The Wagner Daily | January 29, 2004

Commentary:

A dose of reality hit the broad market yesterday after the Feds left interest rates unchanged, but dropped the words “considerable period” from their forward bias with regard to how long rates will remain unchanged. The major indices spent the first half of yesterday in a narrow, sideways range near the previous day’s lows, but a sharp, high-volume selloff began after the FOMC announcement at 2:15 pm EST. The selloff was very broad-based and only the Utilities Index ($DJU) managed to remain in the green by the end of the day. The S&P 500 and Dow Jones Industrial Average both closed 1.4% lower, while the Nasdaq Composite lost 1.8%. Even the Russell 2000 Small Cap Index, which has been showing a lot of relative strength lately, was hit equally hard and closed 1.6% lower. The S&P Mid-cap Index lost 1.5%. Sectors that are sensitive to interest rates, such as the Dow Jones Home Construction Index, got smashed. The $DJUSHB lost 5.5% yesterday! Total market volume was 12% higher in the NYSE and 5% greater than the previous day in the Nasdaq. This means that yesterday was the second consecutive “distribution day” in which the broad market closed lower, but on higher volume. This is indicative of institutional selling. Needless to say, the selloff put our ETF short positions well in the money, especially IWM (small caps) and MDY (mid caps). We may have been a bit early to the short selling party, but it appears we are now well positioned for a broad-based correction.

From a technical point of view, yesterday’s selloff caused many sectors and indices to break below key support levels. The selling was enhanced by the fact that many sell stop orders were placed below these key moving averages and trendlines that were broken yesterday. Our first warning that the market may have been poised for a correction was Tuesday’s high volume “distribution day” that we discussed in yesterday’s newsletter. We also mentioned that both IWM and MDY closed below support of their 40-period moving average on the hourly charts for the first time in about a month. Their inability to quickly rally back above their 40-MAs yesterday increased the likelihood they would break lower. You may also recall that QQQ closed right on its 20-day moving average on Tuesday, so any subsequent selling in the Nasdaq would have caused it to break below support of its 20-day MA, which is what occurred yesterday.

Let’s take a look at some key support/resistnace levels that are now in play on the daily charts. One closely-watched break of support was the Nasdaq Composite’s break of its 20-day moving average, which we have annotated below:

Although the Nasdaq broke support of a multi-week consolidation, this is actually healthy for the overheated Nasdaq because a correction will probably enable the index to drift back down to its 50-day MA, which is right at the 2000 price level. The 50-day MA also converges with the primary uptrend line that began in March of 2003. Since the 20-day MA was broken yesterday, we would be extremely cautious about entering any new long positions in the Nasdaq until the index corrects down to its 50-day MA, which will probably provide a low-risk level to begin building long positions again. Short sellers may want to remain short either QQQ (Nasdaq 100 Index) or ONEQ (Nasdaq Composite Index) with a stop just over yesterday’s high. Also of importance is the fact that the Nasdaq Composite closed BELOW its 200-week moving average yesterday (reference a weekly chart).

Like the Nasdaq Composite, both the S&P 500 and Dow Jones Industrial Average also closed BELOW their 20-day moving averages. Their respective 50-day moving averages are well below yesterday’s closing prices in both the S&P and Dow, so our thoughts on SPY and DIA are the same as we discussed with QQQ and ONEQ above. In summary, use extreme caution getting long here because both these indices could easily correct down to their 50-day MAs, which would be good for the long-term of the markets. On the S&P 500, the 50-day MA is converging perfectly with the primary uptrend line from the March 2003 low, just like with the Nasdaq. Below are daily charts of both the S&P 500 and Dow Jones:

As of yesterday’s close, the S&P 500 Index is now only 3 points above its closely-watched 200-week moving average. Even if the S&P holds above it for the next few days, it is looking pretty likely that the S&P 500 will close lower on the week, which would mark an end to the nine-week winning streak. Last week’s “doji star” candlestick on the weekly chart of the S&P gave us an early warning as to the potential reversal in the S&P this week.

Given the severity of yesterday’s drop, we would not be surprised to see a bounce today. However, rather than buying yesterday’s weakness, we would view the bounce as an opportunity to unload any long positions you became stuck with and to consider selling short if you are not already. If volume would have been light over the past two days, we would be less inclined to be bearish, but the increased volume indicates that institutions have begun selling. Since institutions are responsible for approximately 70% of the market’s activity, your odds are always better when you trade in the direction of institutional interests. As for how high the market may bounce, consider using Fibonacci retracements to predict the extent of the bounce. To do so, simply measure the range of yesterday’s selloff from the intraday high down to the intraday low, and mark the 38.2%, 50%, and 61.8% retracement levels from the intraday lows. These are the levels at which you could expect to see resistance into any strength today. As always, remember to trade what you see, not what you think1.

Today’s watch list:

Since we currently have three open positions, there are no new additional plays for today. Instead, we will focus on micromanaging the stops in our open short positions to achieve maximum profit potential with minimal risk. Any changes to the stops on open positions will be e-mailed to everyone who receives the Intraday E-mail Updates.

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 = + $218

MDY short (from Jan. 28) –
shorted 109.32, new stop 109.70, target 107.80, unrealized points = + 1.22, unrealized P/L = + $122

DIA short (full position, from Jan. 6 and Jan. 9) –
shorted 105.27 (avg.), new stop 106.60, target 100.50, unrealized points = + 0.20, unrealized P/L = + $40

Notes:

All three of our short positions are now in the money. Note that we have lowered the stops in each of the above positions and will continue to trail the stops lower as we are able. MDY came within 5 cents of its profit target yesterday, but we will continue trailing a stop lower to maximize profits because it is acting very weak.

Edited by
Deron Wagner,
MTG
Founder and President