it often takes several days to a week for the price action to follow the volume pattern. The fact that volume precedes price direction is the reason we have been paying such close attention to the broad market’s volume during the past week. Volume dropped off slightly on Friday, but was still well above its 50-day average for both the NYSE and Nasdaq. Breadth confirmed the weakness in the S&P and Dow because declining volume outpaced advancing volume by a margin of 1.66 to 1. However, the Nasdaq diverged and barely saw advancing volume outnumber declining volume by 1.16 to 1. We will continue reporting our interpretation of the market’s volume patterns this week as it relates to predicted price direction in the coming days.

In the Nasdaq, Friday’s opening gap down, intraday rally to a new high, then subsequent selloff in the afternoon caused the index to form a potentially bearish candlestick pattern known as a “doji star.” This type of candlestick formation does not guarantee further selling in an index, but is often a warning sign of a potential reversal. When combined with the high volume churning of the previous several days, the odds of a bearish reversal are further increased. Below is a chart of ONEQ (Nasdaq Composite Index) that illustrates the “doji star” candlestick, as well as the entry point for a new short position, which is below the low of the previous two days:

Both the S&P 500 and Dow Jones closed well below their respective lows of the previous day on Friday. This, of course, is more bearish than the pattern in the Nasdaq, which merely shows the “potential” for a bearish reversal. However, if the Nasdaq does break below Friday’s low, the selling could intensify because many sell stops are just below that level. We are already short a full position of DIA, but will therefore be looking to short ONEQ today if it breaks below the level indicated on the chart above.

Remember that corporate earnings season begins this week and, like we previously mentioned, the Street has already priced some pretty lofty expectations into the current price of the market. As the earnings reports begin to roll out, pay close attention not to the actual reports, but the market’s reaction to those reports. If we start to see selling despite positive reports, that will be taken as a bearish change of sentiment. However, we could just as well see the market surge to new highs if a few of the Big Boys impress the Street. For a list of upcoming earnings reports, click here to visit the Yahoo! Finance earnings calendar and click on the day of your choice. Keep those stops in place to protect your profits if you are long!

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Today’s watch list:

ONEQ – (Nasdaq Composite Index Tracking Stock)
Short

Trigger = below 82.92
(below the 2-day low)
Target = 79.60 (support of the 20-day moving average)

Stop = 84.25 (above the 61.8% intraday retracement from Friday)

Notes = See commentary above for explanation of the trade setup.

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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:

IWM short (from Jan. 9) –
shorted 114.36, covered 115.85, points = (1.49), net P/L = ($152)

Open Positions:

DIA short (full position, from Jan. 6 and Jan. 9) –
shorted 105.27 (avg.), stop 107.55, target 100.50, unrealized points = + 0.58, unrealized P/L = + $116

Notes:

Per the commentary above, we added to the DIA short on Friday, and were also stopped out of IWM due to the sharp intraday reversal. Based on the MTG Position Sizing Model, a full position of IWM is exactly 50% the share size of DIA, which compensated for the additional volatility in IWM on Friday and reduced our losses.

Edited by
Deron Wagner,
MTG
Founder and President