The Wagner Daily | March 24, 2005

Commentary:

The broad market followed up Tuesday’s selloff with an uneventful day of narrow-range consolidation yesterday. Each of the three major indices traded sideways in a tight range throughout the day and finished the day near the flat line. The S&P 500 closed 0.1% higher, the Dow Jones closed 0.1% lower, and the Nasdaq Composite was unchanged. Small cap stocks, however, showed major relative weakness, as did the mid-caps. The Russell 2000 Small Cap Index shed 1.0% while the S&P 400 Mid-Cap Index lost 0.7%. This worked out great, as our only two ETF short positions are IWM (Russell 2000 Index Tracking Stock) and MDY (S&P Mid-Cap Index Tracking Stock). When bullish speculation begins to leave the markets, the small and mid-caps often suffer the most, which is why we shorted IWM and MDY instead of QQQQ or SPY. It’s always most profitable and least risky to short the sectors and indexes with the most relative weakness.

Total market volume in the NYSE increased by 8% yesterday, but volume in the Nasdaq came in 4% lighter than the previous day. Because each of the major indices closed near unchanged levels, it’s difficult to read much into yesterday’s price to volume relationship. But the trend of the past several weeks continues to be higher volume on the down days (“distribution”) and lighter volume on the (rare) up days. Until this pattern changes, the volume patterns are telling us to maintain a bearish bias. Only a string of high volume “accumulation” days, along with the cessation of higher volume on the down days would change this view. Remember that volume never lies and is consistently one of the most reliable leading indicators at your disposal.

Although the broad market was mostly flat yesterday, there were a few sectors that showed interesting divergence. Both the Pharmaceutical Index ($DRG) and the Semiconductor Index ($SOX) closed more than 1% higher yesterday, although both the S&P and Nasdaq did nothing. Conversely, the Oil Service Index ($OSX) dropped more than 3%! This divergence among these sectors tells us we are now beginning to see major institutional sector rotation out of the formerly strong sectors and into the ones that have been left behind. Both Drugs and Semis lagged way behind the broad market during its prior rally of last year, while Oil and Oil Service stocks outperformed most sectors. However, it now appears we are beginning to see weakness in the Oil stocks and relative strength in the Drugs and Semis. When you see this type of divergence between the sectors, you can ride along on the coat tails of the institutions through buying the sector ETFs they are accumulating and shorting those they are selling. Trading in the same direction as the institutions is always a good bet. Interestingly, it appears both the $DRG and $SOX indices are reversing after testing support of their 200-day moving averages, as illustrated on the daily charts below:

Conversely, notice how the Oil Service sector broke a major shelf of support yesterday:

If you wish to lower your overall risk, consider trading the sector-specific ETFs instead of the broad-based ones. In this case, SMH is the primary ETF for the Semiconductor Index, while PPH is the main ETF that tracks the Pharmaceuticals. OIH would be the ETF to short if you are bearish on the Oil Service stocks. For SMH and PPH, you could have a low-risk swing trade if you bought both of them on the open today and placed your stops below yesterday’s lows on both of them. For OIH, you can short the open and put a stop over yesterday’s high. As for the broad market, nothing changed since yesterday’s analysis, so we’ll revisit charts of the major indices on Monday.

As a reminder, the U.S. stock markets will be closed this Friday, March 25 for the Good Friday holiday. As such, The Wagner Daily will not be published that day, but regular publication will resume on Monday, March 28. Enjoy the holiday!

Today’s watch list:

SMH – Semiconductor HOLDR
Long

Trigger = above 32.89 (above March 22 high)
Target = 34.75 (just below its prior high of the recent correction)
Stop = 32.20 (below yesterday’s close and the MA convergence)

Notes = SMH was a long setup two days ago, but it did not trigger. We still like the trade, so are stalking it for entry again today.

As we have been discussing for the past week, the $SOX is hanging around support of its 200-day MA, which has also converged with the 50-day MA. As such, we now have a low risk entry point on SMH long. If it holds the current lows, we will be long at a good price, but we can quickly exit with a minimal loss if it doesn’t. The idea of this trade is to take profits quickly and either be “right or right out.” We don’t intend to play much more than a bounce in this index UNLESS the entire broad market suddenly reverses. If it triggers, we will assess the market carefully and trail a stop as appropriate.

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:

unrealized P/L = + $284

MDY short (from March 23) –
shorted 120.11, stop 122.28, target 116.05, unrealized points = + 0.80, unrealized P/L = + $80

Notes:

Note the new stop on IWM above.

Edited by Deron Wagner,
MTG Founder and
President