The Wagner Daily | May 11, 2005

Commentary:

The broad market followed up Monday’s light volume gains with a day of higher volume selling yesterday, as each of the major indices broke below support of their short-term consolidations. The S&P 500 Index lost 1.1%, the Dow Jones Industrial Average closed 1.0% lower, and the Nasdaq Composite dropped 0.9%. Although the Nasdaq lost nearly 1%, relative strength in the Biotech Index ($BTK) prevented its losses from being much worse. Nearly every sector we monitor closed lower yesterday, but the $BTK index ignored the broad market weakness and gained an impressive 2%.

In yesterday’s Wagner Daily, we expressed caution over the fact that Monday’s rally occurred on the lightest volume in nearly a month at the same time that the Dow and S&P were running into resistance of their 200 and 50-day moving averages respectively. As such, it was not surprising that the major indices closed lower and on increased volume yesterday. Total volume in the NYSE increased by 8%, while volume in the Nasdaq came in 10% higher than the previous day. The lower closing prices combined with the higher volume means that yesterday was technically a bearish “distribution day” that was indicative of institutional selling. Yesterday was the first significant price correction since the recent rally began on April 29, but another one to two “distribution days” within the next several days could be enough to send the major indices back down to their April lows.

Throughout the past several weeks, we have been discussing the bullish potential of the Biotech sector ($BTK), which has begun to show major relative strength in the face of a weak broad market. While it is always better to trade in the same direction as the general market, down in this case, many stocks within the Biotech index have been marching to a different beat. The $BTK has closed higher for the past eight consecutive days. More importantly, it has just broken out above resistance of its weekly downtrend line that had been in place for a little more than a year. The weekly chart of the $BTK below illustrates the breakout above the downtrend line:

Because the prior downtrend line on the $BTK should now act as the new support level, we are now in favor of buying any minor retracements (price corrections) within the sector. On the ETF front, the two main choices are BBH (Biotech HOLDR) or IBB (iShares Nasdaq Biotech Fund). Of the two, IBB is more diversified than BBH, but BBH is showing a much more bullish chart pattern. While IBB is still in a weekly downtrend, BBH conversely is consolidating at a new multi-year high. Note that Genentech (DNA) comprises a large percentage of BBH, so the ETF will tend to follow DNA to a large extent. Regardless, the diversification of the twenty stocks that represent BBH still provides a better risk than trading an individual Biotech stock like DNA.

Yesterday’s loss in the S&P 500 caused the index to drop down into “no-man’s land,” stuck between major areas of both support and resistance. Overhead resistance remains at both the 50-day moving average and the prior weekly uptrend line that was broken last month. But the index has support of its 200-day MA below. It is also holding above the pivotal 1,163 level, which is where the index bounced both in January and March of 2005. Because the index is trapped between support and resistance, we do not recommend trading in SPY right now (unless you are only daytrading it). The daily chart below shows how the S&P is “boxed in”:

As for the broad-based ETFs, the technical picture in DIA (Dow Jones Index Tracking Stock) is more clear because the index has been unable to rally above both its 200-day MA and its prior lows from January and March of 2005. This means there is more overhead supply on the Dow, but not much support below. Take a look:

Between shorting SPY and DIA, the DIA trade provides a better risk/reward, which is why we shorted it yesterday. We also recommend avoiding the short side of the Nasdaq and its related ETFs due to strength in the Biotechs. The Semis are also showing some relative strength and could prevent the index from dropping right now. It’s quite possible we will see divergence among the major indices, as money seems to be flowing out of the Dow and into a few Nasdaq-related sectors such as Biotechs and Semis. Being simultaneously long the strongest sectors and short the weakest ones is a good idea as long as the S&P is “trapped.”

Today’s watch list:

There are no new trade setups for today, although we are now short DIA per yesterday’s newsletter.

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 = + $94

Notes:

We are now short DIA per yesterday’s Wagner Daily trade setup.

Edited by Deron Wagner,
MTG Founder and
President