The Wagner Daily | August 18, 2005

Commentary:

The broad market attempted to rebound from Tuesday’s losses yesterday morning, but afternoon weakness caused the major indices to give back most of their gains. At its mid-day high, the S&P 500 was trading 0.5% higher, but it sold off in the final hours and closed only 0.1% higher and near its intraday low. The Nasdaq Composite and Dow Jones Industrial Average each achieved 0.4% gains, but both indices only managed to close in the middle of their intraday ranges. Both the S&P 400 Mid-Cap Index and the Russell 2000 Small-Cap Index traded in narrow ranges and were unchanged.

Total volume in the NYSE increased by 7% yesterday, while volume in the Nasdaq was less than 1% higher than the previous day’s level. However, despite the broad market gains on higher volume, yesterday can not accurately be defined as an “accumulation day.” Most of the increase in volume came near the day’s highs, which likely indicates institutional selling into strength. Because the S&P 500 gave back nearly all its morning gain and closed near its worst level of the session, it is more accurate to label the session a day of “churning.” If you quickly punch the accelerator on a car with a powerful engine, it will make a lot of noise and the tires will spin, but the car won’t immediately go anywhere. Similarly, “churning” is a trading day in which volume accelerates, but there is no significant price gain. This type of action is usually bearish, as it typically disguises institutional selling into strength. When this scenario has occurred in the past, it has often led to new lows being formed the following day.

One industry sector that is really starting to look interesting is the U.S. Home Construction Index ($DJUSHB). We initially pointed out this index after it had broken support of its 50-day moving average on August 8. In the week that followed, the sector consolidated by trading sideways, in a narrow range near its lows. Just as sideways consolidation near the highs is bullish and usually leads to new highs, consolidation at the lows is equally bearish and often results in new lows being set. This is what happened yesterday, as the $DJUSHB dropped below the range and closed at its lowest level since June 24. The daily chart of $DJUSHB below illustrates the narrow, sideways range that resulted in a breakdown to a new low less than two weeks after closing below the 50-day moving average:

Because the Home Construction Index has been in a steady uptrend for the past five years, it is important to look at the longer term weekly and/or monthly charts in order to see key support levels that you can easily overlook on the daily chart. Doing so enables you to not lose perspective of your time horizon on any trades. The weekly chart of $DJUSHB below shows the index is still pretty far away from its primary, long-term uptrend line:

Notice that the 200-day MA (the orange line in the first chart) is also in the same vicinity as the multi-year uptrend line on the second chart. Therefore, this would be an ideal level to watch for possible reversals in any home construction stocks you may be short. As you probably know, there is not an ETF that specifically tracks this sector, but taking a small basket of stocks within the index is a good way to achieve some of the diversification that ETFs offer. The Morpheus Capital hedge fund, for example, is currently short RYL, PHM, and LEN, three stocks in that sector with similar chart patterns. Others to consider, in no particular order, are: HOV, KBH, DHI, TOL, and BZH.

As for the major indices, the S&P 500 Index is now precariously perched on top of its 50-day moving average, which it touched yesterday, but closed just above. The 50-day MA also converges with the S&P’s prior highs from June, which provides further support. The daily chart below illustrates this:

The convergence of the 50-day MA with the prior highs from June makes for a key level of support in the S&P 500. If the index holds this level, it could provide an ideal entry point to test the waters on the long side of the market again. Conversely, a firm close below the 50-day MA would probably set a negative tone for at least the next several weeks. All eyes will be on how the index acts near the 50-day MA in today’s session.

Don’t forget that the Dow, which we discussed yesterday, is also clinging to support of the more important 200-day moving average. It probed below it intraday, but closed yesterday just above it. A break below yesterday’s low would obviously be bearish for the Dow (and DIA), and could result in “panic selling” in the Dow.

The Nasdaq Composite remains below new resistance of its prior uptrend line that was broken on Tuesday, but the Semiconductor Index is holding above its primary uptrend line and could help to stabilize the Nasdaq. Again, we do not recommend shorting in the Nasdaq-related sectors, as the risk/reward is much better to short the sectors with relative weakness in the S&P and Dow. In addition to the Home Construction stocks, we still like Retail and Utilities on the short side.

Today’s Watchlist:

There are no new “official” trade setups today, as we are near our maximum buying power based on the model account size. Advanced traders, however, may consider shorting DIA if it breaks below its 200-day moving average and SPY if the S&P breaks its 50-day moving average.

Daily Reality Report:

Below is Morpheus Trading Group’s daily
performance report of trades that were closed since the last newsletter, as well an update on all open positions from The
Wagner Daily. Net P/L figures are based on the $50,000 Wagner Daily model account size.

Closed positions (since last report):

Open positions (coming into today):

unrealized P/L = + $621

RTH short (400 shares from Aug. 5) –
shorted 100.20, stop 101.45, new target 95.20, unrealized points = + 1.42, unrealized P/L = + $568

EWA long (800 shares from Aug. 3) –
bought 18.36, stop 18.35, target of new highs (will trail stop), unrealized points = + 0.24, unrealized P/L = + $192

Current equity exposure ($100,000 max. buying power):

$87,710

Notes:

Click
here for glossary and explanation of terms used in The Wagner Daily

Click here to view MTG’s past performance results (updated monthly).

Edited by Deron Wagner,
MTG Founder and
Head Trader