The Wagner Daily | September 1, 2005

Commentary:

Throughout most of yesterday, it appeared the broad market was poised to register another choppy and indecisive session, but a high volume rally during the final ninety minutes of the day caused the major indices to surge sharply higher. Small-cap stocks shook off their recent relative weakness and led the major indices higher. The Russell 2000 Index rocketed 1.9% higher yesterday, its largest single day gain in nearly two months. The momentum in the small caps helped drive both the S&P 500 and Nasdaq Composite to equally solid gains of 1.0%. The Dow Jones Industrials, as we have recently become accustomed to, again showed relative weakness, but still managed to post a 0.7% gain. Completing the picture, the S&P 400 Midcap Index also turned in a strong performance by cruising 1.6% higher. As such, our short position in MDY stopped out when it crossed above its 20-day MA, but the current gain from yesterday’s long entry in BBH easily made up for the loss. As of the close, our new BBH position was showing an unrealized gain of nearly 3 points. Regular subscribers should note the updated BBH stop price in the position summary below.

The most important factor of yesterday’s rally is that volume in both exchanges spiked significantly higher, which confirms institutions were behind the buying. Total volume in the NYSE was 23% higher than the previous day, while volume in the Nasdaq increased by 15%. Considering that NYSE volume also increased by more than 20% in Tuesday’s down day, it was even more impressive that volume surpassed that level by 23% more. Turnover in both exchanges came in well above 50-day average levels, and it was the highest volume day in the NYSE since June 24. The solid, broad-based gains on higher volume gave the major indices a bullish “accumulation day,” the first we have seen in quite a while. Nevertheless, don’t forget that both the NYSE and Nasdaq have had five days of higher volume selling (“distribution days”) within the past month as well. Yesterday’s action was certainly positive and long setups are beginning to re-appear, but caution is still in order on the long side of the market. One good reason, for example, is that the Dow Jones is still trading below its 200-day moving average.

Because the Biotech Index ($BTK) had been showing relative strength by not selling off sharply when the broad market did over the past three weeks, it was not surprising that it was also the first index to rally and lead the Nasdaq higher yesterday. The Nasdaq gained 1%, but the Biotech Index ($BTK) more than doubled that gain and posted a 2.6% increase yesterday. The other Nasdaq sector that had been showing relative strength lately, the Semiconductor Index ($SOX), gained 1.1%. Rather than outperforming the Nasdaq as one might have expected, it merely kept pace with the index instead. Compare the performance of BBH (Biotech HOLDR) and SMH (Semiconductor HOLDR) throughout the past year on the weekly charts below:

Comparing the charts, notice how SMH had been trending modestly lower throughout the past four weeks, but BBH just went sideways during that same time. Such action confirms the relative strength in BBH, which is probably the better play of the two. SMH could take off from here as well, but there is more overhead supply from the prior four weeks to contend with. Also, even if SMH rallies above its August 2 high, it will only be at a new 52-week high. Conversely, BBH is only 0.5% away from setting a fresh four-year high. Several individual stocks within the index, such as DNA and CELG, already closed yesterday at new all-time highs (we are long DNA per The MTG Stalk Sheet). As you probably know, new highs are among the best trades to swing long. Why? Simply because nobody is selling in an attempt to “just break even” if they got stuck at a higher price before the stock or ETF went lower. Anyone who wanted out of BBH has already sold within the past four years. Simply put, sellers from prior recent price levels is what creates horizontal price resistance levels. Human nature causes many people to mistakenly look to buy new lows and sell new highs, but that is usually a costly mistake. New highs typically continue go much higher simply because there are more buyers than sellers. Understanding the psychology behind this is key.

From a technical basis, the Nasdaq recovered more than the other major indices yesterday because it is the only one that is back above resistance of both its 20 and 50-day moving averages. However, we cannot be complacent on the long side because the index also closed right at resistance of its 38.2% Fibonacci retracement level. When a downtrending stock or index bounces, the 38.2%, 50%, and 61.8% retracement levels typically act as key resistance points. It is not until crossing above the 61.8% retracement that odds favor a complete reversal of the downtrend. Therefore, stay alert as the Nasdaq tests these three main Fibonacci resistance levels overhead. Support should now be found in the 2,135 to 2,140 level, near the 50-day moving average. The Fibo retracement levels are shown on the daily chart of the Nasdaq below. We removed the moving averages so you can more easily see the Fibo price levels:

The S&P 500 managed to close only half a point above its 50-day moving average, which is not enough to really confirm it has reclaimed it. Resistance of the 20-day MA is also a factor to watch going into today, as it is only one point above yesterday’s close. It seems we will need some follow through in the form of decent volume in order to push the S&P clearly back above these moving averages. Short-term support on the S&P is at the 1,210 to 1,212 level (prior resistance of hourly downtrend line). Because the S&P is also attempting to recover from a month-long downtrend, Fibonacci analysis is useful with this index as well. You may wish to make a note of the three main Fibonacci retracement levels, as illustrated on the S&P chart below:

Looking at the chart above, notice how the August 22 high (circled in blue) perfectly correlates to the 61.8% retracement. Interestingly, it is a common occurrence for prior highs to match up with pivotal Fibo levels as well. When this happens, it adds further validity to the resistance level due to the convergence that occurs.

The Dow Jones is still below even its first 38.2% Fibonacci retracement and also remains approximately 0.5% below resistance of its 20, 50, and 200-day moving averages which have all converged together. While the Nasdaq and Small Caps may be trying to recover, the Dow is acting like an anchor. When the major indices begin to diverge away from each other, it creates choppy and erratic market conditions rather than smooth trends. Therefore, for the sake of all swing traders, we need to either see the Dow play “catch up” or for the Nasdaq to fall back down. Either one is fine with us because we trade both sides of the market and any trend is better than the chop and indecision that has recently been plaguing the market.

Today’s Watchlist:

There are no new setups for today, although we will be adding to BBH if it clears 197.20 (see bold text in “notes” below).

Daily Reality Report:

Below is an overview of all open positions, as well as a performance report on all positions that were closed only since the previous day’s newsletter. Net P/L figures are based on the $50,000 Wagner Daily model account size. Changes to open positions since the previous report are listed in red text below:

Open positions (coming into today):

also see bold text in “notes” below

stop 192.30

unrealized P/L = + $289

ICF short (300 shares from Aug. 26) –
shorted 72.87, stop 74.75, target 69.80, unrealized points = (1.13), unrealized P/L = ($339)

Closed positions (since last report):

net P/L = + $92

MDY short (300 shares – half from Aug. 25, half from Aug. 26) –
shorted 128.40 (avg.), covered 129.39, target 123.20, points = (0.99), net P/L = ($305)

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

$41,800

Notes:

we will be adding 100 shares to BBH if it trades over 197.20 (which will put BBH at a new four-year high). Stop on the additional shares, if they trigger, will be at 194.20

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Edited by Deron Wagner,
MTG Founder and
Head Trader