The Wagner Daily | October 12, 2006

Commentary:

A less than stellar earnings report from Alcoa (AA) on the first major day of earnings season triggered an opening gap down in the broad market. Buyers immediately stepped in and enabled the major indices to rally higher and “fill the gap,” but the bears arrived back on the scene and took control just after mid-day. As stocks began to retrace the morning recovery, news of a small plane crashing into a New York City building briefly sent the market sharply lower. With one hour remaining, stocks began to rebound after initial fears of terrorism abated, but the technical damage from the afternoon selloff was already done. The major indices finished the wildly erratic session near the middle of their intraday ranges and with modest losses across the board. Both the S&P 500 and Nasdaq Composite lost 0.3%, while the Dow Jones Industrial Average slipped 0.1%. The small-cap Russell 2000 fell 0.6%, but the S&P Midcap 400 declined only 0.2%.

For the first time in several weeks, both the S&P and Nasdaq registered bearish “distribution days” by selling off on higher volume. Total volume in the NYSE was 6% above the previous day’s level, while volume in the Nasdaq increased by 13%. Given that the major indices have been pushing against upper channel resistance of their daily uptrend lines for several days, it was not surprising to see a bit of healthy selling into strength. Tuesday’s session, which we suggested was an institutional “churning” day, was also a warning sign that preceded yesterday’s weakness. When turnover increases without substantial corresponding price gains, it often leads to losses the following day. This is what has happened over the past two sessions. The advancing volume to declining volume ratio was negative yesterday, but only by a margin of less than 3 to 2 in both exchanges.

After a whipsaw session like yesterday, you’re better off focusing your ETF trading efforts on specific industry sectors with relative strength or weakness rather than the broad-based ETFs. Daytraders who attempted to trade the likes of SPY or QQQQ yesterday were likely caught on the wrong side of the trend several times. With that type of action in its wake, today’s session may be equally as indecisive. So, let’s take a look at a few sector ETFs that are likely to hold up well regardless of the broad market’s direction, including two that may even breakout if the market cooperates. We’ll start with the Retail HOLDR (RTH):

As you can see, RTH has been consolidating in a sideways range for the past month and closed yesterday near the high of that range. Since it is trading at its 52-week high, there is also minimal overhead supply to contend with. We like the idea of buying a breakout above the high of its trading range (marked by the dashed horizontal line on the chart above).

Recently, we mentioned that the tight consolidation in the Semiconductor Index ($SOX) would likely lead to a strong move in either direction, but it was difficult to tell which direction it would be. Because of its 200-day moving average overhead, we predicted the next move in the associated Semiconductor HOLDR (SMH) might be to the downside, so we sold it short. Unfortunately for that position, the $SOX suddenly began to show relative strength and outperformed with a solid 1.3% gain yesterday. The sudden strength in the $SOX stopped out us out of the SMH short position, but our tight trailing stop still enabled us to realize a small profit. Despite being stopped out on the short side, it now appears that SMH is about to break out sharply above that 200-day MA and has actually become a potential long setup. Professional traders are not emotionally tied to any positions and are conditioned to purely react to the charts. Potentially switching from the short to the long side like this is one such example. Note, however, that we would only buy SMH if it convincingly clears the high of its consolidation and the 200-day MA (which has converged with the high of the range). Even then, buying such a breakout would require a tight stop just below the 200-day MA to protect against a failed breakout:

Quality short setups are really few and far between right now, but one that caught our interest is the streetTRACKS Capital Markets (KCE). Yesterday, news that Bank of America planned to offer free online trading to its customers had a negative impact on online trading firms, many of which are represented in this ETF. Although KCE has been in a steady uptrend, it gapped down sharply on yesterday’s news and closed below its 10-day moving average (the purple line on the chart below) for the first time since its current rally began one month ago. This resulted in the bulls getting trapped, and should also attract the short sellers today. This is known as a “breakaway gap” to the downside:

If you are planning to sell short KCE, you must be aware of the fact that it could easily snap back above its 10-day MA and resume its uptrend if it turns out that yesterday’s selloff was just a knee-jerk reaction. As such, the safest entry point would be on a break of yesterday’s low. Waiting for it to break the low would confirm the new-found weakness that could realistically send KCE back down to its 50-day moving average. Regular subscribers will see our exact trigger, stop, and target prices on this setup below.

Today’s Watchlist:

KCE – streetTRACKS Capital Markets
Short

Trigger = below 62.58 (below yesterdays’ low)
Target = 59.45 (probe below support of 50-day MA)
Stop = 64.19 (just beyond 61.8% Fibonacci retracement)
Shares = 350

Notes = See commentary above for explanation of the setup. Also, be aware that KCE 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 KCE 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 who 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 = + $467

UTH short (300 shares from September 28 entry) –
sold short 124.62, stop 125.78, target 119.70, unrealized points = + 0.27 unrealized P/L = + $81

Closed positions (since last report):

net P/L = + $75

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

$65,394

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