The Wagner Daily | November 1, 2006

Commentary:

As expected, stocks chopped around in an indecisive fashion on the last day of October before again closing near the flat line. After oscillating on both sides of unchanged throughout the session, the Nasdaq Composite gained 0.1%, the Dow Jones Industrial Average lost 0.1%, and the S&P 500 finished flat. Small and mid-caps showed relative weakness, as the Russell 2000 and S&P Midcap 400 indices both fell 0.5%. Each of the major indices closed near the middle of their intraday ranges, indicative of a tug-of-war between the bulls and bears.

Breaking the trend of declining volume in the previous two sessions, turnover surged higher across the board yesterday. Total volume in the NYSE spiked 23% higher than the previous day’s level, while volume in the Nasdaq increased by 13%. Given that the S&P, Nasdaq, and Dow were each within 0.1% of unchanged, yesterday’s higher volume pointed to a bit of “churning” beneath the surface. “Churning” occurs when overall volume increases substantially, but prices don’t. If this occurs near the lower channel of a downtrend, it is often bullish because it indicates institutions are scooping up shares while the bears are trying to drive stocks lower. Conversely, “churning” near the upper channel of an uptrend is usually a bearish sign of institutional selling into strength. This, of course, doesn’t necessarily mean that stocks will suddenly fall from here, but astute traders should proceed on the long side with caution in the short-term.

Upon observing yesterday’s intraday price action of the Oil Service HOLDR (OIH), we noticed a technical event that would provide a good mini-lesson in today’s commentary. When trading stocks or ETFs with an expected holding time of one to three weeks, we like to use the 120-minute chart interval for setting stops. Specifically, one of the simplest and effective methods is to simply draw a trendline connecting the lows (for an uptrend) or highs (for a downtrend) over a period of weeks. One can then trail a stop just below or above support of said trendline. On the surface, this is a basic technical analysis concept that you may already know, but the important detail that most traders miss is the “wiggle room” required in order to withstand the inevitable “stop hunts” below the trendline.

Throughout my early years of being a novice trader, one of the biggest problems I had was being stopped out of a stock, only to watch it reverse back in the right direction only pennies below my stop. Eventually, I figured out why this was happening. The problem was that I was placing my stops at the same level as all the other traders. My stop was too obvious! Because specialists and market makers knew where the majority of stops were residing, they were making sure that every test of trendline support resulted in a quick probe below those stops. Then, they could accumulate shares of the stock before continuing the primary trend. After years of frustration from losing money in this manner, I learned to give my stops enough “wiggle room” below the obvious trendline support where all the other traders had placed their stops. Years later, I now know my stops are in the right place when the position I am in reverses just before hitting my stop. This is exactly what happened in OIH yesterday:

When we originally bought OIH as it broke out above the 50-day MA on October 19, our original stop was 126.58. On October 26, after OIH had rallied to an unrealized gain of six points, we moved the stop up to break-even (131.65) in order to remove all the risk from the trade. Our mistake in doing so, however, was that we initially failed to realize that a break-even stop of 131.65 coincided exactly with support of the hourly uptrend line that had formed. So, on October 30 we sent an intraday e-mail alert to subscribers, informing them that we were adjusting our stop a bit lower, down to 130.30, because we needed to give OIH a bit of “wiggle room” below the trendline support. As you can see, it’s a good thing we did because OIH dipped below trendline support yesterday, just missed our adjusted stop of 130.30, then reversed sharply higher into the close. Assuming the uptrend continues, OIH should now go on to form another “higher high” above the October 26 high.

Lowering a protective stop on a long position is usually not a very good idea, but it’s something that we do a few times per year. When we realize we have made a mistake by placing too tight of a stop, we have no problem with giving the ETF a little more “wiggle room” that a slightly looser stop affords, just as long as our maximum capital risk per trade is not violated. Because we had already raised the stop up to breakeven, lowering it slightly below that level meant that our maximum capital risk was still minimal if we stopped out. If you’re a trend trader, an easy rule of thumb in setting stops is to ask yourself, “Is my stop placement too obvious?” If it is, you can be assured that you will be stopped out, only to watch the stock or ETF reverse back in the right direction. It’s always better to have smaller share size and the proper stop, rather than trying to hit a homerun with large share size, but being required to have a really tight stop in order to do so.

As for the broad market, we expect more chop and indecision in the coming days. After drifting down towards the middle of their uptrend channels, we can no longer say that the major indices are “overbought,” but this does not mean they can’t continue to correct. Remember that the 20-day MA is the first significant support level for the S&P, Nasdaq, and Dow, so there’s a good chance the indices will at least test that level before staging their next rally attempt to the upside. Sectors with relative strength that trade independently of the broad market, such as Gold and Oil, are probably your best bets for now. Most of the currency ETFs that we discussed in yesterday’s newsletter also moved higher and are breaking out or about to break out soon (such as FXE).

Today’s Watchlist:

There are no new setups today. As always, we will send an intraday e-mail alert if/when we enter any new 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 = + $416

OIH long (150 shares from October 19 entry) –
bought 131.65, stop 130.30, target 142.30, unrealized points = + 2.35, unrealized P/L = + $353

SMH short (500 shares from October 27 entry) –
sold short 33.91, stop 35.06, target 30.60, unrealized points = (0.09), unrealized P/L = ($45)

Closed positions (since last report):

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

$61,196

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