Commentary:

What started out as a bullish day quickly turned ugly, as each of the major indices sold off sharply and on higher volume yesterday. After beginning the day with a large opening gap down, relative strength in the Semis enabled the broad market to quickly recover and “fill the gap,” but the bears quickly stepped in again and sent the major indices back down to their lows. By mid-afternoon, each of the major indices had broken below their opening lows and subsequently spent the remainder of the afternoon in a steady, high volume downtrend. The S&P 500, Dow Jones Industrials, and Nasdaq Composite each closed at their lows of the day and with losses of 1.5%, 1.6%, and 1.4% respectively. Total market volume in the NYSE increased by 12%, while volume in the Nasdaq surged 27% higher than the previous day’s level. It was clearly an institutional “distribution day” that eventually caused even the strong sectors to lose their early gains.

Yesterday’s sudden selloff caused some significant technical damage to the daily charts of the major indices. The Nasdaq Composite, which had been lagging behind the S&P and Dow recovery earlier in the month, closed below support of its primary uptrend line that began with the low of August 2004. It was initially probable that the Nasdaq would make a second attempt at rallying back above its 50-day moving average, but the break of the daily uptrend line obviously decreases the likelihood of that happening anytime soon. The ascending red line on the chart below illustrates the trendline support that was broken yesterday:

Because the prior trendline was broken, extreme caution is now recommended on the long side of the Nasdaq, especially outside of the Semiconductor sector (which continues to show relative strength to the Nasdaq). In fact, you may want to consider shorting either QQQQ (Nasdaq 100 Index) or ONEQ (Nasdaq Composite Index) on any bounce up to the prior uptrend line. The most basic tenet of technical analysis states that prior support becomes the new resistance after the support is broken. Therefore, expect the Nasdaq to have a difficult time getting back above the prior uptrend line (currently around the 2,055 area). The next significant area of support is at the January 24 low of 2,008. Below that, a much more important area of support is the long-term, multi-year uptrend line from the October 2002 low, which also happens to converge with support of the 200-day moving average around the 1,980 area. The monthly chart below illustrates support of the long-term uptrend:

Because both the 200-day moving average and multi-year uptrend line converge at the 1,980 area, it would be a good idea to anticipate taking profits or at least tighten stops on short positions as the Nasdaq approaches that area. If, however, the Nasdaq breaks below the 1,980 area, we would probably see a selloff down to the August 2004 low of 1,838, which also represents a 38.2% Fibo retracement of the entire uptrend from the October 2002 low.

Yesterday’s loss in the S&P put the index back below support of 50-day moving average, which had been acting as support since the beginning of the month. Unlike the Nasdaq, the S&P’s uptrend line from the August 2004 low remains well below yesterday’s closing price. The January 24 low of 1,163 is the next major area of support on the S&P 500. Remember that the January low also converged exactly with support of the major high from March 2004, as annotated by the blue horizontal line on the weekly chart below. The red ascending line illustrates support of its primary uptrend line from the August 2004 low, which also happens to converge with the 200-day moving average (not shown on this weekly chart):

The Dow Jones Industrial Average has shown more relative strength than both the S&P and Nasdaq, but it too failed to rally above its prior high from December 2004. Its sharp loss yesterday put the index just above support of its uptrend line that began with the low of October 2004 (annotated as “1” on the chart below). If that uptrend line is broken, which would only require one more day of losses, expect the Dow to fall back to its low from last month, which also converges with the long-term uptrend line from the low of March 2003 (annotated as “2” on the chart below):

Needless to say, all bets are off on the long side of the broad market, at least in the short-term. A few sectors such as Semiconductors and Pharmaceuticals are now showing relative strength to the broad market, but even strong sectors will eventually go down if the broad-based selling pressure is strong enough. We are not necessarily ready to dump our long positions in the Semis right away, but make sure you honor your stops. Don’t fall in love with your positions, no matter how good they may look. In addition, it may be time to begin testing the waters on the short side again. We’ll be analyzing the market action of the next few days for new potential short entries.

---

Today’s watch list:

There are no new trade setups for 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:

(none)

Open Positions:

SMH long (from Feb. 7) –
bought 32.55, new stop 32.48, target 34.90 on HALF, no target on second HALF (will trail stop), unrealized points = + 0.75, unrealized P/L = + $225

PPH long (from Feb. 22) –
bought 72.19, stop 70.40, target 76.75, unrealized points = (0.93), unrealized P/L = ($93)

Notes:

Per yesterday’s newsletter, we bought PPH on the open. We raised the stop to just below breakeven on SMH.

Edited by Deron Wagner,
MTG Founder and
President