The Wagner Daily | October 20, 2005

Commentary:

After beginning the day with an opening gap down that sucked in the bears, the broad market staged a swift upside reversal that gathered momentum and powered higher in the afternoon. The Nasdaq Composite surged 1.7% higher, the S&P 500 1.5%, and the Dow Jones Industrials 1.3%, as volume zoomed higher as well. Small cap stocks woke up too, as the formerly weak Russell 2000 Index rocketed 2.0% higher. The midcap S&P 400 gained 1.4%. Each of the major indices also closed firmly at their intraday highs, a notable change from most days in the first half of the month. Nearly every industry sector we follow gained more than 1% yesterday. The Semiconductor Index ($SOX) was unchanged, but its intraday reversal was impressive. Intel gapped down 3% on the open, but recovered to close only a few pennies lower. This action resulted in the $SOX trading well below its 200-day moving average in the morning, but reversing to form a bullish “hammer” candlestick with a close above it.!

For the first time this month, the S&P and Nasdaq both gained on higher volume yesterday. Total volume in the NYSE zoomed 25% higher yesterday, while volume in the Nasdaq was 29% heavier than the previous day’s level. The strong percentage gains in the broad market combined with the equally strong volume increases means that yesterday was an unequivocal “accumulation day” that was fueled by institutional buying. The 2.06 billion shares that changed hands in the NYSE made yesterday the highest volume “up day” since September 16. While one “accumulation day” does not change the fact that many “distribution days” have been had over the past month, yesterday’s action should definitely serve as a red flag to the bears.

Admittedly, yesterday’s bullish reversal was a bit surprising. But as professional traders, we don’t care why the market does what it does. The only thing that matters is that we properly react to the market’s actions (trade what you see, not what you think). We shorted both DIA and IWM on Tuesday, but simply followed our original plan and promptly covered DIA when it hit our stop price yesterday. IWM remains just below our stop price. Although it is never fun to stop out of a trade only one day after we enter it, the reasons for our short entries were quite valid at the time and our loss in DIA was kept small because we did not question why it reversed back up through resistance. Consistently maintaining the discipline to keep losses small, but let winners ride, is the reason the Morpheus Capital hedge fund has been consistently profitable since inception. Properly managing risk is much more important than being a good technical analyst.

Each of the major indices closed yesterday above their respective highs of October 17. We feel this is technically significant because it means the hourly charts are now showing a “higher low” being formed that could possibly lead to a break of the daily downtrend lines. However, it is important to wait for confirmation of this break before aggressively re-entering the long side of the market. In order to assist you with this, let’s take an updated look at the new support and resistance levels in each of the three major indices. We’ll begin by taking a look at the benchmark S&P 500 Index:

The most notable thing about the chart above is that the S&P appears to have formed the first “higher low” of the month. Obviously, the index clearly remains in the downtrend that began with its September high, but the first “higher low” increases the odds the S&P will at least attempt to rally back up to resistance of its primary downtrend line (the descending red line). Before that, however, the index will first need to get back above resistance of its 200 and 20-day moving averages, which are at 1,199 and 1,201 respectively. The 1,200 level is a key area of short-term resistance for the S&P. Above that, the closely watched 50-day moving average rests at the 1,215 level, just below the primary downtrend line. Overall, the S&P still must contend with a lot of overhead supply, but yesterday’s high volume rally was powerful and caution is now warranted on the short side because of yesterday’s action. The primary downtrend line near the 50-day MA would be the safest pl!
ace to wait for a new short attempt in SPY, but we will continue to closely assess conditions along the way. Next, take a look at the Nasdaq Composite below:

Like the S&P, the Nasdaq formed its first “higher low” of the month yesterday. More importantly, it powered back above resistance of its 200-day moving average at the 2,072 level. Short-term resistance will be found at both the 20-day MA (2,097) and the 50-day MA (2,128). It will be bullish if the index rallies back above both of those moving averages, but resistance of the primary downtrend line at the 2,152 level still remains. As you can see, the Nasdaq has been in a steady downtrend since the high of August 3. The longer a trend has been in place, the more likely the trend is to continue. Therefore, we must remember the Nasdaq is still in an intermediate-term downtrend until it proves otherwise. Finally, take a look at the Dow Jones Industrial Average:

In addition to also putting in a “higher low” yesterday, the Dow absorbed the overhead supply from its prior lows of August and September, as it closed firmly above the horizontal price resistance at 10,350. The 10,350 resistance level, which we discussed in yesterday’s Wagner Daily, was the reason we shorted DIA on Tuesday. However, we promptly covered DIA yesterday because the reason for being in the trade was no longer valid. Like both the S&P and Nasdaq, the Dow also remains in an intermediate-term downtrend. The upper channel of the primary downtrend is illustrated by the descending red line, currently just above the 200-day moving average. The 50-day moving average, presently at 10,474, is also an area of contention.

Remember that quarterly earnings season is now in full swing. With it, you need to expect erratic moves and high volatility in the markets. The major indices may have put in a short-term bottom yesterday, but a lot of overhead supply remains in the broad market. Therefore, this may be a good time to tread lightly on both sides of the market. Furthermore, you may wish to shorten your average time frame on all new trade entries, as doing so would carry a lower degree of risk in the event of indecisive market behavior. We presently have only one open position and will be looking to play only quick retracements with new trade entries. After earnings season passes, stocks will settle down and we will be able to clearly re-assess the intermediate-term direction of the markets.

Today’s Watchlist:

SMH – Semiconductor HOLDR
Long

Trigger = above 34.44 (above yesterday’s high and hourly downtrend line)
Target = 35.85 (just below 61.8% Fibo retracement and 50-day MA)
Stop = 33.70 (below 61.8% Fibo retracement of yesterday’s range)
Shares = 700

Notes = For the second time this month, SMH found support at its 200-day moving average, this time after running stops well below it yesterday. Yesterday afternoon’s action in SMH was quite bullish and it also trapped the bears. As such, we now expect at least a few days of upside follow-through. However, note that we are only looking to play a short-term bounce into resistance and are NOT expecting a complete reversal of the primary downtrend line at this point. As you can see on the chart above, our entry point will be just above the hourly downtrend line.

Daily Performance 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):

unrealized P/L = ($456)

Closed positions (since last report):

net P/L = ($374)

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

$25,404

Notes:

MTG Opening Gap Rules

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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