The Wagner Daily | October 28, 2005

Commentary:

The broad market suffered its third consecutive session of losses yesterday, as downward momentum generated from the prior two “distribution days” accelerated. Small cap and Nasdaq related stocks were hit the hardest, but the market’s losses were rather broad-based. The Russell 2000 Index swooned 2.3% and the Nasdaq Composite plummeted 1.7%. The S&P 500, Dow Jones Industrials, and the S&P Midcap 400 Index each lost 1.1%. Although yesterday’s action surely did not please long-term investors who never sell short, it was ideal for short-term traders because each of the major indices trended smoothly and steadily lower throughout the entire session. Per yesterday’s Wagner Daily, we shorted SPY near the open and are currently showing a marked to market profit of 1 point.

Despite substantial losses across the board, volume in both exchanges came in slightly lower than the previous day’s levels. Total volume in the NYSE was 2% lighter, while volume in the Nasdaq declined by 5%. The lower volume prevented the S&P and Nasdaq from sustaining a third straight “distribution day.” Nevertheless, volume came in above average levels in both exchanges. Market internals steadily deteriorated as the day wore on and finished quite negative. Declining volume exceeded advancing volume by nearly 5 to 1 in both the NYSE and Nasdaq, as declining issues outnumbered advancing issues by more than 3 to 1.

One driving factor behind the Nasdaq’s slide yesterday was the break of the 200-day moving average support in the Semiconductor Index ($SOX). The $SOX first dropped down to its 200-MA on October 12, but it rapidly bounced off of it. Five days later, the $SOX washed out the bears by trading well below its 200-MA on an intraday basis, but reversing to finish the day above it. The result of that action was the formation of a bullish “hammer” candlestick, but the pattern failed to reverse the October downtrend. Yesterday, for the first time since May 12, the $SOX closed below support of its 200-day moving average. Because the semiconductor stocks are so heavily weighted within the Nasdaq, the 2.7% decline in the $SOX acted as a boat anchor on the Naz. The daily chart of the $SOX below illustrates the break of key support. Also notice that the sector closed at its intraday low:

Needless to say, yesterday’s action in the $SOX does not bode well for the Nasdaq, nor the entire broad market for that matter. After trading back above its for only six days, the Nasdaq Composite also closed below support of its 200-day MA as well. Prior support becomes the new resistance after support is broken, so expect the 200-day moving averages to generate strong resistance on any subsequent rally attempt in the $SOX or Nasdaq.

As discussed yesterday, the S&P 500 never managed to recover above its 200-day MA since falling below it on October 5. Yesterday’s 1.1% slide puts the index only a few points above its October low, which is likely to be tested within the next one to two days. If the S&P breaks the October low, the next major area of support on the weekly chart is the lows of April and May 2005. This range of support from 1,136 to 1,153 is circled on the weekly chart below:

Given the overall technical picture of the major indices, we feel there is a good chance the S&P will soon break its October low and resume selling off down to the area of support circled above. As such, our plan is to remain short SPY and simply trail a stop along the way to protect our profit and maximize the gain. DIA (Dow Jones) and IWM (Russell 2000) are also good candidates to short in anticipation of a drop to their prior lows from April/May. MDY (S&P Midcap 400) has been showing relative strength to the other broad-based ETFs, but it looks good for a short as soon as it breaks its 200-day MA.

As for the long side of the market, there are very few sectors we would buy right now. The one exception is the Gold ETF (GLD), which continues to consolidate near its all-time high. Former market-leading sectors such as Oil, Utilities, and Home Construction have reversed their trends, but there has been a lack of sector leadership to fill the void. When a market lacks leadership that should occur from institutional sector rotation, it is a bearish sign for the overall health of the market. Therefore, even if you find a few stocks or ETFs that look good for long entry, it doesn’t pay to fight the trend. We know it’s an over-used cliche, but the trend really is your friend!

Today’s Watchlist:

GLD – StreetTRACKS Gold Trust
Long

Trigger = above 47.35
Target = new high (will trail a stop)
Stop = 46.25 (below the 20-day MA)
Shares = 600

Notes = This setup did not trigger yesterday due to the MTG Gap Rules, but we still like it for potential entry today. Note the new trigger price for entry and see the October 26 issue of The Wagner Daily for commentary on this setup. Also, be aware that GLD gaps a lot due to overnight changes in the price of spot gold futures. As such, always use the MTG Opening Gap Rules to manage the entry and stop prices.

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 = + $392

Closed positions (since last report):

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

$47,240

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