The Wagner Daily | February 16, 2006

Commentary:

Stocks oscillated between positive and negative territory yesterday before eventually finishing the day modestly higher, but near their best levels of the session. The Nasdaq Composite, which has fallen the harder than the S&P and Dow over the past several weeks, gained 0.6% yesterday. The small-cap Russell 2000 Index bounced 0.8% higher, but the mid-cap S&P 400 continued to show relative weakness by gaining only 0.3%. The Dow Jones Industrials also advanced 0.3%, but the nominal gain was enough to enable the blue chip index to close at nearly a five-year high. The S&P 500 moved 0.4% higher.

Unlike the previous session’s bullish “accumulation day,” total volume declined by 2% in both the NYSE and Nasdaq. However, market internals were positive in both exchanges. In the Nasdaq, advancing volume again exceeded declining volume by a ratio of 5 to 2. The ratio was also positive in the NYSE, but was only slightly better than 3 to 2.

In yesterday’s Wagner Daily, we illustrated that, with the exception of the Dow, all the major indices were still trading below their daily downtrend lines from last month’s highs. This still remains the situation because yesterday’s gains were not enough to push any of the indices through key resistance of their downtrend lines. However, the S&P 500 closed right at resistance of its downtrend line from the January 11 high. The daily chart of SPY (S&P 500 Index) illustrates this:

The most important, yet extremely simple, rule for trend traders is that we must assume any trend (up or down) will continue until the index or stock proves otherwise. Therefore, we must assume that resistance of SPY’s downtrend line will cause a resumption of the current 5-week downtrend until it proves otherwise. Because of this, SPY’s rally into its downtrend line now presents us with a low-risk short entry into strength. By shorting near the current level, stop placement just over the prior high from January 30 represents minimal risk if the downtrend reverses. If, however, the downtrend resumes, we will be short at the ideal entry price. Shorting downtrending stocks and ETFs into resistance of their downtrend lines always presents a better risk/reward ratio than shorting the first break of a support level.

Of the other broad-based indices, both the mid-cap S&P 400 and Nasdaq 100 indices closed at or just below resistance of their downtrend lines. This similarly creates low-risk short entries in both MDY and QQQQ. Between the two, we feel MDY is more attractive because it has been showing more relative weakness than QQQQ over the past two weeks. Furthermore, MDY has rallied into resistance of its prior uptrend line that it fell below on February 10. Remember that a prior support level always becomes the new resistance level after the support is broken. Therefore, MDY now needs to contend with overhead resistance of both its primary five-week downtrend line and its prior uptrend line from the October 2005 low. This is illustrated on the chart below:

As you may have noticed, MDY technically closed a few cents above its daily downtrend line, but not enough to confirm a breakout of the downtrend line. The actual S&P 400 Index remains below the downtrend line, but after-hours trading activity caused MDY to close a bit above its downtrend line. Regardless, the risk/reward for shorting MDY at this level remains positive due to resistance of the prior uptrend line. We covered our short position in MDY for a 2-point gain on February 14, but this bounce into resistance now enables us to reshort it at a much better price. Regular subscribers should note our exact trigger, stop, and target prices below.

Today’s Watchlist:

MDY – S&P 400 Mid-Cap Index
Short

Trigger = below 139.45 (below yesterday’s low)
Target = 133.70 (just above support of Jan. 3 low)
Stop = 141.79 (just above prior high from Feb. 9)
Shares = 300

Notes = See commentary above for complete explanation of the setup. Also, be aware that MDY may be on your broker’s “hard to borrow” list. This means your brokerage firm’s web site may initially tell you that shares are not available for shorting. But if this occurs, we recommend you phone your broker and specifically ask them to locate shares of MDY to borrow for short selling. With a little push, your firm should easily be able to call around and get shares for you within a matter of minutes. If not, consider switching to a different firm who offers a wider selection of stocks and ETFs for shorting. Just a little advice for those of you run into this issue.

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 = + $189

Closed positions (since last report):

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

$22,232

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