The Wagner Daily | May 12, 2006

Commentary:

Stocks showed their real reaction to the Fed rate hike yesterday, as the Nasdaq suffered its worst loss in four months. Unlike a majority of recent sessions, it was also a steadily trending day — a downtrend, but at least there was a trend. The major indices opened near unchanged levels, then trended steadily lower before closing at their intraday lows. In keeping with the recent broad market trend, the Nasdaq Composite showed the most relative weakness, finishing 2.1% lower. It was the Nasdaq’s largest percentage drop since January 20. Small cap stocks realized equally substantial losses, as the Russell 2000 Index plummeted 2.4%. This time, even the Dow Jones Industrial Average and S&P 500 did not fare much better. The Dow lost 1.2%, while both the S&P 500 and S&P Midcap 400 indices fell 1.3%.

Confirming yesterday’s selloff was a surge in turnover across the board. Total volume in the NYSE increased by 13%, while volume in the Nasdaq jumped 21% above the previous day’s level. It was the third consecutive day of higher volume losses in the Nasdaq and the sixth such “distribution day” within the past four weeks. As we warned when the Nasdaq registered its fifth “distribution day” yesterday, a healthy market can usually not absorb more than three or four days of institutional selling in such a short time frame without it typically preceding a substantial selloff. But this time, even the Dow and S&P, formerly ignoring the Nasdaq’ weakness, participated in the institutional selling as well. As one might expect, market internals were firmly negative as well. In the Nasdaq, declining volume walloped advancing volume by a ratio of 7 to 1, while the ratio was negative by 5 to 1 in the NYSE.

A quick look at the daily charts of the major indices shows that a lot of technical damage was done yesterday. For starters, the S&P 500 fell all the way back down to the middle of its multi-month trading range that it broke out of on May 5:

Because the S&P was consolidating for two months before it broke out on May 5, the breakout should have been powerful and remained intact. However, as you may recall, we have been suspicious of the breakout for the past week because it occurred on such light volume. To be specific, yesterday’s fall back down into the range was on 10% greater volume than the breakout day. We get the impression that institutions and the “smart money” were waiting for the breakout, which was largely driven by retail buying, so that they could sell into strength. The breakout showed no signs of institutional participation, but yesterday’s selloff certainly did. Because more than 50% of the stock market’s volume on any given day is done by institutions, the market will usually follow the direction of the money flow from mutual funds, hedge funds, and other institutional activity.

The daily chart of the Nasdaq Composite sustained as much technical damage as the S&P. Although it has been lagging behind the S&P and Dow all along, yesterday’s decline caused the index to not only fall below its 50-day moving average, but below support of its prior low as well. Looking at the chart below, notice how the Nasdaq collapsed below support of its prior lows at the 2,295 to 2,300 level:

As you can see, the next area of support in the Nasdaq is the lows of February and March, which nearly converges with support of the 200-day moving average. Prior support of the 50-day MA has now become major overhead resistance, so we feel the Nasdaq is more likely to test its 200-day MA support level before rallying back up to its 50-day MA.

A lot of overhead supply was created in yesterday’s selloff from the investors and traders who bought the breakout in anticipation of a new uptrend. Further, the selloff attracted new short sellers who have been anticipating a failure of the breakout all along. In trading, we have learned to never say “never,” but we feel comfortable saying that it will be very difficult for the market to recover from the technical damage that was created yesterday. In just one day, the balance of power seems to have shifted to the bears. Therefore, don’t fall into “hope” mode with your long positions. If they have fallen to your predetermined stop price, be sure to maintain discipline by cutting your losses quickly. Rather than looking to buy strong stocks on this retracement, you might consider new short positions in the sectors that are demonstrating the most relative weakness. Because weakness in the techs preceded yesterday’s selloff, there is probably not a very good risk/reward to sell short the technology-related stocks and ETFs at current levels. Instead, look for those sectors that broke some type of key support level only yesterday. On the short side, we continue to like the Broker/Dealer Index ($XBD) because it closed yesterday back below its 50-day moving average after a “lower high” followed its May 1 selloff. Overall, we expect to see the S&P and Dow-related sectors to catch up with the weakness in the Nasdaq.

Today’s Watchlist:

Our patience over the past few days has paid off. Taking a “wait and see” stance on the broad market kept us out of a few long setups that we were stalking for potential entry. Now, our overall bias has shifted to the short side, but we now must wait for the ideal entry points that provide us with the best risk/reward ratio for entry. Therefore, there are no new trade setups in the pre-market today, but we will send an intraday e-mail alert if we enter any ETFs that provide us with an ideal entry point today.

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):

stop 59.69

unrealized P/L = ($28)

UTH long (200 shares from May 5 entry) –
bought 115.65 (avg.), stop 112.45, target 119.95, unrealized points = (1.35), unrealized P/L = ($270)

Closed positions (since last report):

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

$46,352

Notes:

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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