The Wagner Daily | October 18, 2006

Commentary:

After three days of lighter volume gains, stocks fell on higher volume yesterday, but an afternoon recovery greatly reduced the losses. At mid-day, the broad market was at its intraday low and the Nasdaq Composite was down 1.4%. But stocks rallied steadily off their lows throughout the afternoon, enabling the Nasdaq to trim its loss to 0.8%. The small-cap Russell 2000 fell 0.6% and the S&P Midcap 400 lost 0.8%. The S&P 500 followed a similar intraday pattern to the Nasdaq by reducing its 0.9% intraday loss to only 0.4%. The Dow Jones Industrial Average slipped 0.3%. Each of the major indices finished in the upper half of their intraday ranges, with the Dow nearly filling its opening gap down.

Turnover rose across the board yesterday, causing both exchanges to register bearish “distribution days.” Total volume in the Nasdaq increased by 17%, while volume in the NYSE was 6% higher than the previous day’s level. Given that the market moved higher on declining volume in each of the past three sessions, it was not surprising to see higher overall volume on the first day of losses that followed. In the S&P, it was the third “distribution day” within the past four weeks. A healthy market can normally absorb two to three days of higher volume selling within a one month period, but one or two more “distribution days” within the next week would certainly weigh on stocks.

One ETF that ignored yesterday’s weakness and is poised for a breakout of consolidation is the Vanguard Health Care ETF (VHT):

The October 5 high of $57.16 is the top of the consolidation. Yesterday, VHT came within a few cents of that high, but failed to actually test it. Still, it shows solid relative strength that VHT was able to close higher on a day when all the major indices closed lower. If the market drops over the next few days, it could prevent VHT from breaking out of its range, but this should be one of the first ETFs to breakout higher after the market finishes its correction.

The Semiconductor Index ($SOX) began to show relative strength a few days ago, but it seems that a confluence of resistance in the index is taking precedence. As we have discussed extensively in the past, the 200-day moving average is a very powerful support or resistance level that a stock or index will rarely break through on its first attempt. On Monday, the $SOX ran into its 200-day moving average, so it’s not shocking that the index fell 2.5% yesterday. But converging with that 200-day moving average was resistance of the prior uptrend line that was broken in the first few days of October. This prior uptrend line is illustrated as the ascending blue line on the chart below:

Support and resistance levels are always more powerful when there is confluence. As you can see, the 200-day moving average happened to converge with resistance of the prior uptrend line, which made it very difficult for the $SOX to go higher without a correction. Why is is that the prior uptrend line is now a resistance level? Because the most basic tenet in technical analysis states that a prior support level becomes the new resistance level after the support is broken. The chart above is a good example of such.

Yesterday’s action should serve as a warning sign to the bulls. Granted, the actual losses were rather moderate, but the bigger picture is that stocks fell on higher volume after three straight days of gains on declining volume. Remember that volume is the one technical indicator that never lies or gives false readings because it shows what is really happening “under the hood” of the market. The market recovered significantly off its lows in the afternoon, but this type of intraday action at the top of an extended rally is a sign that the bears are testing the water because the bulls are getting tired. Like we said two days ago, our near-term bias remains neutral to bearish, although the charts continue to look bullish for the intermediate-term trends. Keep those trailing stops in place and remember to trade what you see, not what you think!

Today’s Watchlist:

There are no new plays for today. We are stalking a few ETFs for potential entry on the long side, but we first want to see how the market reacts to yesterday’s correction. Short setups will not really present themselves unless the market drops a little more, then rallies into resistance. For now, most short setups do not provide a very positive risk/reward ratio. If, however, we enter anything intraday, we will promptly notify you via intraday e-mail alert.

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 = ($112)

Closed positions (since last report):

net P/L = + $495

UTH short (300 shares from September 28 entry) –
sold short 124.62, covered 126.29, points = (1.67), net P/L = ($507)

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

$25,600

Notes:

MTG Opening Gap Rules

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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