The Wagner Daily | October 25, 2006

Commentary:

The divergence between the major indices continued yesterday, as the market posted mixed results. With little action ahead of today’s Fed meeting on interest rates, the S&P 500 oscillated in a narrow, sideways range and finished unchanged. The Dow followed a similar intraday pattern, but eked out a 0.1% gain. The S&P Midcap 400 outperformed by closing 0.3% higher, but the small-cap Russell 2000 lost 0.1%. The most volatility was found in the Nasdaq Composite, where weakness in the closely-watched Semiconductor Index ($SOX) dragged the tech-heavy index down to a 0.5% loss.

Total volume in the Nasdaq rose by 5% yesterday, causing the index to register its third “distribution day” within the past four weeks. Volume in the NYSE was 10% higher than the previous day’s level, but a flat close enabled the S&P means institutional selling was kept at bay. After three straight sessions of gains on declining volume, it was not surprising that turnover in the Nasdaq picked up on the first “down” day. While the price to volume relationship in the S&P has been relatively healthy all week, the Nasdaq’s last four sessions have consisted of one day of higher volume selling and three days of lower volume gains. Obviously, this is opposite of the pattern we want to see in a strong market. Like the closing prices, market internals were mixed as well. In the Nasdaq, declining volume exceeded advancing volume by a margin of 2.3 to 1, but the NYSE ratio was positive by just under 3 to 2.

The $SOX index shed 1.1% yesterday and closed right at its pivotal 444 level that we have discussed over the past several days. It’s still holding on to support, but a firm close below 444 would likely have a detrimental effect on the broad market, even the seemingly unstoppable Dow. As you can see, the Nasdaq will break support of its prior low if it loses any further ground in today’s session:

The industry sector with the largest gain yesterday was the Oil Service Index ($OSX), which rocketed 3.3% higher. After a shakeout attempt the previous day, the $OSX roared back to life, closing at its highest level since September 7. Our long position in the Oil Service HOLDR (OIH), which we bought on October 19, popped nearly 5 points (3.8%) as well. As you may recall, we bought OIH when it broke out above resistance of its five-month downtrend line. Again, we are not expecting OIH to rally all the way back to its 52-week high, but are simply playing the upside momentum that typically occurs from the break of a multi-month trendline. Our OIH price target remains the same, near resistance of the 200-day moving average at the $142 level.

Two days ago, we illustrated how the StreetTRACKS Gold Trust (GLD) was nearing triple resistance of its 50-MA, 200-MA, and primary downtrend line. Such convergence is powerful resistance, but we felt the recent undercut of its prior low and subsequent reversal back to the prior high was indicative of the ETF putting in a bottom. GLD lost 1.9% on October 23, but yesterday’s price action was quite bullish. GLD gapped another 1.6% lower on yesterday’s open, but immediately snapped back and began rallying intraday. By mid-day, GLD had recovered back to the previous day’s high, which it probed above in the final fifteen minutes of trading. GLD closed only 0.7% higher yesterday, but we really liked the intraday pattern. More importantly, we noticed that GLD is now forming an inverse “head and shoulders” pattern on its daily chart. While the regular “head and shoulders” pattern is bearish and often indicative of a top, the inverse “head and shoulders” is bullish and often corresponds with a stock or ETF putting in a bottom. On the chart of GLD below, we have illustrated the inverse “head and shoulders” (moving averages removed so you can more easily see the chart pattern):

Just as we often initiate short positions on the right shoulder of a regular “head and shoulders” pattern, we like the idea of buying GLD while it is forming its right shoulder of the inverse “head and shoulders.” If you want to play it more conservative, consider waiting for a breakout above the “neckline” of the pattern, which would also correlate to a breakout above the 50 and 200-day moving averages as well. The only negative of waiting for such an entry price is that the risk/reward of the trade is greatly reduced. Being that GLD is directly tied to the price of the spot gold commodity, large overnight gaps above key resistance levels are another strong possibility. Perhaps the best method of entry overall is to “scale in” to the trade by initiating a partial position near its current price level, then add to it on a confirmed breakout above the “neckline.” Regardless of where you may enter the trade, be sure to keep a protective stop just below the top of the “head” (the 55.50 area). Keeping it even tighter is not a bad idea, just as long as you are willing and able to promptly re-enter if necessary.

Remember that the Federal Reserve Board meets this afternoon to discuss interest rates. The firm consensus is that rates will remain unchanged, but, as always, it’s the accompanying comments that the market will react to. Take it easy with new position entries ahead of the 2:15 pm EDT announcement, and be prepared for the usual post-Fed volatility.

Today’s Watchlist:

GLD – StreetTRACKS Gold Trust
Long

Trigger = HALF above 58.32, HALF above 59.77
Target = 66.10 (just below resistance of July 14 high)
Stop = 55.41 (first half) and 57.70 (second half)
Shares = 400 total

Notes = See commentary above for explanation of the setup, as we are playing the inverse “head and shoulders” chart pattern. Regarding entry, we will buy only HALF of the position (200 shares) above the two-day high at 58.32. If GLD confirms the pattern by breaking out above the October 19 high, we will buy the second half of the position over 59.77. “Scaling in” reduces our risk exposure, but enables us to have a positive risk/reward ratio on the first entry. Note that the stop prices are also scaled, with the stop on the first half at 55.41 and the second half, if it triggers, at 57.70. After the second half of the position triggers, we will also raise the initial stop on the first half of the position, thereby keeping our maximum capital risk consistent with other positions.

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 = + $428

IWM short (400 shares from October 24 entry) –
sold short 75.39, stop 76.78, target 72.04, unrealized points = (0.51), unrealized P/L = ($204)

KCE short (400 shares from October 17 entry) –
sold short 63.72 (avg.), stop 65.17, target 59.68, unrealized points = (0.73), unrealized P/L = ($292)

Closed positions (since last report):

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

$76,315

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