As you typically see after several days of a tight volatility contraction and flat prices, the broad market moved sharply yesterday, albeit to the downside. Trading began the day on a positive note that saw the Nasdaq up 0.7% and the S&P 500 up 0.5% within the first ten minutes of trading, but sellers immediately took control and sent the major indices into a steady downtrend that remained intact throughout the rest of the day. Broad-based sector weakness caused the Nasdaq to lose 1.1% yesterday, while the S&P 500 and Dow Jones Industrial Average shed 0.8% and 0.5% respectively. Small cap stocks were the hardest hit group, as the Russell 2000 Index dropped 1.7%. Each of the major indices also closed near their lowest levels of the session. Upon spotting the early relative weakness in the small cap stocks, we sent an intraday e-mail alert to subscribers, informing them we were shorting IWM (Russell 2000 Index Tracking Stock). So far, the trade is working out well, as IWM closed nearly 2 points below yesterday’s short entry.
The most significant factor of yesterday’s selloff was not the percentage losses, but the fact that volume also surged correspondingly. Because the holidays had passed, an increase in volume was obviously expected. But volume in the NYSE increased a whopping 91% over last Friday’s level, while volume in the Nasdaq came in 62% higher. Volume in both exchanges came in firmly above average levels, and the Nasdaq had its highest volume day since December 17. Because the major indices closed lower and on higher volume, yesterday was a confirmed “distribution day,” which indicates institutional selling. One such day is simply a warning sign to astute traders, but more than three distribution days within a two-week period often creates enough pressure to trigger a substantial selloff.
Looking at the daily charts, you will see that each of the major indices gapped up and opened above the highs of last week’s consolidation, but promptly sold off and closed below last week’s respective lows. This type of action is generally quite bearish because it traps many of the bulls who were anticipating a breakout to new highs above the bullish consolidation. Furthermore, each of the major indices also closed below support of their primary uptrend lines that had been in place since the lows of October 25. Below are snapshots of the S&P 500, Nasdaq Composite, and Dow Jones Industrials. Notice how each of the indices have closed below their respective trendlines and are now sitting on their 20-day moving averages:
Remember that prior support levels become the new resistance levels once the support is broken. Therefore, expect each of the major indices to run into short-term resistance on any rally attempt back up to their former uptrend lines. The 20-day moving averages below should act as minor support, but a break below their 20-day MAs will likely cause each of the indices to quickly fall to their 50-day moving averages. We are currently short IWM, which is showing the most relative weakness, but we may also be looking to short SPY over the next few days as well. This, of course, will depend on the broad market’s follow up reaction to yesterday’s sudden reversal over the next few days.
Many individual, market-leading stocks rallied and broke out solid bases yesterday morning, only to fail and close back down in their prior ranges. If the broad market is unable to recover today and sees another day of high volume selling sometime this week, it is likely the major indices would enter into a short-term downtrend. Therefore, you may want to avoid aggressively entering new long positions until we see how the market follows up to yesterday’s sudden shift in sentiment. Also consider tightening up stops on any current long positions in order to protect profits and/or minimize your losses. You can’t control a sudden reversal in the market’s direction, but you CAN control the way you manage your positions. Trade what you see, not what you think!
Today’s watch list:
There are no new setups for today, although we are now short IWM from yesterday’s entry.
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.
SMH long (from Dec. 29) –
bought 33.17, sold 33.25, points = + 0.08, net P/L = + $18
IWM short (from Jan. 3) –
shorted 129.60, new stop 130.25, target 124.30, unrealized points = + 1.78, unrealized P/L = + $178
We closed SMH yesterday when it hit our trailing stop (per intraday e-mail alert). We also shorted IWM due to its sudden relative weakness.
Edited by Deron Wagner,
MTG Founder and