The Wagner Daily | October 27, 2006

Commentary:

Stocks shook off early weakness yesterday morning to finish with another session of gains across the board. After beginning the day with an opening gap up, stocks trended lower throughout the first ninety minutes, but the bulls seized control at mid-day, sending the market higher in the afternoon. Strength in the biotech and internet sectors helped the Nasdaq Composite show relative strength for a change. The Nasdaq rallied 1.0%, double the 0.5% gain of the S&P 500. The Dow Jones Industrials ticked only 0.2% higher, but the small-cap Russell 2000 and S&P Midcap 400 advanced by 1.2% and 0.9% respectively. Each of the major indices finished at their intraday highs, a sign of institutional support into the close.

Total volume in the Nasdaq increased by 11% yesterday, enabling the index to register its second straight “accumulation day.” Volume in the NYSE was 5% lighter than the previous day, but still well above its 50-day average level. The gains on higher volume confirmed the relative strength in the Nasdaq, whereas the tapering of turnover in the NYSE matched the more subdued action in the S&P and Dow. Market internals were firm in both exchanges. Advancing volume exceeded declining volume by a margin of 2 to 1 in both the NYSE and Nasdaq.

Our long position in the Oil Service HOLDR (OIH) continued to move higher yesterday and is now showing a gain of 6.5 points. The long position in the StreetTRACKS Gold Trust (GLD) also moved further into positive territory, but we stopped out of the iShares Russell 2000 (IWM) when it rallied above the high of its consolidation. We initially sold short IWM when it broke support of its hourly uptrend line on October 24, but it promptly snapped back above it the following day. We also made a decision to close the position in the StreetTRACKS Capital Markets (KCE) ahead of its original stop.

The Biotech Index ($BTK), which began a steady uptrend about a month ago, zoomed 2.9% higher and closed at a fresh multi-year high for the first time since February of 2006. The last time the index closed above its current level of 756 was way back in November of 2000. The $BTK index is now only 7% below its all-time high, but there has been quite a bit of divergence between the various Biotech ETFs. The biotech sector is showing more strength than the tech stocks lately and is clearly a good place to be positioned, but it’s important to make sure you are in the ETFs with the most relative strength. Vastly different percentage weightings in the leading biotech stocks has caused major price divergence within the different families of Biotech ETFs. There are presently five different biotech ETFs, but how is one to know which is the best one to buy? The answer lies in using a special kind of chart known as a “percentage change chart.”

Rather than charting the price of a stock or ETF, a “percentage change chart” simply shows the percentage that an equity has gained or lost within a certain period of time. When overlayed with more than one ticker symbol on the same chart, it becomes a great way to quickly and easily compare the relative strength of several different equities. In the chart below, we took all five biotech ETFs and overlayed them with the actual $BTK index. The percentage gains are measured since the close of trading on September 22, as the following session is when the current uptrend began. Match up each line with the color-coded legend on the top left side of the chart in order to see which ETFs have shown the most relative strength over the past month:

As you can see, the actual $BTK index (the thick black line) has gained 16% since September 22. Therefore, if looking to buy one of the biotech ETFs, we ideally would want to buy one that has gained more than the index itself. Curiously, only one ETF, the First Trust Biotech (FBT) has outperformed the index by gaining 16.5%. Relatively close behind is the PowerShares Dynamic Biotech (PBE), which has gained 14.3% over the past month. Curiously, the most popular biotech ETF, the Biotech HOLDR (BBH), has been showing the most relative weakness. While the $BTK index has gained 16%, BBH has rallied only 7.8% during the same period. This is largely due to disproportionate weightings in a few big biotechs like Genentech (DNA) that have lagged the market. The chart above proves that the most well-known ETFs within a particular sector are not necessarily the best ones to buy.

I will conclude with one more important thought about the chart above. It’s a simple premise, but one that most new traders ignore. . . Buy the leaders, not the laggards! When I was a novice sector trader years ago, I often made the expensive mistake of buying the stocks that were lagging behind others in the sector. My thought process was that the leaders had already gained too much, so the laggards were bound to “catch up” to the leaders. While this is a logical theory, I learned the hard way that it rarely works that way. Time and time again, I watched my laggard stocks go nowhere, while the stocks that were “already up too much” continued to surge higher. Simply put, stocks or ETFs showing relative weakness within a sector do so for a good reason — traders and investors are not buying them. The reason they are weak does not matter! All that matters is the price action (and volume). Stocks and ETFs with relative strength are not only the first ones to shoot to new highs when the corresponding sector index bounces just a little, but they are also the last ones to fall if the broad market suddenly reverses to the downside. Given how extended the broad market is right now, buying only the ETFs with relative strength to the overall stock market is crucial.

Today’s Watchlist:

There are no new setups today. While there are tons of ETFs that have broken out of bases to new highs, most remain too extended in order to have a good risk/reward for long entry here. We are already positioned in two of the best ETFs (OIH and GLD) because they are showing relative strength AND move largely independently of the stock market. Admittedly, we have missed decent rallies in some of the other sectors, but chasing a big move at this stage would be quite risky and amateur-like. Instead, we will patiently wait for pullbacks in some of these strong sectors and focus on managing the two open positions we have. We’re also keeping an eye on the Semiconductor Index ($SOX) to see if it holds its reversal attempt. If not, the Semiconductor HOLDR (SMH) may present a short selling opportunity.

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 = + $973

GLD long (200 shares from October 25 entry) –
bought 58.33, stop 55.41, target 66.10, unrealized points = + 0.96, unrealized P/L = + $192

Closed positions (since last report):

net P/L = ($588)

KCE short (400 shares from October 17 entry) –
sold short 63.72 (avg.), covered 64.69, points = (0.97), unrealized P/L = ($396)

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

$32,579

Notes:

remember that we have a trigger to add 200 more shares of GLD above 59.77.

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Edited by Deron Wagner,
MTG Founder and
Head Trader