The Wagner Daily | May 17, 2006

Commentary:

The market attempted to follow-through on Monday’s reversal day, but the rebound attempt fizzled out, causing the Nasdaq Composite to register its sixth straight session of losses. After drifting modestly lower in the morning, the broad market began rallying at mid-day, but resistance of the morning highs caused the major indices to close in the middle of their intraday ranges. The Nasdaq Composite lost 0.4%, both the S&P 500 and S&P Midcap 400 indices fell 0.2%, and the Dow Jones Industrial Average slipped 0.1% lower. The small-cap Russell 2000 Index was unchanged, but it also lost the most of the major indices since the big selloff began on May 11. Because of its relative weakness, we sold short the iShares Russell 2000 (IWM) into yesterday morning’s bounce.

Turnover was mixed in yesterday’s session. Total volume in the NYSE declined by 11%, while volume in the Nasdaq was 2% higher than the previous day’s level. The losses on higher volume resulted in the Nasdaq having its seventh “distribution day” within the past four weeks, four of those within the past week alone. Granted, volume in the Nasdaq was higher by only a small margin, but the fact remains that institutions have not yet given any signs of easing up on the sell side of the market. As with most selloffs in recent years, the Nasdaq’s drop began immediately after registering its fourth “distribution day” within a rolling four-week period. That is the reason why we always warn that a healthy market usually has difficulty absorbing more than 3 or 4 days of institutional selling within a month.

One sector ETF that has really taken a rapid turn for the worse is the Oil Service HOLDR (OIH), which is closely correlated to the Oil Service Index ($OSX). Take a look at the daily chart of OIH below:

After consolidating near its 52-week high for the first week and a half of May, OIH gapped up to a new all-time high on May 11. However, the breakout to the new high failed that same day, causing OIH to actually lose 2.1% that day. The failed breakout trapped the bulls who bought the breakout, which in turn attracted short sellers as well. The combination of these events resulted in another loss of 3.9% the following day. OIH gapped down again on May 15, closing just above support of its 50-day moving average. In yesterday’s session, rather than bouncing off support of its 50-MA, OIH traded in a narrow, sideways range, contained within the prior day’s high and low. Just as a consolidation near a high is bullish, consolidation near a low is bearish. As such, we feel OIH can be sold short for a quick trade of one to three days if it falls below its 50-MA today. Notice how the price of the two-day low and the 50-MA also corresponds to support of the April 27 low as well. A break of that prior low should further add to the downward momentum if it breaks. Other energy ETFs have similar chart patterns (see the ETF Roundup for a list), which is why we remain short half of our short position in the S&P Select Energy SPDR (XLE).

Although the major indices each finished lower yesterday, the one positive is that they held above their lows of the prior day. As such, the broad market could still attempt to bounce higher in today’s session, but it will be quite bearish if the major indices fall below their two-day lows. Such an event would indicate a complete lack of buying interest, despite stocks having fallen such a large percentage over the past week. Typically, we like to see at least a two-day bounce before initiating new short positions on stocks or ETFs that have broken key support levels. However, there is obviously no guarantee the market will bounce higher before setting new lows. In such instances, we will still consider selling short on a break of the two-day lows, but will simply reduce our share size in order to minimize risk. Although we sold short IWM yesterday, we did so with smaller than usual share size.

On a technical level, yesterday was a very significant day for the Nasdaq because it closed below its 200-day moving average for the first time since October 27, 2005. After the May 11 selloff, we mentioned that the Nasdaq was more likely to test support of its 200-MA below before rallying back up to its 50-MA, and that is exactly what occurred only two short days later:

The Nasdaq only closed a fraction of a point below its 200-MA and could easily bounce back above it, but one thing for certain is that traders will be watching to see whether or not the Nasdaq holds this pivotal support level. If it does not, panic selling could begin to set in, which would further exacerbate downward momentum. Again, now is definitely not the time to be in “hope mode” with any long positions that are showing losses. Capital preservation must be your top priority because it’s difficult to place further trades and recover small losses if you lose too large a percentage of your risk capital. Of course, the only way to assure the preservation of capital is by maintaining a disciplined stance on all your stop losses. Above all, remember to trade what you see, not what you think!

Today’s Watchlist:

BBH – Biotech HOLDR
Long

Trigger = above 176.55 (above the two-day high)
Target = 186.20 (resistance of 200-day MA)

Stop = 172.55 (below the May 15 low)
Shares = 100

Notes = This setup did not trigger yesterday, but we still like it for potential long entry today. Note that we are not anticipating a complete reversal of the 6-month downtrend in BBH. Rather, we are playing a technical bounce up to resistance of its 200-day moving average. Because we are in a weak overall market, notice that we have also reduced our risk exposure on the long side by trading only 100 shares based on the model account (less than $500 risk).

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 = + $582

IWM short (300 shares from May 16 entry) –
sold short 73.47 (avg.), stop 76.18, target 69.45, unrealized points = + 0.18, unrealized P/L = + $54

Closed positions (since last report):

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

$33,191

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