The Wagner Daily | August 15, 2006

Commentary:

The major indices leapt higher out of the starting gates yesterday morning, but as we often see in a weak market, stocks rolled over in the afternoon. The broad market still closed higher, but each of the indices gave back most of their gains and finished near their intraday lows. Both the S&P 500 and Dow Jones Industrial Average eked out gains of 0.1%, while moderate strength in the Networking and Semiconductor sectors helped the Nasdaq Composite advance 0.6%. The small-cap Russell 2000 similarly closed 0.4% higher, but the S&P Midcap 400 only managed a gain of less than 0.1%. At their mid-day highs, both the Nasdaq and Russell indices were printing 1.7% higher, but the stock market’s afternoon downtrend erased most of those gains.

Total volume in the NYSE was 6% higher than the previous day’s level, while volume in the Nasdaq increased by only 1%. Technically, the market’s broad-based gains on higher volume registered as a bullish “accumulation day” for both the S&P and Nasdaq, but the intraday action was rather negative and certainly not indicative of institutional buying. The positive is that turnover did not increase during the afternoon selloff, but it didn’t decline either. Volume levels in both exchanges finished the day about the same percentages higher than where they were when stocks were at their intraday highs. Again, we expect turnover to remain light throughout the rest of the month, as the summer doldrums don’t really end until after the Labor Day holiday.

In healthy markets, buying a breakout to a new 52-week high is one of the most simple and profitable trading strategies. However, breakouts to new highs in a weak market have a very high rate of failure. When the breakouts do fail, they trap the bulls who bought the breakouts, which typically leads to rapid downward price action. In fact, one of our favorite techniques in a bear market is short selling stocks and ETFs that break out to new highs, but immediately fail and fall back down to the bottom of their prior trading ranges. Momentum accelerates, which usually results in further downward price action and a break of the primary uptrend lines. The key to all this, of course, is making sure the breakout has actually failed before attempting to sell short. Obviously, selling short a stock or ETF that has just broken out to a new high without first waiting for confirmation of the price failure is suicidal. One such ETF that meets our criteria for a failed breakout i
s the iShares DJ Real Estate Index (IYR). On the daily chart below, notice how IYR gapped up and broke out to a new high on August 4, but promptly fell back into its prior range two days later:

Since failing its breakout, IYR has been consolidating near the low of its range. If it breaks below the August 11 low, it will also correspond to a break of its 50-day moving average. That is the point at which we would consider initiating a new short position in IYR. A logical protective stop price would be 50 cents to 1 point over the 20-day moving average. Taking a longer-term look at the technical picture of IYR, we also like that a double top has formed on the weekly chart. Resistance of the prior high from March of 2006 was one of the major reasons this month’s breakout attempt has failed:

Yesterday’s action caused both the S&P 500 and Nasdaq Composite to form bearish “inverted hammer” candlestick patterns on their daily charts. This pattern occurs when an index rallies at some point during the day, but subsequently sells off and closes near its lowest level of the session. Such price action tells us there was indecision and a tug-of-war between the bulls and bears, but the bears took control in the end. Similar bearish formations have occurred with the S&P 500 on three other days since the beginning of the month. Notice also how the 200-day moving average once again held the S&P down:

The Nasdaq Composite tested resistance of its primary downtrend line for the third time within the past two weeks, but once again failed to break out. Its “inverted hammer” candlestick formed after failing to overcome the downtrend line:

The bears had the upper hand yesterday, but don’t forget that the broad market remains choppy and range-bound in the short-term. As long as the major indices remain below their respective downtrend lines, the overall odds favor the short side of the market. However, we are laying low and focusing on managing existing positions rather than entering new ones. As mentioned in yesterday’s newsletter, this is a good time to develop your plan of attack and watchlist for both sides of the market so that you are prepared when traders return back to business in a few weeks.

Today’s Watchlist:

Until the S&P and Nasdaq break out of their ranges discussed yesterday, we are not excited about entering new positions. It is easy to overtrade in a range-bound, low-volume market, and we are not interested in churning our accounts. If, however, the market makes a big move intraday, we will send an intraday e-mail alert with any new ETF positions we assume. A potential re-entry in SLV remains on our watchlist.

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 = + $163

SDS long (300 shares from August 8 entry) –
bought 70.73, stop 68.60, target 75.30, unrealized points = + 0.28, unrealized P/L = + $84

PPH long (250 shares from August 10 entry) –
bought 74.41, stop 72.65, no target (trailing stop due to new high), unrealized points = (0.34), unrealized P/L = ($85)

Closed positions (since last report):

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

$56,823

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