The Wagner Daily | May 10, 2004

Commentary:

Last Friday began as a day of divergence, with the Nasdaq showing much strength and trading above the previous day’s high, while the S&P 500 and Dow Jones Industrial Average both consolidated near their intraday lows. This resulted in the Nasdaq spending most of the day in the positive, while the S&P and Dow both spent most of the day in the red. When the major indices diverge as widely as they did on Friday, it typically creates choppy conditions because one index is trying to break out while the other is trying to sell off. In the end, one of the the indices usually wins the battle and drags the other one with it. This time, the weakness in the S&P and Dow overpowered the strength in the Nasdaq, which caused a broad-based selloff in the afternoon. The S&P 500 Index was the hardest hit and closed with a 1.4% loss, while the Dow followed closely behind and closed 1.2% lower. The Nasdaq Composite Index, which usually registers larger gains on the winning days and bigger losses on the losing days, only closed 1.0% lower. Volume increased by 8% in the NYSE, which means that Friday was another day of distribution in the S&P and Dow. However, total market volume declined by 7% in the Nasdaq, which is what the bulls would want to see on a day of lower closing prices. The increased volume in the NYSE, but lower volume in the Nasdaq, confirms the heavier selling in the S&P and Dow. More importantly, Friday’s breadth in the NYSE was extremely negative, as declining volume outpaced advancing volume by a whopping margin of 12 to 1! There have only been four days within the past five years in which negative breadth registered at a margin greater than 6 to 1!

To illustrate Friday’s divergence between the S&P and Nasdaq, take a look at the two charts below. The first is an intraday chart of the Nasdaq 100 Index futures, which you will notice spent the entire morning in a bullish ascending triangle pattern, consolidating above the high of the previous day. Conversely, the second chart shows the weakness the S&P 500 Index futures exhibited during that same period of time. Notice how the S&P spent most of the morning near the previous day’s low, while the Nasdaq spent the morning at or above the previous day’s high. The horizontal red lines represent both the high and low of the previous day:

Those of you who are long-term subscribers to our services would probably agree that, as traders, one of our greatest strengths is sticking to winning positions and netting multi-point gains when we’re on the right side of a trade. However, despite having correctly anticipated last week’s selloff, the short positions we initiated in the broad-based ETFs resulted in either small profits or minimal losses. This occurred because the volatility that was associated with last Friday morning’s employment data made it difficult to stay with our winning short positions. The employment report’s anticipation and subsequent reaction caused a bullish reversal in the broad market on Thursday afternoon, large gap down on Friday morning, sharp rally to the previous day’s high, then selloff to new lows in the afternoon. When you factor in Friday’s relative strength in the Nasdaq, which formed a bullish ascending triangle throughout most of the day, it was tricky to remain short. The reason I explained all this to you is to make an important point that the market’s behavior is changing.

As trend traders, we like to trade in the direction of a stock or ETF’s primary trend because it provides us with maximum profits and minimal risk. However, when an index acts erratically or whipsaws in the opposite direction before resuming its primary trend, it makes it challenging for us to profit from the usual trend-following strategy. When this occurs, it involves a slight change in strategy, primarily with regard to the time duration of each trade. Experience has taught us that volatile markets require us to either shorten our time horizon to focus on intraday trading or use longer periods to catch bigger trends. A shorter time period, such as intraday trading, increases your probability of a profitable trade, but also requires you to take much smaller profits. A shift to a longer time frame works equally well because it allows you to have looser stops and ignore the day-to-day gyrations that occur in volatile markets. Using weekly charts, rather than daily charts, to look for support and resistance levels is helpful.

As we predicted last week, it appears that the major indices are going to at least test support of their prior lows from March. In fact, today’s pre-market gap down will already cause many of the indices to open at or near their 200-day moving averages. The Nasdaq is trying to cling to support of its 200-day MA, but it appears the other indices will soon be facing the very same test. After we see how the market reacts today, we’ll analyze the areas of the 200-day moving averages in tomorrow’s newsletter.

Although a steady downtrend may develop, it is equally possible that the major indices will enter into an extended period of sideways, range-bound trading action, particularly in the Nasdaq. Based on the divergence between the S&P 500/Dow Jones and the Nasdaq over the past several days, we feel there is a good possibility that the Nasdaq will trade sideways while the S&P and Dow trend lower. If this occurs, your best bet is to short the downtrending sectors and indices rather than attempting to trade the one that is stuck in a trading range. At this point, it’s all just educated speculation, but time will tell whether or not a change in our normal trading time frame is required. Remember that the best traders are out of the markets more than they are in the markets, so don’t feel the need to trade every day. There’s a time to be aggressive and there’s a time to chill, and right now seems to be the latter. Cash is indeed a position, and often is the best one you can possibly have.

Today’s watch list:

There are no new plays for today. We will, however, send an e-mail update when/if we enter any new ETF swing positions today.

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:

net P/L = ($10)

Open Positions:

(none)

Notes:

We closed the IWM short on Friday morning when it rallied to a new high and hit our stop. We were flat over the weekend.

Edited by Deron Wagner,
MTG Founder and
President